United States: SEC Adopts Landmark Climate Disclosure Rules

The U.S. Securities and Exchange Commission (SEC) on March 6, 2024, adopted a new slate of standardized climate-related disclosure rules for public companies and foreign private issuers. Adopted by a 3-2 vote, the final rules represent the SEC's most comprehensive and complex disclosure initiative in decades.

This Holland & Knight alert summarizes the history behind the new rules, what they will require companies to disclose, when companies must begin to make the disclosures, how the rules are already being challenged, what companies should consider to ensure compliance readiness, future enforcement considerations, and how companies should view the rules within the broader domestic and global climate-related regulatory framework. In brief, readers need to know:

• the new rules – though dialed back from original proposals that would have mandated so-called "Scope 3" disclosure – require public companies to provide standardized qualitative and quantitative disclosure about climate-related risks, expenditures and greenhouse gas (GHG) emissions, among a long list of other items; attached at Appendix A
• the rules are lengthy and complex and will require companies to ensure they have competent systems, professionals and governance structures in place to implement, administer and oversee processes to identify and accurately disclose required information and financial data
• the rules will take effect over the course of a complicated and lengthy "phase-in" period
• companies may benefit from using the phase-in period to prepare internal rough draft disclosures and use that trial-run exercise to test and refine internal controls and procedures in advance of the date on which they will be subject to the rules
• as expected, the new rules are already being challenged in Congress and the courts, both by opponents who feel the rules exceed SEC authority and by proponents of climate-related rules who feel the rules fail to go far enough; despite existing and likely additional challenges, companies need to continue preparing for compliance readiness

The Final Rules at a Glance

The SEC's new climate disclosure rules will require public companies to provide qualitative disclosure under new Item 1500 of Regulation S-K, as well as quantitative financial statement disclosure under new Article 14 of Regulation S-X, covering

• climate-related risks
• identification, oversight and management of such risks
• the impact of those risks on the business
• climate-related targets and goals
• data relating to a company's GHG emissions and
• climate-related capitalized costs, expenditures, charges and losses, and impacts on financial statement estimates and assumptions

The rules, as originally proposed in March 2022, would have required considerably more (and more expensive to prepare) disclosures relating to GHG emissions. Perhaps most notably, the final rules no longer include Scope 3 disclosures, and the requirement to disclose Scope 1 and 2 GHG emissions is limited by a materiality standard. Attached at Appendix B is a redline showing a comparison of the final rules to the proposed rules.

The final rules also provide a relatively lengthy phase-in period, summarized below.

What the Final Rules Require Public Companies to Disclose

Citing the need for investors to receive consistent and comparable disclosure, the final rules require public companies to take the following actions with respect to climate-related disclosures in their SEC filings:

• file climate-related disclosure in registration statements and Exchange Act annual reports
• electronically tag climate-related disclosures in Inline XBRL and
• provide required climate-related disclosures under Regulation S-K (except for any Scope 1 or Scope 2 emissions disclosures), either
• • in a separate and appropriately captioned section of a registration statement or annual report
  • in another appropriate section of the filing, such as Risk Factors, Description of Business, MD&A or
  • by incorporating by reference from another filing so long as it meets Inline XBRL electronic tagging requirements

The new rules require 1) qualitative disclosure under new Regulation S-K Item 1500 and 2) quantitative financial statement disclosure under new Regulation S-X Article 14, summarized by the SEC as follows.

Summary of Required Climate-Related Disclosures

• Climate-Related Risks: Climate-related risks that have had or are reasonably likely to have a material impact on business strategy, results of operations, or financial condition
• Impacts of Climate-Related Risks: Actual and potential material impacts of any identified climate-related risks on strategy, business model and outlook
• Mitigation or Adaptation Activities: 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
• Activities to Mitigate Climate-Related Risks: Specified disclosures regarding 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
• Board Oversight: Any board oversight of climate-related risks and any role by management in assessing and managing the registrant's material climate-related risks
• Process for Managing Climate-Related Risks: Any processes 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 overall risk management system or processes
• Climate-Related Targets: Information about climate-related targets or goals that have materially affected or are reasonably likely to materially affect the business, results of operations or financial condition, including 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
• Emissions Disclosure: For large accelerated filers and accelerated filers that are not otherwise exempted, information about material Scope 1 emissions and/or Scope 2 emissions
• Assurance Report: For those required to disclose Scope 1 and/or Scope 2 emissions, an assurance report at the limited assurance level for a Large Accelerated Filer (LAF) and, following an additional transition period, at the reasonable assurance level
• Financial Impact of Weather Events: 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
• Financial Impact of Carbon Offsets: Capitalized costs, expenditures expensed and losses related to carbon offsets and renewable energy credits or certificates if used as a material component of plans to achieve disclosed climate-related targets or goals, disclosed in a note to the financial statements
• Estimates and Assumptions: If estimates and assumptions used to produce financial statements are 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

Phase-In Periods and Accommodations

The final rules will become effective 60 days after publication in the Federal Register, and compliance will be phased in over time for all companies. A company's compliance date depends on a company's filing status (i.e., whether it is a LAF, Accelerated Filer (AF), Non-Accelerated Filer (NAF), Smaller Reporting Company (SRC) or Emerging Growth Company (EGC)) as summarized below.

