SEC Proposes New Rules for Climate-Related Disclosures

The U.S. Securities and Exchange Commission (SEC), released a comprehensive set (Proposed Rule) of rules that mandate climate-related risk disclosures by public companies on March 21, 2022.¹Some see the release as a significant and long-awaited breakthrough.²It is a crucial moment in the history of financial markets.³For others, it exceeds SECs statutory authority to turn the disclosure regime on its head.⁴These are only the reactions of the commissioners.⁵Despite their differing views, however each commissioner, including Gary Gensler the Chairman of SEC, encouraged investors and issuers alike to weigh-in on the requirements, consequences and timing of Proposed Rule. The 510-page release contains more details.

Highlights of The Proposed Rule

The Proposed Rules requires public companies to make stronger disclosures in their periodic reports to the SEC about their exposure to climate risks and its effect on the environment. They must also disclose more information about their exposure to climate-related hazards and their impact on environmental conditions. The Proposed rule focuses primarily upon greenhouse gas emissions (i.e. carbon dioxide, methane. nitrous oxide. The Proposed Rule is based on the Task Force on Climate-Related Financial Disclosures, (TCFD), and the Greenhouse gas Protocol (GHG Protocol).

• Climate-related risks are disclosed in registration statements under Securities Act of 1933, as modified (the 33 Act), as well as in annual reports under Securities Exchange Act of 1934 (the 34 Act).

  • The Proposed Rule defines climate risks as both material and physical risks. This refers to the risks posed either by climate change (e.g., disruptions to business operations or climate-induced damage) or transition risk (the risk of transitioning to a lower-carbon economy with the associated reputation, policy, legal and technological measures to mitigate climate change).

• Disclosure of climate-related goals or targets and transition plans, if applicable, as well as relevant baseline, metrics and time expected to achieve those targets or goals.

• Scope 1 & Scope 2 emissions by disaggregated green gases (the seven gases mentioned above) as well in aggregate and in terms intensity. GHG intensity refers to the ratio between GHG emission and economic value, such as the ratio of metric tonnes of carbon dioxide per unit total revenue or production.

• Scope 3 emissions must be reported if they are significant or if the company has set a GHG emission reduction target or goal that includes Scope 3 emissions.

  • The Proposed Rule provides an additional phase-in period to Scope 3 emissions transparency, a safe harbor for Scope 3 emission disclosure, and an exemption for Scope 3 emission disclosure for a company that meets the definition of a smaller report company.

• Attestation reports for large accelerated filers and accelerated filers for Scope 1 or Scope 2 emissions.

• Disclosure of certain climate-related financial statements metrics in a note to company’s audited financial reports. This includes disaggregated climate impacts on existing financial statement lines items. If climate risks affect more than 1% of the absolute value of a line item, disclosure would be required. This means that gains and losses are added to the line item in order to reach such disclosure determinations.

• Financial statement metrics will need to be audited by an independent registered accountant firm. They will be considered within the scope for the company’s Internal Controls Over Financial Reporting.

• How a company identifies and assesses climate-related risks. How such risks could affect its strategy and business model. If such risks are likely, whether they will have a material impact upon its business and consolidated financial accounts over the medium and long term.

• Disclosure by the company’s board of directors and its management of oversight and governance of climate related risks. Companies will need to test a variety of accounting and disclosure controls to ensure compliance.

Accordingly, the Proposed Rule will require public companies develop and design new disclosures. Accounting controls will also need to be mapped, audited, and tested.

Prior Efforts by the SEC to Improve Climate-Related Disclosures

On February 8, 2010, extensive interpretive guidance was published by the SEC on the extent to which disclosure requirements require substantial and detailed discussion in periodic reporting of the climate change risks and costs that face public companies. The SEC announced, on March 4, 2020, that its Division of Enforcement had formed an ESG task team of 22 people to investigate and recommend enforcement actions in response to misleading statements about climate risk and failures of money mangers to invest and maintain proper procedures consistent to any professed commitment of ESG priority in deploying investor fund funds.

