Securities and Exchange Commission, or Securities and Environment Commission The SEC Proposes New Rules for Climate Related Disclosures | Foley & Lardner LLP

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, 2022.¹ For some the release marks “an important and long-awaited step forward”² and a “watershed moment” for financial markets;³ for others it exceeds the SEC’s statutory authority and “turns the disclosure regime on its head”⁴ — and these are just the reactions of the commissioners themselves.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 Rules

The Proposed Rule requires public companies to make more detailed disclosures to the SEC in their periodic reports regarding climate-related risks and their impact on the environment. This includes information about the company’s exposure to climate-related risk and its impact on the environment. It focuses primarily on greenhouse gas emissions (i.e., carbon dioxide and methane, nitrous oxides, hydrofluorocarbons and perfluorocarbons), as well as sulfur hexafluoride and nitrogen trifluoride The Proposed Rule is based on the Task Force on Climate-Related Financial Disclosures, (TCFD), and the Greenhouse gas Protocol (GHG Protocol).

• Climate-related risk disclosures in registration statements under the Securities Act of 1933, as amended (the ’33 Act), and in annual reports under the Securities Exchange Act of 1934, as amended (the ’34 Act).
  • The Proposed Rule defines climate-related risks as both physical and material risks. These are the risks posed due to climate change, such as disruptions or damage to businesses, or transition risks. These are the risks associated with transitioning to a lower carbon economy and the associated policy, reputation and technological efforts to mitigate climate changes.
• Disclosure of climate-related targets, goals, and transition plans, where applicable, along with the relevant baseline, metrics, time expected to achieve these targets or goals.
• Scope 1 and Scope 2 emissions of disaggregated greenhouse gas (the seven listed above) are reported. GHG intensity is the ratio between GHG emissions and economic value — for example, the ratio of metric tons of carbon dioxide per unit of total revenue or production.
• Scope 3 emissions should be reported if they’re material or if the company set a GHG emissions reduction goal or target that includes Scope 3 emission.
  • 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 are available for large accelerated filers as well as accelerated filers.
  • The Proposed Rules allows such attestations to be provided by parties other than registered public accounting firms.
• Inclusion of certain climate-related financial statement metrics and related disclosure in a note to the company’s audited financial statements, including disaggregated climate-related impacts on existing financial statement line items. Disclosure would be required if climate risks affect 1% or more of the absolute value of the line item — meaning gains and losses are added, not netted, in reaching such disclosure determinations.
• Financial statement metrics will be subject to audit by an independent registered public accounting firm and considered within the scope of the company’s Internal Controls Over Financial Reporting (ICFR).
• 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 of oversight and governance of climate-related risks by a company’s board of directors and management. This oversight will require companies test a range of accounting and disclosure controls in order to ensure compliance.

Public companies will be required to design and develop new disclosures and accounting controls under the Proposed Rule. These will need to map, test, and audit.

The SEC’s Prior Efforts to Enhance 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, 2021 that its Division of Enforcement had established a 22-member ESG task force to investigate misleading statements about climate risks and failures of money managers to invest and maintain proper procedures consistent in any professed commitment to prioritize ESG when deploying investor funds.

Allison Lee, Acting Chair of SEC, spoke out about the growing investor interest in the effects of climate change on public corporations and the desire of the investment community to have more climate-related information to help inform its investment decisions. Acting Chair Lee stated that the SEC wanted more public input into its process of fashioning further guidance on disclosure in this space and solicited answers to 18 questions she believed should inform the SEC’s efforts to enhance the disclosure of climate-related information in the periodic reports of public companies.

On April 19, 2021, the SEC’s Division of Examinations published a Risk Alert describing observed shortcomings of money managers’ professed commitment to investing with an emphasis on ESG. To further inform preparers of securities filings of the heightened expectations of the SEC, in September 2021 the SEC’s Division of Corporation Finance published a form comment letter containing sample observations on the method and quality of climate-related disclosures of a hypothetical public company. The SEC sent similar comments letters to 38 other issuers after publishing this form comment letter. These responses were used to inform the crafting of Proposed Rule.

