Securities and Capital Markets
On March 21, 2022, the SEC proposed landmark rules regarding climate-related disclosures that would, if finalized, impact both domestic and foreign private issuers that are subject to the reporting requirements of the Securities Exchange Act of 1934. The much-anticipated proposal will elicit discussion regarding the type, amount, and materiality of certain climate-related information that a company could be required to report. The proposal also highlights the significant shift in market expectations globally regarding a company's oversight of evolving climate-related risks and opportunities. The SEC also published a fact sheet describing the proposed new disclosure requirements, which includes a matrix outlining the proposed phase-in periods and accommodations for the new disclosures. The timing and scope of final rules remains uncertain, but the earliest that certain large accelerated companies would need to comply with the proposed rules if adopted would be 2023 (with the possibility of a filing by 2024).
Below we summarize:
- Background developments that led to the proposal;
- Key provisions of the proposed rules;
- Controversial elements of the proposal that may engender further debate; and
- What companies should be doing now.
In recent years, investors have become increasingly focused on climate-related issues and risks related to a company's business. This heightened awareness has resulted in the SEC taking various steps to address investor demand for more transparent, comparable, decision-useful climate-related disclosure. For example, in 2010, the SEC released guidance on how companies should apply existing disclosure requirements pertaining to a company's business operations and exposure to material climate-related matters.1
In March 2021, SEC Commissioner and then-Acting Chair Allison Herren Lee requested public input from investors, companies and other market participants on whether current disclosures regarding climate-related opportunities and risks provided adequate information to investors.2 ESG-related task forces were also established with the purpose of evaluating climate-related disclosures and claims. In July 2021, SEC Chair Gary Gensler announced the SEC would propose mandatory climate-related disclosure rules. In September 2021, the SEC's Division of Corporate Finance issued a Sample Letter to Companies Regarding Climate Change Disclosures to provide companies with additional guidance regarding climate-related disclosures.
In addition, the proposed rules reflect contemporaneous proposals and regulations from the Biden Administration, Congress, and international legislatures and regulators.3 For example, in the European Union (“EU”) and the United Kingdom, there have been ongoing efforts to require greater transparency around climate-related matters and the enactment of measures that will support sustainable investment in Europe. Such efforts are reflected in the EU's Sustainable Finance Package, and most directly for companies, in the detailed ESG disclosures that the EU Corporate Sustainability Reporting Directive will require through its subsidiary European Sustainability Reporting Standards. These reporting rules are complementary to the EU Taxonomy and its delegated acts as well as the Sustainable Finance Disclosure Regulation. Global efforts at possible convergence around harmonized sustainability disclosures is also manifest in recent activities of the International Financial Reporting Standards foundation, which announced the formation of a new International Sustainability Standards Board and released the climate and sustainability disclosure prototypes.
Key Provisions of the Proposed Rules
The proposed rules would amend Regulations S-K and S-X to require additional climate-related disclosure in registration statements and periodic reports.
Climate-Related Governance, Risk Management and Emissions Information
Proposed disclosure requirements include discussion of a company's:
- Oversight and governance of climate-related risks;
- Potential or actual impacts of climate-related risks to the company's business, strategy, business model, or outlook; and
- Processes and framework for identifying, assessing and addressing climate-related risks, including any scenarios used and impacts predicted if the company's climate-related risk management framework includes scenario analysis.
When responding to any of the proposed rules' provisions concerning governance, strategy, and risk management, a company may also disclose information concerning any identified climate-related opportunities.
Additionally, the proposal would require public companies to disclose their Scope 1 and Scope 2 emissions and, if material or if otherwise included in their reported emissions targets or goals, Scope 3 emissions, all in absolute terms and in terms of intensity per unit of economic value or production.4 Importantly, this disclosure would be required to exclude the impact of offsets or renewable energy credits, which would be separately disclosed. For accelerated and large accelerated filers, these emissions disclosures would be subject to a graduated framework of third-party attestation requirements, moving from limited assurance to reasonable assurance within specified timeframes outlined in the proposed rules. Smaller reporting companies are exempted from Scope 3 emissions disclosure requirements and would have the longest period to comply with Scope 1 and 2 disclosure rules.
Transition Plans and Climate-Related Targets and Goals
The proposed rules contemplate that companies would be required to describe any transition plans for climate-related risk management, including any metrics and targets integrated into their plans. Companies would be required to disclose whether they use an internal carbon price and if so, how they calculate this price.
If a company has publicly announced climate-related targets or goals, the company would be required to disclose information about the targets or goals, including the scope of activities and emissions included in the goals (i.e., Scopes 1, 2 and 3), the measures the company intends to undertake in order to meet the goals, information on any annual progress the company has made toward the published goals, and whether and how much of the goals will be achieved through obtaining carbon offsets or renewable energy certificates.
Financial Impacts of Climate-Related Risks
The rules also propose changes to the requirements in Regulation S-X, which apply to a company's financial statement reporting. The proposed amendments would enhance disclosures about the financial impact of climate-related events materially affecting a company, including severe weather events and other natural conditions and transition activities in the line items of a company's consolidated financial statements unless the aggregated impact of such climate-related events is less than one percent of the total line item for the relevant fiscal year, as well as any estimates and assumptions used in calculating these financial impacts.
