On March 21, 2022, the Securities and Exchange Commission (SEC) issued for comment proposed rules requiring companies to include climate-related disclosures in their registration statements and periodic reports filed under the Securities Act of 1933 and the Securities Exchange Act of 1934. This proposal would implement a disclosure framework aligned with two sets of internationally recognized standards: the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and the form of greenhouse gas emissions accounting set forth by the Greenhouse Gas Protocol. The comment period on the proposed rules will remain open for 30 days after publication in the Federal Register, or until May 20, 2022, whichever period is longer.1
Content of the Proposed Disclosures. The proposed rules would add new subparts to Regulation S-K and Regulation S-X requiring companies to disclose information concerning their greenhouse gas (GHG) emissions and climate-related risks.2 As part of these proposed rules, the SEC would define "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, as a whole."3 The proposed rules specify that "climate–related risks" include three types of risks: acute physical risks, chronic physical risks and transition risks. Acute physical risks are defined as event-driven risks related to shorter-term extreme weather events such as hurricanes or floods; chronic physical risks are defined as longer term weather patterns and related effects such as sustained higher temperatures, increased wild fires or sea level rise; and transition risks are defined as risks attributable to regulatory, technological and market changes that occur in response to climate-related risks. Transition risks could include "reduced market demand for carbon-intensive products leading to decreased prices or profits for such products, the devaluation or abandonment of assets, risk of legal liability and litigation defense costs."
The proposed rules would require the disclosures of the following items relating to climate-related risks and GHG emissions:
- A description of all climate-related risks "reasonably likely to have a material impact on the registrant" and a discussion of whether each risk is a physical or transition risk
- A discussion of board and management oversight and governance of climate-related risks
- An analysis of the expected material impact of the identified risks on the company's business and financial statements in the short, medium, and long term
- An explanation of how identified risks have affected or are likely to affect the registrant's strategy, business model and outlook
- The company's processes for identifying, assessing and managing climate-related risks and whether such processes are integrated into the registrant's overall risk management system
- The impact of climate-related events and transition activities (efforts to reduce GHG emissions or otherwise mitigate exposure to risks associated with transitioning to lower carbon operations) on the line items of a registrant's consolidated financial statements and related expenditures, as well as any financial estimates and assumptions impacted by climate-related events and transition activities
- The registrant's direct GHG emissions from operations that are owned or controlled by the registrant (Scope 1 emissions) and indirect GHG emissions from the generation of the registrant's purchased electricity and other forms of energy (Scope 2 emissions), each separately disclosed and expressed both by disaggregated constituent GHG and in the aggregate, and in absolute and intensity terms4
- Indirect GHG emissions from upstream and downstream activities in a registrant's value chain (Scope 3 emissions) and their intensity, but only if this information is "material," or if the registrant has set a GHG emissions reduction target or goal that includes its Scope 3 emissions
- If used, the company's internal carbon price, including the rationale for selecting the internal carbon price used
- The registrant's climate-related targets or goals, and transition plan, if any
In making these disclosures, registrants may also choose to disclose information concerning climate-related opportunities. All disclosures would need to be made using the Inline XBRL structured data language and would be filed rather than furnished. In addition, registrants that are accelerated filers or large accelerated filers would need to include in their disclosures an attestation report for their disclosures concerning their Scope 1 and Scope 2 emissions.
Regulation S-K. Under the proposed rules, these disclosures would be provided in a registrant's registration statements and annual reports. Disclosures under the proposed amendments to Regulation S-K would be made in a separately captioned section of a registrant's registration statement or annual report, or alternatively incorporate the required information in a separately captioned section by reference from another section, such as "Risk Factors" or "Management's Discussion and Analysis."
Regulation S-X. Disclosures under the proposed amendments to Regulation S-X would need to be provided in a note to the registrant's audited financial statements.
