On March 6, the Securities and Exchange Commission (SEC) finalized two significant rules: Disclosure of Order Execution Information and Enhancement and Standardization of Climate-Related Disclosures for Investors.
605 Rule:
The SEC adopted a rule that would update the disclosures required under Rule 605 of Reg NMS for order executions in stocks listed on national securities exchanges. The rule, the first and least impactful of the four changes to equity market structure the SEC has proposed under Chairman Gensler, was approved by a unanimous vote and faces less opposition from Republicans than other equity market structure rules.
The amendments:
· Expand the definition of “covered order” to include certain orders submitted outside of regular trading hours, certain orders submitted with stop prices, and non-exempt short sale orders;
· Modify the existing order size categories to base them on both notional dollar value and whether an order is for a fractional share, for an odd-lot, or for a round lot or greater rather than number of shares;
· Establish four new order type categories: marketable immediate-or-cancel orders, market orders submitted with stop prices, marketable limit orders submitted with stop prices, and non-marketable limit orders submitted with stop prices; and
· Replace three existing categories of non-marketable order types with four new categories of order types: midpoint-or-better limit orders, midpoint-or-better immediate-or-cancel orders, non-marketable limit orders, and non-marketable immediate-or-cancel orders. The amendments also scope in non-marketable orders and orders submitted with stop prices if they become executable during regular trading hours.
605 reports are also amended as follows:
· The time-to-execution reporting categories will be modified to use more granular time-to-execution buckets with timestamp conventions of a millisecond or finer;
· Realized spread statistics will be required to be calculated using additional time horizons ranging from less than 100 microseconds to 5 minutes after the time of order receipt; and
· New statistical measures of execution quality will be required, including:
o Average effective divided by average quoted spread (a percentage-based metric that represents how much price improvement an order received);
o Percentage-based effective and realized spread statistics that complement certain dollar-based statistics;
o A size improvement benchmark that could be used to calculate whether orders received an execution of more than the displayed size at the quote;
o A size improvement statistic that indicates the amount of size improvement in those instances in which an order could have received size improvement;
o Certain statistical measures that could be used to measure execution quality of non-marketable orders; and
o Additional price improvement statistics for market and marketable orders showing price improvement relative to the best available displayed price in the market, which could be a displayed odd-lot price.
Chairman Gary Gensler said, “[This rule] will improve transparency for execution quality and facilitate investors’ ability to compare brokers, thereby enhancing competition in our markets…. In the 24 years since Rule 605 was adopted our equity markets have been transformed by ever-evolving technologies and business models.”
Commissioner Hester Peirce said, “Although I have some reservations, the staff has carefully considered the many comments we received in response to this rule and worked to make Rule 605 reports more useful to investors and those who serve investors…. If we move forward with the other market structure rules that were proposed In December 2022, which I am not arguing we should do, getting Rule 604 amended and implemented first makes sense.”
Commissioner Caroline Crenshaw said, “These amendments will increase the relevance and use of information contained in 605 reports by expanding the scope of reporting entities, modernizing the content of the reports, and broadening the reports’ accessibility.”
Commissioner Mark Uyeda said, “It makes logical since to approve the Rule 605 amendments [before considering other equity market structure reforms]. Given the significant information on execution quality that the Commission will receive from the updated disclosure requirements, I would have significant concerns moving forward with the Order Competition Rule and Regulation Best Execution without analysis of the new data.”
Commissioner Lizarraga said, “Today’s reforms will enhance the decision-useful information included in the monthly Rule 605 reports on order execution, including improved statistical measures of execution quality.”
Climate Disclosures:
The SEC’s finalized climate rule omitted many of the most stringent requirement included in the original proposal, including reporting on indirect emissions known as Scope 3 emissions, the most significantly challenged aspect of the proposal. The rule also reduces originally proposed disclosures on Scope 1 and 2 emissions, requiring reporting only if companies deem them to have a material impact on their business, and it excludes smaller companies.
Despite being pared back, the rule still faces an uphill battle with several groups including a group of states led by West Virginia and trade associations like the Chamber of Commerce looking likely to sue the SEC over the rule.
The rule was adopted by a 3-2 vote, with Republican Commissioners Hester Peirce and Mark Uyeda voting against it.
The rule requires SEC registrants to disclose:
· Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition;
· The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook;
· If, as part of its strategy, a registrant has undertaken activities to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that directly result from such mitigation or adaptation activities;
· Specified disclosures regarding a registrant’s activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices;
· Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks;
· Any processes the registrant has for identifying, assessing, and managing material climate-related risks and, if the registrant is managing those risks, whether and how any such processes are integrated into the registrant’s overall risk management system or processes;
· Information about a registrant’s climate-related targets or goals, if any, that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition. Disclosures would include material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal;
· For large accelerated filers (LAFs) and accelerated filers (AFs) that are not otherwise exempted, information about material Scope 1 emissions and/or Scope 2 emissions;
· For those required to disclose Scope 1 and/or Scope 2 emissions, an assurance report at the limited assurance level, which, for an LAF, following an additional transition period, will be at the reasonable assurance level;
· The capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds, disclosed in a note to the financial statements;
· The capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of a registrant’s plans to achieve its disclosed climate-related targets or goals, disclosed in a note to the financial statements; and
· If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements.