SEC Proposes Climate Change Disclosure Rules Applicable To Public Companies - Securities

Background

On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) voted 3:1, with only Commissioner Hester Peirce dissenting, to propose long-awaited rules that, if adopted, would require extensive reporting by public companies of climate change-related disclosure and related attestation (the "Proposal").¹ Comments on the Proposal are due 30 days after publication in the Federal Register or May 20, 2022 (which is 60 days after issuance), whichever is later.²

In a departure from existing "principles-based" disclosure requirements rooted in materiality, the SEC proposed rules that are prescriptive and intended to provide investors with consistent and comparable data, despite recent evidence that a significant majority of companies questioned by SEC staff currently do not find climate change-related physical or transition risks to be material to their businesses.³

Notably, and subject to certain exceptions and transitional provisions discussed below, the proposed rules would require that registrants disclose:

Direct greenhouse gas (GHG) emissions (Scope 1) and indirect GHG emissions from purchased electricity and other forms of energy (Scope 2); and
Indirect emissions from upstream and downstream activities in a company's value chain (Scope 3), if material, or if the company has set a GHG emissions target or goal that includes Scope 3 emissions.

While some companies are already familiar with, and even collecting data on, their Scope 1 and 2 GHG emissions (and likely a much smaller number on their Scope 3 emissions) since these concepts were introduced by the GHG Protocol⁴ (and are used in several GHG reporting frameworks (e.g., the Task Force on Climate-Related Financial Disclosures (TCFD) framework⁵)), the GHG Protocol Corporate Standard guidance⁶, the GHP Protocol Scope 2 guidance⁷ and the GHG Protocol Corporate Value Chain (Scope 3) guidance⁸ are complicated concepts that are not self-explanatory. Furthermore, the frameworks include elections as to permissible methods used under these standards (e.g., location- or market-based methods for purchased energy), indicating that resulting data reported may not be consistent or comparable. If implemented, these requirements will likely require significant time, effort and money for registrants to both understand and comply with.

Given the complexities involved in tracking and reporting this information, the Proposal is not surprisingly voluminous in its explanation of requirements, especially with respect to financial statement reporting.

The Proposal also seeks responses to over 200 separate numbered questions (many, or even most of which, are compound questions resulting in well over 750 total questions). The questions raise significant matters, including whether the required disclosures should be treated as filed (to which securities law liability would attach) or furnished (for which such liability may not attach) and whether additional phase-ins or exemptions should be adopted.

Proposed Changes to Regulation S-X (Financial Statement Disclosures)

The Proposal would amend Regulation S-X to require companies to include certain climate-related financial statement metrics and related disclosures in a note to their audited financial statements. The proposed disclosures would be required for the company's most recently completed fiscal year and for the fiscal years included in the consolidated financial statements in the applicable filing.⁹ The proposed financial statement metrics would consist of disaggregated climate-related impacts on existing financial statement line items and categories. As part of the company's financial statements, the financial statement metrics would be subject to audit by the company's independent registered public accounting firm and come within the scope of the company's internal control over financial reporting.

A company would be required to calculate the proposed financial statement metrics using financial information that is consistent with the scope of the rest of the company's consolidated financial statements included in the filing (i.e., including information from consolidated subsidiaries) and apply the same set of accounting principles that it is required to apply in preparation of the rest of its consolidated financial statements included in the filing, whenever applicable. The Proposal requests comment on whether the SEC should require registrants to calculate metrics at a reportable segment level or by geographic area.

FINANCIAL IMPACT METRICS

The Proposal would require a company to include disaggregated information about the impact of climate-related conditions and events and transition activities on the consolidated financial statements that are included in the relevant filing, unless the impact is below a specified threshold. An impact would be below the specified threshold if the sum of the absolute values of all the impacts on the line item is less than one percent of the total line item for the relevant fiscal year.

Climate-related conditions and events would include flooding, drought, wildfires, extreme temperatures and sea level rise and are intended to map physical risks. Transition activities would include any efforts to reduce GHG emissions or otherwise mitigate exposure to transition risks.