Phase-In Periods and Accommodations. The phase-in period for the proposed disclosures would depend on a registrant's status as a large accelerated filer, accelerated filer, non-accelerated filer or smaller reporting company (SRC). In addition, the length of the phase-in period will depend on the particular disclosure. For example, for non-Scope 3-related disclosures, if the proposed rules became effective in December 2022 and a registrant had a fiscal year-end of December 31, the compliance deadline would be fiscal year 2023 for large accelerated filers, fiscal year 2024 for accelerated and non-accelerated filers, and fiscal year 2025 for SRCs. In addition, the proposed rules would exempt SRCs from the Scope 3 disclosure requirements and offer a safe harbor for all registrants from liability from Scope 3 emission disclosures. The safe harbor provides that Scope 3 disclosures constitute a fraudulent statement only if the statement was made without a reasonable basis or made in the absence of good faith.5 The other disclosures to be added to Form S-K and Form S-X would not enjoy this heightened standard and would be subject to the same liability as any other statements "filed" with the SEC.6
The Materiality Standard in the Proposed Rule. In the context of SEC disclosure rules, a matter is "material" if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to cast a shareholder vote.7 The materiality standard is raised by two parts of the disclosure rules and in different ways. First, the registrant must make a materiality determination regarding disclosure of climate-related risks. The SEC proposal explains that this materiality determination is "similar to what is required when preparing the MD&A section in a registration statement or annual report," which requires disclosure of material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or future financial conditions.8 Second, the issue of materiality arises in connection with the registrant's Scope 1, 2 and 3 disclosures. The proposed rules direct the disclosure of all Scope 1 and Scope 2 emissions, without requiring a separate analysis as to their materiality. By contrast, the proposed rules would require the disclosure of Scope 3 emissions only if the registrant has stated a goal for Scope 3 emissions reduction or if those emissions are material. That is, if a registrant has not stated a goal of Scope 3 emissions reduction, such emissions must be disclosed only if information about such emissions — emissions by the upstream and downstream third parties in the registrant's value chain — would be substantially likely to assist a reasonable investor in decision-making about investing in the registrant or in casting a shareholder vote.9
The SEC Release and fact sheet can be found here.
1. SEC Release Nos. 33-11042; 34-94478.
2. The proposed rule would require business development companies to make such disclosures. However, the SEC has asked whether business development companies, among other types of registrants, should be excepted from the disclosure rules.
3. Id. at 61. "Value chains" are further defined as the "upstream and downstream activities" by parties other than the company that relate to initial stages of the company's productions of a good or service or that relate to processing materials produced by the registrant into a finished product or providing the company's service to the end user.
4 "GHG Intensity" or "carbon intensity" is defined as a ratio of units of GHG emissions per unit of economic value or per unit production (e.g., metric tons of CO2e per unit of total revenues or per unit of product produced).
5. In the "Discussion" section of the proposal, the SEC explains that this safe harbor is an accommodation offered because, "depending on the size and complexity of a company and its value chain, the task of calculating Scope 3 emissions could be challenging." Id. at 218.
6. However, safe harbors pursuant to the Private Securities Litigation Reform Act would apply to any forward-looking statements, whether in Scope 3 or other disclosures.
7. See Basic Inc. v. Levinson, 485 U.S. 224 (1988).
8. Id. at 70 (citing 17 CFR 229.303(a)).
9. The proposed rule was issued over Commissioner Hester M. Peirce's lengthy dissent. Two of her primary complaints concern the alleged misuse of the materiality standard — first, that the proposed rule dispenses with a materiality determination in the disclosure of Scope 1 and 2 emissions, and second, that the two applications of the materiality standard discussed above are, in her view, distortions of that concept. She argues further, echoing comments from the American Enterprise Institute, the Heritage Foundation and others, that these rules exceed the SEC's statutory authority. This criticism may be reflected in future opposition to the proposed rules. See Hester M. Peirce, Statement: We are Not the Securities and Environmental Commission – At Least Not Yet, SEC.gov (Mar. 21, 2022), https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321; SEC Release Nos. 33-11042; 34-94478 at 35.
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