The U.S. Securities and Exchange Commission (SEC) has proposed to expand and standardize company disclosures about their carbon emissions and other climate-related metrics, as part of a complicated set of rules that will require extensive effort for companies to complete. The SEC intends that these rules will provide investors with a more uniform and effective mechanism to analyze a company’s progress on reducing carbon emissions and information about the effects of climate-related risks on its business. The comment period will remain open until at least May 20, 2022, and will close 30 days from the date published in the Federal Register, suggesting a desire for a quick turnaround. The earliest that disclosures would be required is for fiscal year 2023, to be filed in 2024.
The proposed regulations are contained in a more than 500-page release that includes many more details than we have summarized here. Our summary is based on a read of that proposal and both the SEC press release and fact sheet released on March 21.
The main part of the proposal is a new Subpart 1500 of Regulation S-K that would require both domestic and foreign private issuers to include climate-related disclosures in annual reports. These disclosures would also need to appear in company registration statements and reports. The expanded rules would require a reassessment of how boards of directors oversee company actions to address climate-related risks that, for many companies, would require increased board engagement with management efforts to mitigate those risks.
This new subpart would require a company to disclose (1) certain climate-related information, including information about its climate-related risks that are reasonably likely to have material impacts on its business or consolidated financial statements; and (2) greenhouse gas (GHG) emissions metrics that could help investors assess those risks. Companies also may choose to disclose climate-related opportunities.
The proposed climate risk disclosures are aligned with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), with the goal being that disclosures are consistent, comparable and reliable. It is noteworthy that unlike with the TCFD recommendations, which would have been mandatory, companies would be given the latitude to determine if information must be disclosed based on this “reasonably likely to have material impacts” standard, rather than having the SEC require these disclosures for all companies in all cases. Some pundits have suggested this softer stance is a nod to the possibility of litigation against the SEC for establishing an overbroad rule that would create additional costs for companies in industries where certain of these risks might not be material.
The GHG metrics are based on the GHG Protocol’s Corporate Accounting and Reporting Standard that provides uniform methods to measure and report the seven greenhouse gasses covered by the Kyoto Protocol: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride and nitrogen trifluoride.
The proposed Regulation S-K would require these climate-related disclosures to appear in a separate, appropriately captioned section of a company’s registration statement or annual report as the Climate-Related Disclosure. Alternatively, this information could be incorporated in this section by reference to another disclosure section, such as Risk Factors, Description of Business, or Management’s Discussion and Analysis (MD&A). The proposed rules are extensive and detailed — best understood with detailed study — so this description should be viewed only as a synopsis.
(Item 1501) Governance. This disclosure would focus on both the level of board of director expertise and its actual oversight activities relating to climate-related risks. Disclosures would need to detail how these climate-related risks factor into the board’s oversight of business strategy, risk management and financial management. The extent to which the board sets climate-related goals for management, and the specifics of those goals, also would need to be disclosed.
The governance disclosure also would focus on management’s roles in assessing and managing climate-related risk that mirror those required for the board. There is a greater emphasis here on who does what (process-focused) and how management is organized to deal with climate risks, along with a similar description of the expertise of management in this area.
(Item 1502) Strategy, business model and outlook. As mentioned above, the key standard by which a company would determine whether a disclosure under this section would be required is whether any climate-related risks are “reasonably likely to have a material impact on a [company], including its business or consolidated financial statements, which may manifest over the short, medium, and long term." Actual and potential impacts of any climate-related opportunities also could be presented, if applicable.
These disclosures could fall into one of several categories, including physical risks to property, processes or operations (e.g., flooding) or transitional risks relating to regulatory, technological, market (including changing consumer, business counterparty and investor preferences), liability, reputational or other transition-related factors (e.g., operations in jurisdictions imposing GHG emissions reduction standards). Quantification of relative risks and time horizons would also need to be described.
Once the climate-related risks are identified, the company would then need to describe the actual and potential impacts of these risks on its strategy, business model and outlook. Impacts could be on the company itself; its suppliers, products and services delivered; how it might mitigate those impacts, including research and development efforts to do so; and any other significant changes or impacts, along with time horizons for impacts and mitigations. The actual and potential impacts of these considerations would also need to be included in both current and forward-looking disclosures as to business strategy, financial planning and capital allocation.
Climate-related risks described above would also need to be included into a narrative on how they have affected or are reasonably likely to affect the presentation of the company’s consolidated financial statements. Specific reference should be made to climate-related financial metrics that are described in the financial statement reporting rules also proposed in this release. These could include the impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a company’s consolidated financial statements, and the financial estimates and assumptions used.
