IMPACT OF CLIMATE CHANGE
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Climate change is a topic of intense public discussion
among scientists, government leaders, legislators,
regulators, businesses, investors, analysts and
the public at large. In recent years, institutional
investors and social activists have called for the SEC
to require public companies to address the impact of
climate change on their businesses in their securities
filings. While a few companies have provided a limited
amount of climate change disclosure in the past,
the practice has not been widely adopted outside of
the energy industry and the level of disclosure has
been largely limited to compliance with environmental
regulation.
Electric utilities, as one of the most heavily regulated
economic sectors in America, are accustomed to
reporting the potential impact of regulatory decisions
on their investment and operations strategies.
However, utilities’ needs to upgrade infrastructure
and generation reserves now
stand to be affected by far more than state
utility commission rate decisions.
Climate change is at the center of the
American Clean Energy and Security Act
of 2009, which is now before the Senate
after having been passed by the House of
Representatives and which contains greenhouse
gas (GHG) reduction provisions and
mechanisms. |
Thomas P. Conaghan is a
partner in the Washington, DC
office of global law firm
McDermott Will & Emery and
is based in the Firm’s
Washington, D.C., office.
He represents both publicly held
and closely held businesses in a
wide range of securities law
matters.
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Moreover, whatever Congress does,
the Environmental Protection Agency
(EPA) has already implemented a GHG
reporting regime for utilities and many
other heavy emitters, and EPA’s recent
finding that GHGs threaten public health
and welfare is likely a prelude to even
more regulatory action. Government mandates
for meeting GHG reduction targets
will surely require additional capital investment
and the assumption of new technology
and regulatory risk.
The key question becomes: how
much of this risk must utilities assess and
report to investors through public securities
filings?
SEC GUIDANCE
Expanded GHG emission reporting
and compliance will have significant
impact on any company.
For those that are publicly held, on
February 12, 2010, the U.S. Securities and
Exchange Commission (SEC) released
interpretive guidance on the application of
existing SEC disclosure requirements to
climate change issues.
In her remarks, SEC Chairman Mary
Schapiro clarified that the SEC’s guidance
is intended to ensure that existing disclosure
rules are consistently applied by public
companies in a manner that provides
enhanced clarity to investors, and that the
interpretive guidance is not an attempt by
the SEC to weigh in on the existence or
potential causes of global warming, or to
amend well-defined SEC rules concerning
public company reporting obligations or
determinations of materiality.
The standard for determining the
materiality of information (including climate-related matters) under the federal
securities rules is whether there exists a
substantial likelihood that a reasonable
investor would consider the information
important in deciding how to vote or make
an investment decision.
This standard does not take into
account subjective sensitivities that certain
investors have to issues such as climate change.
With respect to contingent or speculative
information or events (such as pending
legislation), materiality depends at any
given time upon a balancing of both the
probability that the event will occur and the anticipated magnitude of the event in
light of the totality of the company activity.
The SEC's interpretative guidance
highlight the following four areas as examples
where climate change may trigger
disclosure requirements in a company's
risk factors, business description, legal
proceedings, and management discussion
and analysis:
IMPACT OF LEGISLATION AND
REGULATION
With respect to existing federal, state
and local laws which relate to greenhouse
gas emissions, companies should disclose
any material estimated capital expenditures
for environmental control facilities as
part of an assessment of whether any
enacted climate change legislation or regulation
is reasonably likely to have a material
effect on the registrant’s financial condition
or results of operation.
The Release emphasizes that companies
other than those in industries traditionally
considered to be most at risk by
“cap and trade” and greenhouse gas legislation
(e.g., electricity, oil and gas, and
heavy manufacturing) need to consider
how they might be affected indirectly by
potential legislation and regulation.
INTERNATIONAL ACCORDS
Companies should consider, and disclose
when material, the impact on their
business of treaties or international
accords relating to climate change, such
as the Kyoto Protocol, the EU Emission
Trading System (ETS) and other international
activities in connection with climate
change remediation.
INDIRECT CONSEQUENCES OF
REGULATION OR BUSINESS TRENDS
Legal, technological, political and scientific
developments regarding climate
change may create new opportunities or
risks for companies, either by creating
demand for new products and services or
reducing demand for existing ones.
