Corporate Governance

Shearman & Sterling LLP 13 | After Years of Debate, Climate Change Impact Reporting Gets Real 20th ANNIVERSARY OF CORPORATE GOVERNANCE REPORTING Financial Reporting and Estimates and Assumptions The proposed financial disclosure requirements necessitate the qualification of financial impacts from, or expenditures incurred in respect of, climate-related events and transition activities, but allocating impacts and spending according to a singular cause — namely whether or not it was climate-related — will be a challenge for many companies, and especially those who do not currently analyze financial data in this way. Quantifying how much of a change in contract price is as a result of climate-related impacts as compared to other market dynamics, or to what extent a particular capital allocation decision was driven by transition activities, will require the exercise of significant judgment and estimates by management. Under the Proposal, all financial disclosures will be subject to a company's internal control over financial reporting and audit procedures, making the corresponding audit process challenging and time consuming. TIMING AND POTENTIAL LITIGATION According to the SEC's regulatory agenda, the final rules on climate disclosure are scheduled for October 2022. Given the extension of the comment period, and subsequent and technical reopening of the comment period in October 2022, 2023 may be more likely, but in any event we should expect the SEC to do everything possible to publish final rules as soon as possible. Once published, there will be at least several months before they take effect, and there will almost certainly be significant phase-ins for some of the more onerous obligations for preparers. Regardless of when the rules take effect, there is the possibility that litigation will delay the implementation of the rules. A number of comment letters reflected the view that the Proposal exceeds the scope of the SEC's authority, and it is somewhat likely that, if the final rules reflect the requirements of the Proposal, one or more plaintiffs will sue to prevent the rules from taking effect, not unlike the efforts to delay implementation of the SEC rules on conflict minerals disclosure. Litigation could be brought on the basis of a number of theories, including that the Proposal violates the Administrative Procedures Act as arbitrary and capricious, violates the First Amendment by unconstitutionally compelling speech or exceeds the SEC's statutory authority. While it is difficult to say whether any of these suits will be brought or might succeed, there is the possibility of additional delays resulting from a legal challenge. SHAREHOLDER PROPOSALS Climate-related shareholder proposals have arrived in record numbers in 2022, driven in part by the SEC's shift of policy which limits a company's ability to exclude proposals. 2 This shift has fostered an environment for greater activism from shareholders and added proposals. As of July 2022, a record 941 shareholder proposals had been submitted, with a 46% increase in environmental proposals from the prior year. However, support for these proposals was more muted in 2022 than in the past. With the SEC allowing proposals that perhaps would not have survived a company's challenge for micromanagement in the past, a number of the climate-related shareholder proposals in 2022 were more prescriptive than in the past. This resulted in pushback from management and institutional investors alike, citing a lack of alignment with long-term shareholder value. For example, BlackRock reduced its support for ESG shareholder proposals by nearly half in 2022, voting for only 24% of them. Proposals related to specific company action, such as those calling for banks to withdraw from financing of fossil fuels, saw muted support among investors. As of July, nine proposals proposing a pullback from fossil fuels had gone to a vote, with a 100% failure rate and the highest level of support being only 19.4%. Additionally, a growing number of proposals specifically requested inclusion of Scope 3 emissions targets or strategies, of which a majority failed. 2 See U.S. Securities and Exchange Commission, "Shareholder Proposals: Staff Legal Bulletin No. 14L (CF)," https://www.sec.gov/ corpfin/staff-legal-bulletin-14l-shareholder-proposals (November 3, 2021).

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