(Item 1503) Risk management. This section is really the mirror of the prior section, in that a company would describe its 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. We would expect this section to include extensive discussions of the specific transition plan a company is taking to mitigate climate-risk impacts and whether it is focused on the metrics it will measure to understand success in those mitigations (e.g., restricting GHG emissions). Another example cited would be if a company uses an internal carbon price, it must disclose information about the price and how it is set. Consistent with the rules noted in prior sections, there are a litany of potential disclosures a company could include, based on its specific circumstances.
(Item 1504) GHG emissions metrics. This section is part of the Regulation S-K disclosures section, but we have listed it as a separate topic because the proposal requires these disclosures for Scope 1 and 2 emissions for all companies without regard to the materiality standard referenced above. Noteworthy is the fact that Scope 3 emission disclosures would be subject to a materiality standard in determining the need for disclosure.
Many details on how to calculate GHG intensity in the proposal are technical in nature and must be carefully studied, so we have presented a general description of the terminology provided by the SEC, with a few of our impressions (pardon the legalese).
Scope 1 emissions are direct GHG emissions that occur from sources owned or controlled by the company. These might include emissions from company-owned or controlled machinery or vehicles, or methane emissions from petroleum operations.
Scope 2 emissions are those emissions primarily resulting from the generation of electricity purchased and consumed by the company. Because these emissions derive from the activities of another party (the power provider), they are considered indirect emissions.
Scope 3 emissions are all other indirect emissions not accounted for in Scope 2 emissions. These emissions are a consequence of the company’s activities but are generated from sources that are neither owned nor controlled by the company. These might include emissions associated with the production and transportation of goods a company purchases from third parties, employee commuting or business travel, and the processing or use of the registrant’s products by third parties.
Determining whether Scope 3 emissions must be disclosed is generally subject to a materiality threshold; however, it appears that to determine if the emissions from the activities are material, a company must first identify the categories of upstream and downstream activities that take place from other sources. This means a significant amount of information must be solicited from outside the company, which suggests this information would be provided as a contractual matter from other entities both up and down a company’s supply chain.
To mitigate potential liability for relying on a third-party source for this information, the proposal provides that companies would not be deemed to make a fraudulent statement on Scope 3 emissions unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.
The Scope 3 rule also would require, without regard to materiality, that a company disclose its Scope 3 emissions if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.
(Item 1505) Attestation of Scope 1 and Scope 2 emissions disclosure. This rule would require a third party — called a GHG emissions attestation provider — to attest to certain assurance levels that ramp up over time covering these disclosures for large accelerated and accelerated filers. The details here are beyond the scope of this summary but underscore that companies would have a lot of work to do internally before they would be prepared to hand that information over to a third party for attestation. The SEC does not include the standards for those attestations in its proposal but contemplates they could be set by a governing body that will authorize so-called GHG emissions attestation providers to perform these services.
(Item 1506) Targets and goals. We read this section to mean that disclosing targets and goals, if applied to climate-risk mitigation, might already have been included in disclosures referenced earlier (1502 or 1503). The proposal would require disclosure if a company has set any targets or goals related to reducing GHG emissions, or any other climate-related target or goal (e.g., regarding energy usage, water usage, conservation or ecosystem restoration, or revenues from low-carbon products), such as actual or anticipated regulatory requirements, market constraints, or other goals established by a climate-related treaty, law, regulation, policy or organization. These disclosures would include the scope of activities and emissions included in the target, how the company intends to meet its targets and goals, updates in each fiscal year on progress toward the target or goal and how such progress has been achieved, and if carbon offsets or renewable energy certificates detailed information on how they helped to meet the targets or goals.
The SEC also proposed to add a new Article 14 of Regulation S-X that would require certain of the above-referenced climate-related financial statement metrics and related disclosure to be included in a note to a company's audited financial statements. These would consist of what are known as disaggregated climate-related impacts on existing financial statement line items. These financial statement metrics would be subject to audit by an independent registered public accounting firm and would come within the scope of the registrant’s internal control over financial reporting.
The proposed rules would include:
Generally speaking, the rules would go into effect for large accelerated filers beginning in fiscal year 2023 for disclosure in 2024 filings. Please refer to the fact sheet, page 3, for more details on effective dates for the phase-ins.
We will continue to track these proposed climate disclosures through the regulatory process and provide more insights.