Companies should be prepared to
assess and disclose the impact of both,
whether it involves increased demand for
“green” products and renewable energy
output, or decreased demand for goods
that produce significant GHGs.
PHYSICAL IMPACTS OF CLIMATE
CHANGE
Climate change itself can have a
material effect on a company’s business
and operations through impact on personnel,
physical assets, supply chains and distribution
chains.
This can include the impact of
changes in weather patterns (such as
increases in storm intensity, rising sea levels,
and temperature extremes), changes
in the availability or cost of natural
resources, or increased insurance risk from extreme weather.
Companies whose businesses may
be vulnerable to such events should consider
whether they constitute material
risks and require disclosure.
MANAGEMENT ASSESSMENT
Although the SEC Release was met
with criticism from those who feel that the
agency should not be inserting itself into a
sensitive scientific and social debate, the
release itself does not create any new disclosure
requirements.
Instead, it merely reflects the SEC’s
position that the federal securities laws
only require disclosure of information that
is “material” to investors (all investors,
that is, not just the socially minded) and
that current disclosure requirements
already provide a basis for disclosures
related to climate change, to the extent the
requisite materiality standards are met.
For most utilities, the materiality
standard discussed previously will have its
greatest impact in the Management
Discussion & Analysis (MD&A) section of
the Form 10-K annual report. There management
must identify and disclose known
trends, events, demands, commitments
and uncertainties that are “reasonably likely”
(a lower disclosure standard than
“more likely than not”) to have a material
effect on the company’s financial condition
or operating performance.
If management determines reasonable
likelihood, disclosure is required
unless management determines that the
occurrence would not have a material
impact on financial condition or operations.
Here are two examples of real-world
events related to climate change that could
fall under the materiality standard,
depending on utility management’s evaluation:
LITIGATION
Climate change is a subject ripe for
litigation in ways that could directly impact
electric utilities. Consider the reporting
implications of a recent case that could
have direct impact on utility operations.
In 2009, the US Court of Appeals for
the Second Circuit, ruling in Connecticut
v. American Electric Power, potentially
opened the way for claims in tort for the
abatement of greenhouse gas emissions as
a public nuisance under Federal or State
laws.
A lower court had considered GHG
regulation to be a political issue for the
executive and legislative branches, but the
Second Circuit said GHG regulation has
not advanced sufficiently to displace the
federal common law of nuisance under
which pollutants can be regulated.
The fact that a major electric utility
was the defendant in the lawsuit is all the
more reason to ask whether the court
decision poses a material risk.
TAXATION
In February 2010, President Obama
released his proposal for the 2011 federal
budget. It proposes to phase out subsidies
for fossil fuels that are provided under the
Internal Revenue Code, and a number of
tax preferences available for coal activities
are proposed for repeal in the budget,
which would have a direct impact on any
electric utility.
These include the expensing of
exploration and development costs, the
percentage depletion for hard mineral fossil
fuels, and the ability to claim the
domestic manufacturing deduction against
income derived from the production of
coal and other hard mineral fossil fuels.
At the same time the budget proposal
more than doubles the 2009 cap on the
aggregate amount of tax credits made
available in the American Recovery and
Reinvestment Act for qualifying renewable
energy projects – a definite plus for cogeneration
and other renewable energy producers.
Is one tax provision a material
risk and the other a material advantage?
The question is there for each utility
to decide.
CAREFUL CONSIDERATION
Clearly, whatever risk factor disclosure
is made, should state the risk and
specify how the particular risk affects each
specific company (rather than boilerplate
disclosures applicable to all companies).
Given this caveat, some commentators
have suggested that the new SEC guidance
is a signal that the SEC intends to
scrutinize compliance with existing disclosure
rules, and that the Release will serve
as the basis for SEC comments issued to
companies questioning the adequacy of
companies’ climate-related disclosures in
their SEC filings.
If that is the case, particularly legislation,
regulation and court decisions continue
to advance GHG regulation, public utilities
are well advised to carefully consider
these matters and update their disclosures
to reduce the likelihood of receiving such
a comment from the SEC.
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