A company would be required to determine the impacts of severe weather events, other natural conditions, transition activities and identified climate-related risks described above on each consolidated financial statement line item. Within each category (i.e., climate-related events or transition activities), impacts would, at a minimum, be required to be disclosed on an aggregated, line-by-line basis for all negative impacts and separately, on an aggregated, line-by-line basis for all positive impacts. However, for purposes of determining whether the disclosure threshold has been met, a company would be required to aggregate the absolute value of the positive and negative impacts on a line-by-line basis.

A company would have the option to disclose the impact of any opportunities arising from severe weather events and other natural conditions; any impact of efforts to pursue climate-related opportunities associated with transition activities; and the impact of any other climate-related opportunities, including those identified by the company pursuant to proposed Item 1502(a) (discussed below), on any financial statement metric. If a company made a policy decision to disclose the impact of a climate-related opportunity on the proposed financial statement metrics, the company would need to do so consistently and follow the same presentation and disclosure threshold requirements applicable to the required disclosures related to financial impact metrics and expenditure metrics.

The proposed rules would also require companies to provide contextual information about financial impact metrics. The Proposal notes that contextual information may include disclosure of the company's election to include the impact from opportunities in its disclosure analysis and calculation; the specific events that were aggregated for purposes of determining the impact on the cost of revenue; and, if applicable, a discussion of the estimation methodology used to disaggregate the amount of impact on the cost of revenue between the climate-related events, transition activities and other factors.

EXPENDITURE METRICS

The Proposal would require a company to disclose aggregated information about the impact of climate-related conditions and events and transition activities on annual expenditures and capitalized costs. For each category, a company would be required to disclose separately the amounts incurred during the fiscal years presented toward (i) positive and negative impacts associated with the climaterelated events and (ii) transition activities, including toward the mitigation of exposures to transition risks (including identified transition risks). This would include expenditures incurred to increase the resilience of assets or operations, retire or shorten the estimated useful lives of impacted assets, relocate assets or operations at risk or otherwise reduce the future impact of severe weather events and other natural conditions on business operations. It also would include expenditures incurred to research and develop new technologies or to purchase assets, infrastructure or products that are intended to reduce GHG emissions, increase energy efficiency, offset emissions (purchase of energy credits), or improve other resource efficiency.

The amounts of expenditure disclosed pursuant to the proposed metrics would be a portion, if not all, of the company's total recorded expenditure (expensed or capitalized) as calculated pursuant to the accounting principles applicable to the company's financial statements. The proposed expenditure metrics would be subject to the same disclosure threshold as the financial impact metrics discussed in the prior section. However, a company would be required to aggregate expenditure related to climate-related events and transition activities within the categories of expenditure (i.e., amount capitalized and amount expensed) when determining if information must be disclosed.

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Footnotes

1. See https://www.sec.gov/rules/proposed/2022/33-11042.pdf.

2. Of course, it is possible (or even likely) that there will be requests to extend this period in light of the complexity of the Proposal and the substantial information requested from commenters. Recent use by the SEC of "short" comment periods in rulemakings has drawn Congressional attention. See the Jan. 10, 2022 letter to Chair Gensler from Representative McHenry and Senator Toomey at https://republicans-financialservices.house.gov/uploadedfiles/2022-01-10_pmc_toomey_letter-gensler_sec_comment_period.pdf.

3. See Nicola M. White, SEC Drops Hints About ESG Rule in Retorts to Vague Disclosures, Bloomberg Law (Mar. 18, 2022), https://news.bloomberglaw.com/securities-law/sec-scrutiny-of-big-companies-sheds-light-on-climate-priorities.

4. See GHG Protocol, available at https://www.ghgprotocol.org.

5. See TCFD Recommendations, available at https://assets.bbhub.io/company/sites/60/2021/10/FINAL-2017-TCFD-Report.pdf.

6. See GHP Protocol Corporate Accounting and Reporting Standard (Revised Edition), available at https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf.

7. See GHG Protocol Scope 2 Guidance available at https://ghgprotocol.org/sites/default/files/standards/Scope%202%20Guidance_Final_Sept26.pdf.

8. See GHP Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard, available at https://ghgprotocol.org/sites/default/files/standards/Corporate-Value-Chain-Accounting-Reporing-Standard_041613_2.pdf.

9. A company, however, would not need to provide a corresponding historical metric for a fiscal year preceding its current reporting fiscal year if the company is eligible to take advantage of the accommodation in Rule 409 or Rule 12b-21.

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