Continuing the SEC’s drumbeat, on December 7, 2021, Chairman Gensler predicted that the SEC’s anticipated climate-related risk rules would require public companies to measure the impact of their commitments to mitigating climate change and the challenges they face in responding to climate change. After the Commission signaled earlier in 2022 that its expected rule proposal might be delayed, Senator Elizabeth Warren wrote a letter to Chairman Gensler expressing her displeasure and characterizing the delays as “unwarranted and unacceptable, and violat[ive of]Your commitment made seven months ago [during Gensler’s confirmation process].” On March 15, 2021, Senator Warren again berated the SEC for its delay, stating “it’s taken far too long for the SEC to take action.”

Recent Actions by International Regulators and their Advisors to Promote Climate Related Disclosures

The SEC’s release follows extensive efforts by international regulators and their advisers to develop standards for climate-related disclosures that foreign public companies are increasingly expected to publish. The G-20 Financial Stability Board created the TFCD in December 2015 to establish requirements for disclosures about corporate efforts to address climate change risks. The TFCD, which was headed by Mary Schapiro, ex-SEC Chair, and Michael Bloomberg, was responsible for defining the metrics companies should use in order to measure and report on their effectiveness. The work of the TFCD features prominently in the substance of the SEC’s Proposed Rule.

According to the TFCD, as of 2021 more than 2,000 companies having a market cap of over $22 trillion and financial institutions managing nearly $180 trillion expressed support for the TFCD’s recommendations. The TFCD’s recommendations have been adopted by the United Kingdom, Australia, Japan and Canada.

On September 11, 2020, the Carbon Disclosure Project, Climate Disclosure Standards Boards, the Global Reporting Initiatives, the Global Reporting Counsel, The International Integrated Reporting Counsel and the Sustainability Accounting Standards Board published a jointly published report that proposed a framework and standards to ensure sustainability disclosure, including climate-related reporting. 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 ISSB is expected to build on the work of the TFCD and other sustainability standard setters to develop disclosure standards that provide financial markets with actionable information on companies’ exposure to climate change risk and the impact of those companies on the environment.

The above suggests that the SEC has been late in adopting climate-related disclosure requirements for public companies in the U.S.A and elsewhere. That perception, and many of the nearly 600 comments received in response to Acting Chair Lee’s March 2021 invitation, has undoubtedly prompted the SEC to advocate for the extensive disclosure contemplated in 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 also requires public companies to disclose:

• The oversight and governance of climate-related risks by a company’s board and management; any board committees responsible for oversight of climate-related risks; whether any specific board member has climate-related risk expertise and, if so, a description of such expertise; and how frequently the board committees discuss climate-related risks.
• How climate-related risk (physical risks and transition risks) have had or are likely have a material affect on the company’s business and consolidated financial statements. This could be in the short, medium or long term. Companies would be required to describe what they mean by “short, medium, or long term.” Companies also would be required to describe physical risks as either acute or chronic and would have to provide the ZIP code location of the properties or operations subject to physical risk
• How any identified climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook. Companies would have to disclose how these risks impact their consolidated financial statements. 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 that use an internal carbon price in assessing climate risk or determining climate strategy would need to disclose how this price was calculated, as well as the price per metric tons of carbon dioxide. Companies must describe the resilience of their business strategy. A detailed description of the assumptions and parameters required for scenario analyses is essential.
• The company’s processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into the company’s overall risk management system or processes.
• Reporting on the impact of climate-related events on the line items of the company’s consolidated financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities, including:
  • Severe weather events or other natural conditions
  • Risks physical
  • Transition activities (including any identified transition risks by the company).
• Scopes 1 and 2, GHG emissions, intensity, separately disclosed. Scope 3 GHG emission and intensity, if any, if the company has set an emissions reduction target or goal that includes Scope 3.
• The company’s climate-related targets or goals and transition plan, if any. Any discussion on a transition plan should address relevant metrics and targets.

When responding to any of the Proposed Rule’s provisions concerning governance, strategy, and risk management, however, a company may also disclose information concerning any identified climate-related opportunities.

