Tuesday, March 22, 2022

SEC climate update

Three additional thoughts on climate financial regulation, building on the last post about the SEC  

1) A big question about SEC and related regulation. May the SEC regulate only on financial issues, i.e. "materiality," or may it regulate with larger social, economic, or political objectives in mind? 

The big squeeze now is to squeeze the latter in to the former. Disclose that the company doing something unpopular, even if it may have no financial effect, because someone might decide they don't like it -- either the twitter mob or future regulators -- and cause you trouble. (I am deliberately not using legalize here.) The carbon rules are not entirely new ground here, but so deep into that territory that the question is now loud and clear. 

2) "Disclosure" usually means revealing something you know. A perfectly honest answer to "disclose what you know about your carbon emissions" is, "we have no idea what our carbon emissions are." Back that up with every document the company has ever produced, and you have perfectly "disclosed." There is no asymmetric information, fraud, etc. 

The SEC has already required the production of new information, and as Hester Peirce makes perfectly clear, the climate rules again make a huge dinner out of that appetizer: essentially telling companies to hire a huge number of climate consultants to generate new information, and also how to run businesses.  

The fixed costs alone are huge. The trend to going private and abandoning public markets, at least in the U.S. will continue. The trend to large oligopolized politically compliant static businesses in the U.S. will continue. 

I would bet these rules wind up in court, and that these are important issues. They should be. 

3)  The SEC's timing relative to Russian sanctions makes an interesting one-two punch, as Walter Russell Mead points out. Suppose you're Brazil. Hmm. When will the U.S. decide to impose financial sanctions on Brazil for not following our ideas of climate policy, or the SG (social, governance) part of ESG? Maybe we should find alternative financial channels, pronto.  


  1. I'm yet to read the 500 page PDF, but am curious, do Scope 3 disclosures include the greenhouse gas emissions from employees? Like, hiring someone with a longer commute may result in higher emissions reported, underuse of work from home policies, or even use of labor in high emissions markets (USA) vs low emissions (take your pick of developing countries).
    If not, it creates a disadvantage from employing Capital vs Labor - if energy use on servers/forklifts/conveyor belts must be captured, this then creates a disincentive to employing such labor saving technologies if you're not capturing the carbon "savings" from not needing people to perform the procedures anymore. Another nudge against productivity growth.

    1. They do ask that commute emissions be included in Scope 3. This is inconsistent with other federal policy like the inability to deduct commute times as a business expense. Ultimately commute distances are a lifestyle choice. Strangely they don't ask about employees' other lifestyle choices. Like I'm sure the senior management take much more lavish vacations to Europe and Asia using company provided compensation. They also don't seem to demand tracking of the carbon emissions associated with employees' respiration or digestion which I find equally peculiar. Surely labor intensive industries are worse respiratory polluters and that needs to be disclosed! And are the companies optimally incenting their employees to sufficiently optimize their diets to limit digestive pollution?

    2. The thing that’s bizarre to me is that there are far worse environmental impacts from companies other than CO2. Those disclosures never show up at all in public filings and aren't mandated by the SEC either before or as part of these newly proposed rules. There’s no NOX emission disclosure requirement as an example. The difference is that really harmful emissions are highly regulated under authority of the EPA as authorized by Congress. The EPA doesn’t have the legal authority to regulate CO2 because it was never deemed sufficiently harmful by Congress to regulate. But that’s an unsatisfying position for the Greens which are now desperate to impose backdoor regulation through any other instrument of federal authority no matter how strained. Recent jurisprudence and the unchecked expansion of SEC dominion has been a big problem for a while, but if this continues along the SEC will likely be the most powerful federal agency in government with the ability to regulate near any tangentially commercial activity.

    3. Yes, the lifestyle choices were mostly what I was thinking of when raising the possibility of hiring people in high emissions localities vs low emissions. And ignoring respiration/digestion would fall into the same problem area of disadvantaging capital investment over employing labor: more machines = less food

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  3. OT, but maybe worth pondering as a similar type of over-reach.

    "ARLINGTON, Va. -- The Securities and Exchange Commission on Friday approved Nasdaq's groundbreaking proposal to boost the number of women, racial minorities and LGBTQ people on U.S. corporate boards.

    The new policy — the first of its kind for a U.S. securities exchange — requires most of the nearly 3,000 companies listed on Nasdaq to have at least one woman on their board of directors, along with one person from a racial minority or who identifies as gay, lesbian, bisexual, transgender or queer. It also requires companies to publicly disclose statistics on the demographic composition of their boards."


    There are lot of reasons to feel uncertain about this Nasdaq rule. Including...do we want to get into people's private sex lives?

  4. "Hmm. When will the U.S. decide to impose financial sanctions on Brazil for not following our ideas of climate policy, or the SG (social, governance) part of ESG?"

    Financial sanctions, if used indiscriminantly by the U.S., will simply serve to accelerate the trend to stop using the U.S. dollar for international trade payments.

    We are seeing Saudi Arabia toy with the idea of trading its crude oil to China in exchange for Yuan ("CNY", to use Niel Fergusson's terminology). Russia has announced that purchases of Russia's exports of crude oil and natural gas to Europe must be paid for with Russian roubles ("RUR"). Saudi Arabia is believed to be prepared to exchange Yuan for Chinese armanents and other engineered commodities. Doing so will set up a two-way exchange that avoids U.S. financial markets, and the U.S. dollar (i.e., U.S. sanctions and extra-territorial U.S. laws). Russia's decision to force importers to pay for its exports in RUR is designed to avoid sanctions in the financial markets imposed by the U.K. and threatened by the U.S., and to boost the demand (price) of the RUR on world currency markets. There is doubt that the gambit will work for Russia, but the chances are greater for use of the Yuan in international trade if the Yuan becomes freely convertible.