On March 15, 2021, Allison Lee, Acting Chair of the SEC, spoke out about the increasing investor interest in climate change and the need for more climate-related disclosures to inform investment decisions. Acting Chair Lee stated the SEC needed more public input in its process of forming further guidance in this area. She solicited responses to 18 questions that she felt should be included in the SEC’s efforts to improve the disclosure of climate-related information within periodic reports of public corporations.

The SECs Division of Examinations published a Warning Alert on April 19, 2021. This alert highlighted the weaknesses of money managers’ commitment to investing with a focus on ESG. In September 2021, the SECs Division of Corporation Finance published an informal comment letter with sample observations about the quality and method of climate-related disclosures of hypothetical public companies in order to inform preparers of securities filings of increased expectations of the SEC. The SEC sent similar comments letters to 38 other issuers after publishing this form comment letter. These replies were used to inform the creation of the Proposed Rule.

The SECs drumbeat continues. On December 7, 2021, Chairman Gensler predicted the climate-related risk rules that public companies would have to measure the effect of their commitments to reducing climate change and the challenges they face in responding. After the Commission indicated in 2022 that its anticipated rule proposal might be delayed earlier, Senator Elizabeth Warren wrote a note to Chairman Gensler. She expressed her displeasure at the delays and called them unacceptable and violative.[ive of]The commitment you made seven years ago [during Genslers confirmation process]. Senator Warren criticized the SEC for delaying action on March 15, 2021. He stated that it took far too long for them to act.

Recent Actions of International Regulators & Their Advisors to Encourage Climate-Related Disclosures

The SEC’s release comes after extensive efforts by international regulators as well as their advisers to create standards for climate disclosures that foreign public corporations are increasingly expected to publish. In December 2015, the G-20 Financial Stability Board set up the TFCD to regulate disclosures of corporate efforts to address climate risk. The TFCD, which was headed by Mary Schapiro, ex-SEC Chair, and Michael Bloomberg, was responsible for defining the metrics that companies should use in order to measure and report on their effectiveness. The SECs Proposed Rule contains prominently the work done by the TFCD.

The TFCD reports that more than 2,000 companies with a market capital of more than $22 trillion and financial institutions totaling nearly $180 trillion supported the TFCD’s recommendations as of 2021. The TFCD recommendations have been implemented in the mandatory corporate disclosure regimes of Australia, Japan, Canada and Switzerland by the UK, Australia, Japan Japan, Canada, Canada, and Switzerland.

The Carbon Disclosure Project (CDP), Climate Disclosure Standards Board and the Global Reporting Initiative published a joint report on September 11, 2020. It included the International Integrated Reporting Counsel, the Climate Disclosure Standards Board, Global Reporting Initiative, Global Reporting Initiative, and the Sustainability Accounting Standards Board. In response to investors’ strong demand, the International Financial Reporting Standards Foundation created the International Sustainability Standards Board (ISSB) in November 2021. The ISSB is set to merge with Climate Disclosure Standards Board, Value Reporting Foundation and the Climate Disclosure Standards Board in June 2022 to align the standards and frameworks. The TFCD’s work and that of other sustainability standard setters is expected to be used by the ISSB to develop disclosure standards to provide financial markets with actionable data on companies’ climate change exposure and the effects of those companies on the environment.

As Senator Warren stated, the SEC was late to adopt climate-related disclosure standards that apply to public companies in the U.S. The perception and many of the 600 comments received in response Acting Chair Lees March 2021 invite have undoubtedly prompted SEC advocates for the extensive disclosure contemplated by the Proposed Rule.

Overarching Disclosures

The Proposed Rules requires public companies to disclose information on climate-related risks that are reasonably expected to have a material effect on their business. This includes consolidated financial statement metrics as well as GHG emissions metrics. These metrics are designed to assist investors in assessing climate-related risks. The Proposed Rule requires public companies to disclose:

• The oversight and governance by a company’s board and management of climate-related hazards; any board committees that are responsible for monitoring climate-related threats; whether any board member is climate-related risk expert and, if yes, a description of such expertise; how often the board committees discuss and debate climate-related issues.

