Liability for sustainability disclosures under the FIEA

Anderson Mori & Tomotsune, one of Japan's leading law firms, has published a newsletter discussing the application of disclosure liability under the Financial Instruments and Exchange Act (FIEA) concerning sustainability disclosures, particularly Scope 3 greenhouse gas emissions, and the introduction of a new safe harbor provision.

Introduction

Sustainability disclosures are gaining global momentum, with Europe leading the charge in their implementation, expansion of scope, and enhancement of content. The International Sustainability Standards Board (ISSB) has finalized the ISSB Standards, comprising general disclosure requirements (IFRS S1) and climate-related disclosure standards (IFRS S2). These standards serve as a foundation for countries to integrate them into their own disclosure systems.

In Japan, the Sustainability Standards Board of Japan (SSBJ) is developing specific disclosure standards (SSBJ Standards) under the Japanese disclosure system. Concurrently, the Financial Services Agency's Financial Council has established a working group (WG) to discuss disclosure and assurance of sustainability information, aiming to provide investors with reliable information necessary for evaluating long-term corporate value and engaging in constructive dialogue.

The newsletter focuses on the new safe harbor provision being discussed, which addresses potential issues arising from the expanded scope of sustainability disclosures, particularly concerning the FIEA's disclosure liability.

Current State and Future of Sustainability Disclosure in Japan

In response to increasing demands for sustainability disclosures, revisions to the Corporate Affairs Disclosure Ordinance introduced a new section for disclosing "Approaches and Initiatives Related to Sustainability" in annual securities reports starting from the fiscal year ending March 2023.

However, the current ordinance primarily outlines a broad framework for disclosure, including governance, strategy, risk management, indicators, and targets, without specifying detailed criteria. While listed companies, especially those in the Prime Market with global operations, are making efforts towards enhanced disclosure, there is a noticeable variation in the depth and focus of their disclosures.

The WG emphasizes the importance of aligning disclosures with international standards for comparability, both domestically and internationally, providing useful information to investors. The WG is discussing the mandatory disclosure of sustainability information based on the SSBJ Standards, potentially starting from the fiscal year ending March 2027, initially targeting large companies (likely Prime Market listed companies).

The draft SSBJ Standards cover a wide range of information, notably including the disclosure of Scope 3 greenhouse gas emissions under the climate-related disclosure standards. This presents challenges related to disclosure liability due to the reliance on data from third parties outside the reporting company's control, particularly within the value chain.

Historically, the FIEA's strict false disclosure regulations ensured that only highly reliable information was included in securities reports. However, with the introduction of risk information (MD&A), corporate governance disclosures, etc., the scope and volume of information subject to disclosure liability under the FIEA have significantly increased. The SSBJ Standards-based sustainability disclosures are expected to further this trend.

The existing safe harbor provisions under the FIEA, which focus on forward-looking information, are insufficient to address the new disclosure rules requiring the disclosure of actual figures with inherent uncertainties. The WG recognizes the need for a more comprehensive safe harbor to encourage proactive and appropriate disclosure by companies.

Scope 3 Greenhouse Gas Emissions

The ISSB and SSBJ standards categorize greenhouse gas emissions into Scope 1, 2, and 3. This classification considers all emissions related to a reporting company's business activities, not just its direct emissions.

• Scope 1: Direct emissions from sources owned or controlled by the reporting company (e.g., emissions from a company's factory using fossil fuels).
• Scope 2: Indirect emissions from the generation of purchased or acquired electricity, steam, heat, or cooling consumed by the reporting company (e.g., emissions from a power plant generating electricity used by the company).
• Scope 3: Indirect emissions (not included in Scope 2) that occur in the reporting company's value chain, including both upstream and downstream emissions (e.g., emissions from a car manufacturer's supply chain, including raw material procurement, transportation, consumer use, and end-of-life vehicle disposal).

The SSBJ draft standards specify two methods for measuring Scope 3 emissions: direct measurement and estimation. Direct measurement involves directly monitoring emissions, while estimation uses activity data (representing company activities resulting in emissions) and emission factors (coefficients to estimate emissions from activity data).

Since Scope 3 emissions cover the entire value chain, direct measurement is often difficult. The SSBJ draft assumes that estimation will be the primary method used in practice. This involves assumptions by the reporting company, such as transportation distances within the supply chain, and data collection from value chain partners, leading to inherent uncertainties in the measurement results.

Uncertainty in Measurement and Liability for False Statements

Under the FIEA, companies and their officers are subject to strict disclosure liability if a securities report contains false statements or omits material facts. This applies to Scope 3 disclosures, and if the disclosed emissions figures are inaccurate due to errors in assumptions or data from the value chain, and the error is material, it could constitute a false statement, leading to sanctions under the FIEA. The WG is concerned about this potential chilling effect on proactive and sufficient disclosure due to inherent uncertainties in Scope 3 data.

While Scope 3 disclosure is crucial for investors, particularly institutional investors, the inherent uncertainty in the information differs from traditional financial information. The WG discusses the need for a safe harbor for Scope 3 disclosures based on the following considerations:

• The safe harbor should be based on due process rather than outcome, focusing on whether reasonable efforts were made in the disclosure process.
• If a company can demonstrate reasonable internal consideration of the appropriateness of using third-party information and the rationality of estimations, and if the disclosure is within a generally reasonable range, it should not be held liable for false statements.

This approach shifts the focus from outcome liability to due process liability, similar to the business judgment rule in corporate law.

Conclusion

The safe harbor being discussed by the WG addresses the global need for Scope 3 disclosure while considering the FIEA's disclosure liability. It aims to prevent excessive caution by companies and encourage the provision of useful information to investors. It is important to note that this safe harbor is specific to Scope 3 disclosures and does not represent a general relaxation of standards for information disclosure based on third-party data. Thorough due diligence and validation of information remain crucial in other disclosure scenarios, such as equity story disclosures.

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