    If the U.S. dollar loses its 'reserve currency' status, the U.S. will be forced to a make major shift in its economy in order to earn the foreign currency that it will need to pay for its imports of commondities from the rest of the world. Not a highly likely scenario, but not a trivially unlikely one, as the past experience of the U.K. demonstrates.

  5. "A big question about SEC and related regulation. May the SEC regulate only on financial issues, i.e. "materiality," or may it regulate with larger social, economic, or political objectives in mind?"

    We can ask that of any regulatory agency. Talk about marching through the institutions! The neo-marxists and their opportunist fellow-travelers have very nearly won.

  6. One interesting aspect of the proposed rules is the definition of "long term" in relation to the Scope 1, 2, and 3 disclosures, specifically in terms of “materiality”. James K. Galbraith and Wm. Darity, Jr., writing in their textbook "Macroeconomics", Boston, Houghton Mifflin Co., 1994, p. 52, concerning John Maynard Keynes's view of uncertainty, state, "He did not view the type of uncertainty that affects economic decisions as probabilistic in a quantifiable sense. It is not a mere lottery. It is not the type of uncertainty that is subject to calculable gambles." Galbraith and Darity then quote Keynes (1937),

    ''By "uncertain" knowledge... I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealthonwners [sic.] in the social system of 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.'' Citation: J. M. Keynes, "The General Theory of Employment", Qtrly. J. of Econ., Vol. 52 Feb. 1937, p. 214.

    "Materiality", in a financial reporting context, such as the proposed S.E.C. rules, concerns the impact of a current or future event on the cashflow of a registered entity that would bear on the decision of an investor or creditor to invest in the securities of the registrant or to extend or retract credit facilities to or from the registrant. If the event is expected to have no effect on the decision of the investor or the creditor, then the event is not considered to be material. Keynes's definition of "uncertainty" (i.e., an event not capable of a calculable probability) puts the concept of "materiality" to the test. What is the "materiality" of an event, such as climate change, in a long-term time frame if the event is "uncertain", in Keynes's sense of that term.

    In the present version of the proposed rules, the use of scenarios by the registrant is envisioned, but the description of the framework around the use of scenarios is omitted, and the definition of "short term", "medium term", and "long term" is left open for discussion. Without specifying scenarios, the S.E.C. commissioners have blunted the effect of the rules through the action of the criterion of "materiality" amid Keynesian "uncertainty" over those future events that the commissioners evidently wish to warn investors and creditors against bearing.

    As you point out in your article, it would appear that the three commissioners who voted for the proposed rules believe that the definition of "materiality" must be stretched to include events that are "uncertain" in Keynes's sense of '"uncertain" knowledge' described in the passages quoted above.

    Can there be any doubt that the three commissioners who voted for adoption of the proposed rules intend that those rules will be used to (indirectly) transform the financial markets to the detriment of listed entities that have operations which are not "sustainable" viz. the hypotheses of climate change?

    This is what comes of a regulatory state that is not neutral towards the outcomes resulting from the states' regulation of private initiatives.

  7. ps. "Uncertain" knowledge is not limited to the distant future. Governments in Europe and North America are facing a present danger that can best be described by Keynes's "uncertain" knowledge viz. the path-wise evolution of the Russian aggression against the free state of Ukraine and the chimera of Mr. Putin's obsessions of recreating the realm of former Imperial Russia in Europe.

  8. Two articles appearing in separate editions of The Wall Street Journal on Taskforce on Nature-Related Financial Disclosures ("TNFD") illuminate the uncertainty around disclosure of impacts on the natural environment of multi-national companies' operations.

    The TNFD framework remains a work-in-progress. The articles (URLs below; behind a 'pay-wall') give an indication of both the state of the disclosure standards (fluid) and what two proponents think of the process required to develop the standards and what the standards are intended to achieve.

    Needless to say, but if reduced impacts on the natural world is the goal of TNFD then the organizations causing negative externalities must cease their operations, or, if that is not possible, then to retrench their operations and stop all growth that contributes to those negative externalities. As an alternative, the negative externalities require compensation be paid to those individuals or societies that are directly or indirectly affected by those negative externalities. A Pigouvian tax is one method of compensation for the negative externalities (similar to a tax levy on GHG emissions). For TNFD the focus is on driving financing away such entities in order to raise the cost of capital of those entities and, thereby, to put those entities out of business or to curtail their operations. In the context of the S.E.C., the proposed disclosure rules are intended to have the same effect--raise the cost of capital for those entities by warning financial institutions away, and thereby curtail those entities' operations and growth.

    The S.E.C. proposed disclosure rules and the TNFD and Task Force on Climate-Related Financial Disclosures frameworks rely on decisions by investors and creditors (present and future) to achieve a balance between the marginal net social costs of the multi-nationals’ operations, and the marginal net private benefits derived from those operations. As with ESG rankings, the outcome is dependent on the selected characteristics chosen for disclosure and the congruity of those characteristics with the marginal net social costs (i.e., net negative externalities). One might ask: “What is the likelihood of congruency being attained?”

    https://www.wsj.com/articles/disclosures-on-nature-climate-go-hand-in-hand-nestle-risk-chief-says-11648116000?mod=hp_minor_pos18 [March 24, 2022]

    https://www.wsj.com/articles/quantifying-companies-impact-on-forests-oceans-is-a-challenge-11647349201?mod=article_inline [March 15, 2022]


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