Specific GHG Disclosures

Scope 1 emissions are direct GHG emissions from sources controlled or owned by a company. Scope 2 emissions must also be disclosed by all companies. These are emissions that primarily result from electricity generated and consumed by the company. Scope 1 emissions must be disclosed as both disaggregated greenhouse gases and in aggregate. Scope 2 emissions must also be disclosed, including in terms intensities. 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 are indirect emissions not accounted for in Scope 2 emissions, meaning emissions that are a consequence of the company’s activities but are generated from sources that are neither owned nor controlled by the company, such as suppliers, vendors, and customers. Scope 3 emission must be disclosed if they’re material or if the company sets a GHG emission reduction target or goal that includes Scope 3 emission. The Proposed Rule provides a phase-in period to disclose Scope 3 emissions, a safe harbor for Scope 3 emission disclosure, and an exemption for companies that meet the criteria for a smaller reporting company.

The Proposed Rule requires disclosure, in addition to aggregate GHG emissions, of Scope 1 & 2 emissions in terms GHG intensity. Companies reporting Scope 3 emissions must also disclose the separate GHG intensity.

Non-Compliance: Liability

The Proposed Rule requires companies that climate-related disclosures be filed, not furnished, by the companies. Thus, the disclosures are subject to potential liability under Section 11 of the ’33 Act and Section 18 of the ’34 Act. The exception would be for disclosures furnished on Form 6-K as disclosures on Form 6-K are treated as furnished under the SEC’s foreign private issuer disclosure system.

Scope 3 emissions disclosure would also be exempted from certain types of liability. The SEC recognizes that information about Scope 3 emissions is outside a company’s control and may be difficult for a company to verify, such that a company will need to rely on estimates and assumptions. The Proposed Rule states that disclosures of Scope 3 emissions will not be considered fraudulent unless there is evidence that the statement was made or reaffirmed on a reasonable basis or disclosed in good faith.

In the commentary to the Proposed Rule, the SEC notes that the existing safe harbor for forward-looking statements under the ’33 Act and the ’34 Act would be available for forward-looking climate-related disclosures. It should be noted, however, that the safe harbor protections for forward-looking statements under the Private Securities Litigation Reform Act of 1995 do not apply to companies that are filing an IPO registration statement and are otherwise subject to the Proposed Rule’s climate-related disclosure requirements.

Timing

The Proposed Rule’s comment period expires 30 days after its publication in Federal Register. Or May 20, 2022, depending on which period is shorter. May 20, 2022, which is sixty days after the SEC released the Proposed Rule, is in keeping with the SEC’s current practice of providing relatively short comment periods.

The Proposed Rule outlines a phase-in process for all companies, with the final compliance date dependent on the company’s filer status as a large accelerated filer, accelerated or non-accelerated filer, or smaller reporting company, and the content of the item of disclosure. If the Proposed Rule is effective in December 2022 and a company has a December 31st financial year-end, the compliance deadline for the Proposed Rule disclosures in the annual reports, other that the Scope 3 emission disclosures, is December 2022.⁶ 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 and fast filers would have more time to transition to the attestation requirements of Scope 1 and 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 in 2024);
• Limited Assurance – fiscal year 2024 (filed 2025);
• Reasonable Assurance – fiscal year 2026 (file 2027).

For accelerated filers

• Initial Disclosures – fiscal year 2024 (filed in 2025);
• Limited Assurance – fiscal year 2025 (filed 2026);
• Reasonable Assurance – fiscal year 2027 (file 2028).

Filers with a non-calendar fiscal year-end that occurs in their 2023, or 2024 fiscal years before the compliance dates set forth in the Proposed Rule will not be required to comply until the next fiscal year.

Other Observations and Closing Thoughts

The Proposed Rules refers to materiality in several instances in connection to disclosures that should have been made. The possibility that the SEC might change its traditional definition of materiality in connection with climate-related disclosures was rumored prior to the Proposed Rule’s release. However, the SEC didn’t do so.

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 remains to be seen if smaller reporting companies would have the ability to scale up quickly and cost-effectively to comply with this Proposed Rule. In the release for Proposed Rule, the SEC acknowledges that the Proposed Rule will have significant costs. However, it does not mention that the Proposed Rule could be more expensive.

The Proposed Rule, if adopted, would require public companies increase their investment in the design, maintenance, testing, development, and auditing accounting controls and disclosure controls. However, it will be important to ensure that the investment is of high quality in order to minimize any potential negative consequences of non-compliance.