• How climate-related risks (physical or transition risks) identified and assessed by the company have or are likely to have an impact on the company’s business and consolidated financial statements. These impacts could manifest over the long, medium, or short term. Companies would have to define what they mean by “short, medium, and long term”. Companies would also have to describe whether physical risks are acute or chronic.

• How climate-related risks have impacted or are likely to impact the company’s strategy, business model, outlook, and outlook. Companies should disclose how these risks could affect their consolidated financial reports. Companies that use carbon offsets or renewable electricity credits in their emission reduction strategies would be required to disclose the short-term and long-term risks. Companies would have to disclose how they determined an internal carbon price, including the price per ton of carbon dioxide, in order to assess climate risk and determine their climate strategy. Companies must describe the resilience of their business strategy. A detailed description of the assumptions and parameters required for scenario analyses is essential.

• How the company identifies, assesses, and manages climate-related risks.

• Reporting on the effects of climate-related activities on the line items in the company’s consolidated financial statements, and related expenditures. Disclosure of financial estimates, assumptions, and financial estimates that were impacted by such climate events and transition actions including:

• Scopes 1 and 2, GHG emissions, intensity, and separately disclosed Scope 3 GHG emission and intensity, if material or if the company has set an emissions reduction target or goal that includes Scope 3.

• If applicable, the company’s climate-related goals or targets and transition plan. Any discussion about a transition plan would need to address relevant metrics or targets.

A company can also provide information about any climate-related opportunities when responding to any of Proposed Rules provisions regarding governance, strategy and risk management.

Specific GHG Disclosures

Scope 1 emissions are direct GHG emissions from sources controlled or owned by a company. Scope 2 emissions are emissions that are primarily caused by electricity generation and consumption. Scope 1 emissions must be disclosed as disaggregated greenhouse gases, and as an aggregate, which must include intensity. The SEC argued that investors would be able to gain actionable information about the relative risks each greenhouse gas poses to their company, as well as the risks posed to them by its total GHG emissions.

Scope 3 emissions refer to indirect emissions not included in Scope 2 emission. These emissions are a result from company activities but are generated from sources other than the company’s control, such as suppliers, vendors and customers. Scope 3 emission must be disclosed if they’re material or if the company sets a GHG emissions reduction goal or target that includes Scope 3 emission. The Proposed Rule provides a phase-in period to disclose Scope 3 emissions, a safe harbor to disclose Scope 3 emissions, and an exemption from disclosure for companies that meet the criteria for a smaller reporting company.

The Proposed Rule requires disclosure not only of aggregate GHG emissions, but also of Scope 1 and 2, in terms of GHG intensity. Scope 3 emissions must be reported by companies that also disclose separate GHG intensity.

Non-Compliance – Liability

The Proposed Rule requires companies that climate-related disclosures be filed, not furnished, by the companies. The disclosures could be subject to liability under Section 11 and 18 of the 33 Act. Only disclosures on Form 6-K would be exempted from liability, as disclosures on Form 6K are considered to have been furnished under the SECs foreign issuer disclosure system.

Scope 3 emissions disclosure would also enjoy a safe harbor from some forms of liability. The SEC recognizes that Scope 3 emissions information is not under a company’s control and can be difficult to verify. Therefore, companies will need to rely upon estimates and assumptions. According to the Proposed Rule, Scope 3 emissions disclosures will not be considered fraudulent statements unless it is proven that such statement was made, reaffirmed, or disclosed without a reasonable basis, or was not made in good faith.

The SEC comments on the Proposed Rule and notes that forward-looking disclosures related to climate will be covered by the 33 Act and 34 Act safe harbors. The safe harbor protections under the Private Securities Litigation Reform Act of 1985 for forward-looking statements do not apply to companies filing an IPO registration declaration and are subject to the Proposed Rules climate related disclosure requirements.