A handful of noteworthy accommodations were made in the final rules, including 1) exemption for SRCs and EGCs from GHG emissions disclosure requirements, 2) certain delayed disclosure allowances for companies required to provide Scope 1 and Scope 2 disclosure, and 3) a safe harbor from private liability for climate-related disclosures about transition plans, scenario analysis, the use of an internal carbon price and a company's targets and goals other than disclosures that are historical facts.

Table 1: Phase-In Periods

Next Steps: What Companies Can Do Now to Prepare for the New Rules

Many companies already include climate-related disclosure in some form in their SEC filings and voluntary reports, but the final rules mandate significant new disclosure content. Although many companies have been preparing to adjust to a new disclosure paradigm in the two years since the climate-related rules were first proposed, it will be important for companies to spend the transition period before the rules become effective ensuring that they have the right people and processes in place. Legal challenges to the climate rules have already been filed and more are expected, but companies are advised to ensure preparedness in line with the phase-in periods and not wait until after any legal actions are resolved.

Companies should start to develop their own implementation plans for the new rules and consider these action items:

• Assess Current Disclosure: Review the climate-related disclosure that is already gathered, reviewed and publicly disclosed.
• Evaluate Current Capabilities, Processes and Controls: Consider how current climate-related information is compiled and reviewed by management and the board, and examine the current processes and controls in place for quantitative and qualitative information.
• Enhance Current Governance and Reporting Systems: Revise disclosure controls and procedures related to GHG emissions and other mandated climate disclosures (for within and outside of the financial statements) as necessary to implement the new rules, which include a materiality determination and measurement of certain financial impacts. Ensure close collaboration between the accounting, finance and sustainability functions, and review management's role in managing climate risks and how information is collected, evaluated and reported, as needed.
• Review Board Oversight: Evaluate the current structure for board or committee oversight of climate matters, and consider whether to implement any changes to roles, responsibilities and the accompanying committee charters.
• Evaluate Internal Team and Resources: Determine if there are any gaps in organizational talent or specific expertise at the company and also consider if additional resources are needed, including internal and external support, to timely comply with the climate rules.
• Consider Materiality of GHG Emissions and Climate-Related Risks: Begin to assess the materiality of the company's Scope 1 and Scope 2 GHG emissions (if applicable). Continue to evaluate the company's climate-related risks and their potential impacts on the company's business, results of operations and financial condition.
• Identify Goals and Targets: Review the company's climate-related goals and targets and be prepared to disclose, if material to the company's business, the results of operations or financial condition.
• Consider Impact of Disclosure: Consider the likely benefits of preparing a rough draft of climate-related disclosure as early as possible to go through the exercise of preparing for public disclosure that will enable companies to 1) refine the disclosure approach, test controls and procedures, 2) leave time to adjust operations to allow for changes in disclosure (if necessary) or 3) mitigate any adverse stakeholder impact of the disclosure.
• Prepare for Attestation (If Applicable): Review and understand the upcoming requirements with your internal team and external advisors, and consider the additional support and services that will be needed. Plan to begin discussions with attestation providers this year.

Why the SEC Cares About Climate Change and the Evolution from Interpretive Guidance to Proposed and Now-Final Rules

On March 21, 2022, the SEC first proposed rules to require registrants to disclose information regarding climate-related risks in certain periodic reports and registration statements. The proposed rules drew both swift rebuke and strong support, resulting in more than 24,000 public comments and, ultimately, a somewhat scaled-back set of final rules. For SEC Chair Gary Gensler, the final rules – described in an 886-page Release and accompanied by a high-level Fact Sheet – "will provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements."

Current and recent commissioners have offered a variety of reasons why a majority of them have supported establishing new and specific climate disclosure requirements for public companies. Chief among them is to ensure that investors and stakeholders have access to relevant, standardized and material information when deciding whether to trade public company securities. The SEC's adopting release underscores the view that "investors, companies, and the markets have recognized that climate-related risks can affect a company's business and its current and longer-term financial performance and position in numerous ways" and the "actual and potential impacts of a registrant's identified climate-related risks [are] central to helping investors...

• understand the extent to which a registrant's business strategy or business model may need to change to address those impacts
• evaluate management's response to the impacts and the resiliency of the registrant's strategy to climate-related factors and
• assess whether a registrant's securities have been correctly valued."

