On March 21, 2022, the U.S. Securities and Exchange Commission (the "SEC") released a long-anticipated proposed amendment to its rules under the Securities Act of 1933 ("Securities Act") and Securities Exchange Act of 1934 ("Exchange Act"). This rule would require public companies to disclose climate-related risks when they file registration statements and Exchange Act periodic reports.1 The proposed rule amendment is likely to prove highly controversial with opponents arguing that the amendment is beyond the SEC's jurisdiction.2
While the scope of the final rule remains subject to public comment, much of the focus has been on the requirement that certain registrants disclose information on greenhouse gas ("GHG") emissions. The proposed rule would define "greenhouse gases" as those gases viewed by the international scientific community as the primary driver behind climate change and would be consistent with other significant climate frameworks, including the UN Framework Convention on Climate Change and the Kyoto Protocol. As currently drafted, the GHGs requiring disclosure include carbon dioxide (CO2), methane (CH4), nitrous oxide (N20), nitrogen trifluoride (NF3), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulfur hexafluoride (SF6).
In an effort to facilitate uniform GHG reporting, the proposed rule adopts the Greenhouse Gas Protocol ("GHG Protocol"), a widely accepted GHG accounting methodology. The GHG Protocol developed so-called emission "scopes" to help differentiate between emissions directly attributable to the disclosing entity and those emissions only indirectly attributable to the disclosing entity. The GHG Protocol defines Scope 1 emissions as those GHG emissions generated from emission sources "that are owned or controlled by the company, [e.g.,] boilers, furnaces, vehicles., emissions from chemical production in owned or controlled process equipment."3 Scope 2 emissions are those emissions resulting from the generation of electricity purchased by the company for its operations.4 The GHG Protocol treats so-called Scope 3 emissions as a sort of catch-all to capture indirect emissions unrelated to purchased electricity. For example, a company may contract for the extraction and production of certain materials used in its products. The emissions generated by those extraction/production activities would be considered Scope 3 emissions. Other major sources of Scope 3 emissions include transport-related activities, including goods transport and other supply-chain related emissions, business travel, employee commutes, waste transport, etc.5
The proposed rule's GHG emissions reporting framework is implemented in a phased approach, with registrants first required to disclose all Scope 1 and Scope 2 GHG emissions starting with fiscal year 2023 for large accelerated filers, fiscal year 2024 for accelerated and non-accelerated filers, and fiscal year 2025 for smaller reporting companies ("SRCs"). With the exception of SRCs, registrants will be required to disclose Scope 3 GHG emissions beginning in fiscal years 2024 and 2025. The SEC acknowledged the inherent difficulties in calculating Scope 3 emissions due to the unavailability of necessary data from suppliers and other third parties. As such, the proposed rule includes a safe harbor for Scope 3 emissions disclosure that would limit liability to disclosures "made or reaffirmed without a reasonable basis or.disclosed other than in good faith."6
The proposed rule also requires disclosure of GHG intensity, i.e., metric tons of carbon dioxide equivalent (CO2e) per unit of total revenue. Rather than developing different units of measurement for each individual gas, the GHG Protocol developed CO2e as the common unit of measurement across all GHGs to indicate the "Global Warming Potential" of each. This metric could be used by companies to set targets or goals to reduce the carbon intensity or certain products or operations.
The other primary source of contention in the proposed rule is the required disclosure of material "climate-related risks."7 The rule defines "climate-related risks" as the "actual or potential negative impacts of climate-related conditions and events on a registrant's consolidated financial statements, business operations, or value chains.."8 Although "climate-related risks" is defined to include what are commonly seen as the biggest consequences of climate change, e.g., sea-level rise, drought, wildfires, etc., it also includes those risks associated with the transition to a less carbon-intensive economy, e.g., reduced market demand for carbon-intensive products, changes in consumer behavior, etc.
Among other requirements, the proposed rule would also require disclosure of the following:
- The oversight and governance of climate-related risks by the registrant's board and management;
- The registrant's processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into the registrant's overall risk management system or processes;
- If the registrant has adopted a transition plan as part of its climate-related risk management strategy, a description of the plan, including the relevant metrics and targets used to identify and manage any physical and transition risks;
- If the registrant uses scenario analysis to assess the resilience of its business strategy to climate-related risks, a description of the scenarios used, as well as the parameters, assumptions, analytical choices, and projected principal financial impacts;
- If a registrant uses an internal carbon price, information about the price and how it is set;
- The impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant's consolidated financial statements, as well as the financial estimates and assumptions used in the financial statements; and
- Information about climate-related targets and goals, and transition plan, if any.
The proposed rule is now in a public comment period until at least May 20, 2022. The rule is likely to be the subject of litigation potentially delaying implementation for several years.
Footnotes
1. https://www.sec.gov/rules/proposed/2022/33-11042.pdf
3. https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf (Page 27)
4. https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf (Page 27)
5. https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf (Page 31)
6. 17 C.F.R. 229.1504(f).
7. 17 C.F.R. 229.1502(a).
8. 17 C.F.R. 229.1500(c).
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