Timing

The Proposed Rule’s comment period ends 30 days after publication in the Federal Register. May 20, 2022 is the longer period. The Proposed Rule was published on May 20, 2022, sixty days after its publication. This is consistent with the current practice of the SEC, which provides relatively short comment periods.

The Proposed Rule describes a phase-in process that all companies must follow. The final compliance date is dependent on whether the company is a large accelerated, accelerated, or non-accelerated filer or a smaller reporting company and the disclosure item. If the Proposed Rule is effective in December 2022 and the company’s fiscal year ends in December, the compliance date to the Proposed Rule disclosures in the annual reports, other that the Scope 3 emission disclosures, is December 31st.⁶It would be:

• For large accelerated filers fiscal year 2023 (filed on 2024);

• Fiscal year 2024, filed in 2025; and

• For smaller reporting businesses, fiscal year 2025 can be filed in 2026.

Large accelerated filers, accelerated filers, and accelerated filers will have additional time to transition into the attestation requirements for Scope 1 or 2 emissions. They would have one fiscal-year to provide limited assurance, and two fiscal years to provide reasonable assurance.

Large accelerated filers:

• Initial Disclosures fiscal year 2023 (filed 2024);

• Limited Assurance fiscal Year 2024 (filed 2025);

• Reasonable Assurance fiscal years 2026 (file 2027)

For accelerated filers

• Initial Disclosures fiscal year 2024 (filed 2025);

• Limited Assurance fiscal year 2025 (filed in 2026);

• Reasonable Assurance fiscal Year 2027 (file 2028).

Filers who have a fiscal year-end other than a calendar year that ends in their 2023 or twenty24 fiscal year before the compliance dates for the Proposed Rule, would not be required comply with the GHG disclosure obligations until the following fiscal.

Other Observations, Closing Thoughts

The Proposed Rule addresses materiality in a variety of cases in relation to the disclosures that should occur. There was speculation that the SEC might alter the traditional definitions of materiality to address climate-related disclosures. However, this was not the case.

The SEC acknowledged potential legal challenges to its Proposed Rule and argued in the Proposed Rule’s release that (1) the proposed disclosures are an outcome of investor demand; (2) many issuers (large accelerated filers) are quite far along in reporting on matters related to climate; (3) the Proposed Rule will ultimately simplify matters for investors and companies by providing a single reporting format in contrast to multiple reporting standards and non uniform reporting under such standards. It is not clear whether smaller reporting companies will be able to increase their compliance with the Proposed Rule in a cost-effective and timely manner. The SEC acknowledges the Proposed Rule’s costs in the Incremental, Aggregate Burdens and Cost Estimates section. However, it doesn’t mention that the Proposed Rule’s cost of implementation may be even more costly.

If adopted, the Proposed Rule will require public companies to substantially increase their investment in development, design maintenance, testing, auditing, and reporting of accounting controls. The quality of this investment will however make it easier to minimize any potential negative consequences of non-compliance.

Samuel J. WinerContributed to this article.

¹Proposed Rule available at https://www.sec.gov/rules/proposed/2022/33-11042.pdf.

²Statement on the Standardization and Enhancement of Climate-Related Disclosures by Investors, Caroline Crenshaw (Commissioner), Mar. 21, 2022).

³Commissioner Allison Lee, Shelter From the Storm: Helping Investors Navigate Climate Risk (Mar. 21, 2022).

⁴Commissioner Hester Peirce: We are not the Securities and Environment Commission At All Yet (Mar. 21, 2022).

⁵Three of the four Commissioners voted in favor of the Proposed Rule, with Commissioner Crenshaw, Chairman Gensler and Commissioner Lee applauding the rule and Commissioner Peirce disapproving.

⁶Scope 3 emissions disclosure obligations would be subject to an additional year of compliance by companies.