Although recent focus and debate have centered around the proposal to adopt mandatory climate disclosure rules, the SEC's interest in climate goes back decades. In 1971, the SEC issued an interpretive release indicating that companies should consider disclosing the cost to comply with environmental laws if material. In 1975, the SEC considered a variety of "environmental and social" disclosure issues and its own power to mandate such disclosure. In 2010, the SEC issued additional interpretive guidance to provide public companies with guidance on "existing disclosure requirements as they apply to climate change matters." Additionally, in March 2021 – a year before the SEC proposed the now-final rules – then-acting SEC Chair Allison Herren Lee requested public input from investors, registrants and other market participants about climate-related disclosures. The SEC received thousands of comments in response.

Dissenting Commissioners, Early Challengers and Political Blowback

As expected, Commissioners Hester Peirce and Mark Uyeda voted against adopting the rules. Commissioner Peirce and many in business and government share Commissioner Uyeda's view that the final rules are, pure and simple, "climate regulation promulgated under the Commission's seal." In a more than two-hour discussion about the rules among the commissioners and senior agency staff, each made their concerns clear. For his part, Commissioner Uyeda observed that the SEC "is a securities regulator without statutory authority or expertise to address political and social issues" and that it has "ventured outside of its lane and set a precedent for using its disclosure regime as a means for driving social change." In his view, "if left unchecked, we may see further misuse of the Commission's rules for political and social issues and an erosion of the agency's reputation as an independent financial regulator." Concerned that the new rules will "spam" investors with unwanted climate details, Commissioner Peirce noted that the new rules will result in a "flood of climate-related disclosures [that] will overwhelm investors, not inform them," and will "increase the typical external costs of being a public company by around 21 percent," which will "overwhelm small public companies, many of which are already struggling under the costs of being public."

Both Commissioners Peirce and Uyeda contend that the final rules may well exceed the agency's congressionally granted authority, implicating the Major Questions Doctrine and signaling a likely litigation risk the Commission recently confronted when its stock buyback rules were invalidated in 2023.

The final rules, which were already the subject of considerable political interest since first being proposed, immediately will become part of the 2024 election landscape. Due to the breadth of impact on corporate America, the rules have already started generating vocal support and opposition from industry and political leaders in Washington, D.C., and across the country. Many Democrats in Congress praised the SEC for their actions, while others don't believe the rules go far enough, given the exclusion of the Scope 3 requirements. The House Committee on Financial Services is expected to conduct oversight hearings and introduce a resolution through the Congressional Review Act (CRA) to halt the rules from taking effect. Committee Chair Ron Wyden (D-Ore.) has announced two hearings to explore the impacts of these rules. In the Senate, Sen. Tim Scott (R-S.C.), the top Republican on the Senate Committee on Banking, has indicated he would use congressional power to try to overturn the rules. Should the House successfully pass a CRA to block implementation of the rules and if industry leaders are able to pressure moderate Democrats in the Senate to support that CRA, it is anticipated that President Joe Biden would immediately veto it.

And perhaps before the virtual ink was dry on the final rules, 10 states' attorneys general (Alabama, Alaska, Georgia, Indiana, New Hampshire, Oklahoma, South Carolina, Virginia, West Virginia and Wyoming) announced a legal challenge in the form of a petition to the U.S. Court of Appeals for the Eleventh Circuit to block the rules from taking effect, claiming that they exceed the SEC's authority and violate the First Amendment. The petition asks the Appeals Court to declare the rules unlawful and vacate the Commission's final action adopting them. Separately, Louisiana, Mississippi and Texas have lodged a challenge in the U.S. Court of Appeals for the Fifth Circuit and at least two energy industry suppliers have filed a lawsuit with the Fifth Circuit (with a possible companion challenge in federal district court).

More litigation seems given, including challenges under the Major Questions Doctrine and Administrative Procedures Act. Already, the U.S. Chamber of Commerce, National Association of Manufacturers and the American Farm Bureau Federation have threatened to sue the SEC just as they filed a lawsuit to stop California from implementing Senate Bill (SB) 253 and SB 261. On the other side, environmental groups Earthjustice and the Sierra Club have threatened to bring suit for the SEC's "arbitrary removal" of the Scope 3 disclosure requirement. Pending challenges to do away with Chevron deference – which grants agencies like the SEC the ability to interpret its rules-based and statutory authority to act absent explicit authority from Congress – may make for a tougher fight on the SEC's part. On the other hand, the final rules go to great lengths to explain the underlying investor-protection purposes of the rules and expressly indicates that each component of the rules is severable from the others, so that the invalidation of one aspect of the rules does not bring down the entire structure.