Disclosure of Scope 1, 2, and 3 Greenhouse Gas Emission Data
The proposed rules require companies to disclose information about their Scope 1 and Scope 2 emissions, the direct and indirect greenhouse gases (“GHGs”) emitted from companies' operations and energy use. Scope 3 emissions are emissions resulting from activities or assets not directly controlled or owned by the reporting company but released as a part of its value chain – either upstream by its suppliers and vendors or downstream by its customers. The proposal would require large accelerated and accelerated filers to disclose their Scope 3 emissions if they are material or they have otherwise set an emissions reduction target or goal that includes Scope 3 emissions. As proposed, Scope 3 emissions would be subject to certain safe-harbor provisions unless it is shown that a statement was not made or was reaffirmed without a reasonable basis or was disclosed other than in good faith.
Critics of mandatory Scope 3 reporting have questioned whether these value chain emissions have a material impact on a reporting company's financial statements or whether companies should be expected to accurately quantify the full range of Scope 3 emissions with certainty. Despite the difficulty of accurate carbon accounting around emissions, Scope 3 emissions often account for a majority of a company's total greenhouse gas emissions.
In drafting this proposal, the SEC reviewed public comments and considered the frameworks commentators and companies indicated they already use, including the Task Force on Climate-related Financial Disclosures framework and the Greenhouse Gas Protocol. The objective articulated in the Commission's proposal was to facilitate apples-to-apples comparisons across companies and industries. In this regard, the proposal would also require certain narrative and quantitative disclosures to be provided in Inline XBRL format.
Assurance & Financial Metrics in Audited Financial Statements
The proposed rules attempt to address the debate surrounding data validation, reliability and assurance of climate-related metrics. By some reports, approximately half of S&P 500 companies already obtain some form or assurance or third-party verification of their sustainability data. The proposed rules' requirement for accelerated filers and large accelerated filers to include an attestation report and certain related disclosures on Scope 1 and 2 emissions will likely generate comment. In addition, commentators may question the standards that should apply to a GHG emissions attestation provider or the timeframe for implementation of the requirement relating to graduating attestations from a limited assurance to reasonable assurance level.5 The proposed rules' requirement to disclose certain climate-related financial metrics in a registrant's audited financial statements may also be controversial. Overall, the relative costs and benefits associated with achieving certain levels of assurance and/or reliability of climate-related metrics will likely generate a range of views from commenters.
In responses to the SEC's request for comment on climate-related disclosures, many companies expressed a preference for a liability framework that would balance investors' need for climate-related metrics with the concern companies have of exposure to litigation for reporting on difficult to measure climate-related information. Commentators are invited to address the scope of possible safe harbor protections for Scope 3 emissions as well as for financial metrics reporting that are proposed to be included in the notes to the audited financial statements. Notably, the proposed rules would require climate-related disclosures, except for disclosures on Form 6-K, to be deemed “filed” versus “furnished” for purposes of liability under the Exchange Act and, through incorporation by reference, the Securities Act.
What Companies Should Do Now
Keep Calm and Carry On
The SEC's proposal would not impose requirements on companies until final rules are adopted. Moreover, as indicated in the proposal, the rules would include phase-in periods for different categories of reporting companies after any effective date. Companies may however, begin to think about possible actions they could implement in anticipation of any final rules, in particular around their processes for gathering and disclosing information regarding their GHG emissions.
Submit a Comment
The SEC is soliciting public input on various aspects of the proposal. The agency is accepting public comments on or before 30 days after publication in the Federal Register or May 20, 2022, whichever is longer. It will review and consider any submitted comments before releasing final rules.
Watch for Litigation
Any SEC rulemaking on climate-related disclosures will likely face litigation, which could delay the implementation of final rules. In her dissenting statement, Commissioner Hester M. Peirce argues that the rulemaking is beyond the scope of the SEC's authority and quotes from a Supreme Court case that is among the Court's “major questions” precedents, which have recently been applied by the Court to strike down efforts by agencies to regulate in areas beyond their traditional authority, in the absence of a clear statement from Congress. She also suggests that the proposal may be unconstitutional under the First Amendment. These issues are likely to be raised in challenging any final rule along the lines of the proposal and their resolution may ultimately need to await Supreme Court review.
2 Over 550 comment letters were submitted in response to Commissioner Lee's request, three out of four of which advocated for mandatory climate-related disclosure rules, including from large institutional investors.
3 The Biden Administration issued an Executive Order on Tackling the Climate Crisis at Home and Abroad and has outlined the administration's whole-of-government approach to climate risk, which includes addressing climate risk and financial risk across federally-regulated entities. The United States House of Representatives also passed the Corporate Governance Improvement and Investor Protection Act (pending in the Senate), that included directives to the SEC to require public companies to report ESG metrics.
4 For Scope 1, 2, and 3 emissions, the proposed rules would require companies to disclose greenhouse gas emissions in the aggregate and also disaggregated by each constituent greenhouse gas such as carbon dioxide, methane, and nitrous oxide.
5 Companies may also comment on the potential reporting cycle timing issues associated with obtaining GHG emissions data and filing an attestation report, if such report must be included as part of a calendar year- end company's annual report. Companies typically do not have access to such data until after the calendar year-end and possibly after the company's reporting deadline.
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