Agency Enforcement of the New Rules

Time will tell when and how the SEC will seek to enforce its new climate disclosure rules, although certain possibilities are already apparent. The following chart provides bases for which the SEC could challenge a company's compliance with the final rules and some suggestion considerations.

Thinking About the Bigger Picture: Considering the SEC's New Climate Disclosure Rules Within the Domestic and Global Climate Regulatory Mosaic

It will be important to evaluate the final rules in the context of the global climate disclosure regulatory regime. Requirements already exist in many parts of the world regarding climate and other sustainability disclosures. In fact, some U.S. companies may already be subject to these other disclosure requirements.

The Corporate Sustainability Reporting Directive (CSRD), for example, now applies to some European-based companies, with reporting first due in companies' annual reports in 2025. The CSRD is expected to apply to an estimated 3,000 U.S. companies that have annual revenues in the European Union (EU) exceeding 150 million euros for two consecutive years, although these reporting obligations have been delayed and will now apply two years later than originally expected.

The CSRD applies to Scope 1, 2 and 3 emissions. It utilizes a double materiality standard, in that companies will be expected to report on 1) the financial impacts of climate change on their business and 2) the impact of their business upon the environment. As approved and adopted, the SEC's final rules neither include Scope 3 emissions nor a double materiality standard.

The International Sustainability Standards Board (ISSB) has also issued directives on sustainability-related financial disclosures (IFRS S1) and on climate-related disclosures (IFRS S2). These directives address four areas: governance, strategy, risk-management, and metrics and targets.

Yet another organization, the European Financial Reporting Advisory Group (EFRAG), issued guidance late last year on conducting materiality assessments.

The EU Commission is still working on the Corporate Sustainability Due Diligence Directive (CS3D), which focuses on identifying, preventing, mitigating and ending environmental and human rights harms by companies and their supply chains. This directive would apply to both public and private companies, including some non-EU companies.

Similar climate disclosure obligations are being considered in Australia, Canada and India.

In the U.S., many states have enacted or are contemplating their own climate disclosure requirements. California enacted SB 253 and SB 261 last year, which are scheduled to phase into effect alongside the SEC's own disclosure requirements. Both California laws broadly sweep in organizations doing business in the state that meet an annual revenue threshold, regardless of where those organizations are located and whether they are public or private. SB 253 and SB 261 are anticipated to impact 5,000 and 10,000 companies, respectively.

Unlike the SEC's new adopted rules, California's SB 253 will require impacted organizations to calculate and disclose their Scope 3 emissions. While Gov. Gavin Newsom expressed his intent to propose further amendments to both laws, the author of SB 253 strongly opposes any changes to the timelines or requirements of the bills. SB 253 requires the California Air Resources Board (CARB) to adopt regulations to minimize duplication and allow a reporting entity to submit reports meeting "other national and international reporting requirements," but this authorization only applies if "those reports satisfy all of the requirements" of SB 253, including Scope 3 emissions reporting. Reports under the current SEC rules would not rise to this level.

California is not alone in evaluating disclosures above and beyond SEC's requirements. If enacted, New York's SB S897A would also require disclosure of Scope 3 emissions. Like California's SB 253, the proposed legislation would apply to entities doing business in New York that meet a revenue threshold. And in the Illinois General Assembly, the pending House Bill (HB) 4268 would also require disclosure of Scope 3 emissions, but on an even faster track. The current draft legislation would require the adoption of rules by July 1, 2024, with disclosure of Scope 1 and 2 emissions for 2024 due on Jan. 1, 2025, and Scope 3 emissions for 2024 no later than 180 days later. Like the California laws and New York's bill, Illinois' HB 4268 would apply to organizations meeting the revenue threshold that do business in the state of Illinois. While SB S897A and HB 4268 are in early stages, they demonstrate a continued momentum to require disclosures above and beyond the SEC's requirements.

Given all of this, it will be important for companies to evaluate not just how the now-final rules adopted by the SEC affect their business, but how they may be impacted by the states' and other nations' broader regimes of sustainability and climate disclosure regulations. It will also be important to evaluate how best to comply with these differing – and potentially conflicting – climate disclosure directives.

Conclusion

Understanding when and how to comply with the SEC's new and mandatory climate disclosure rules will be no easy task, even for the most well-resourced companies. The new rules will require enhanced accounting and financial reporting capabilities and controls, additional internal and external subject-matter experts, improved information-gathering systems and added rigor in drafting climate-related disclosures. Although phase-in periods mean there are nearly two years before disclosures under the new rules will be required, for many companies – especially large industrial and manufacturing operations – there is likely no time to waste.

Readiness will require companies to assess their climate-related risks, opportunities and operations rigorously and consider their processes to identify, collect, monitor and disclose material information thoughtfully, all against the backdrop of challenges to the rules, as well as potential future private litigation and agency enforcement risks.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.