Earlier this week, the SEC announced proposed rules (Release No. 33-11042) for new, climate-related disclosures. The proposals dramatically expand the requirements of the SEC’s 2010 guidance on climate-related disclosures. While most large companies have been providing some climate-related information as part of ESG reporting in CSR or Sustainability Reports outside of their SEC filings, these rules, if adopted, will necessitate a significant overhaul of companies’ climate-related analysis, procedures, and reporting and will subject any climate-related disclosure to stricter securities law liability standards.
The proposed amendments modify Regulation S-X and Regulation S-K to require the following disclosures:
- Processes used to identify, assess, and manage climate-related risks, including how their materiality is determined
- Oversight and governance of climate-related risks by the board and management, including a description of expertise in climate-related matters
- Climate-related risks (physical or transition related) reasonably likely to have material impact on the company in the short-, medium-, and long-term (as defined by the company), on consolidated financial statements line items, subject to audit by the company’s outside auditors
- Material impact on strategy, business model, and outlook, from climate-related risks
- Details of the strategy and implementation plan to reduce climate-related risks (a transition plan), if adopted, including relevant metrics and targets used to identify and manage any physical and transition risks
- Description of any scenario analysis performed, including the scenarios, parameters, assumptions, analytical choices, and projected principal financial impacts
- The carbon price, if any, used in internal company planning, including a description of how the price was set and any expected change in that carbon price over time
- Impact of potential climate-related events (including severe weather events and sea level changes) and transition activities on financial statement line items, as well as any financial estimates and assumptions used
- Quantitative disclosure of greenhouse gas (GHG) emissions, both direct (Scope 1) and indirect (Scope 2), including individual GHGs, aggregate GHG emissions, absolute emissions and emissions per unit of economic activity (emissions intensity)
- Quantitative disclosure of additional indirect emissions from activities in the value stream that are upstream and downstream from the company (Scope 3), if material or if the company has set GHG reduction targets or goals (with the exemption of Smaller Reporting Companies, further described below)
- Any GHG emission reductions targets and the use of carbon offsets or renewable energy credits to achieve those targets
Notably, disclosures regarding GHG emissions by accelerated filers and large accelerated filers will require an attestation from an independent third-party expert. The proposed rules establish guidelines for this new type of attestation provider based on some of the approaches used for independent financial audits.
Mitigating Aspects of the Proposed Rules
The SEC made some choices reflecting the expected costs and difficulties:
- TCFD and GHG Protocol:
The proposed rules are based on existing voluntary sustainability reporting frameworks: the G-20 affiliated Taskforce on Climate-Related Financial Disclosure (TCFD) and the Greenhouse Gas Protocol (GHG Protocol). The SEC says it selected TCFD because of its wide use internationally, with the EU and the UK indicating their intention to base mandatory climate-risk disclosures on it. The SEC says it chose the GHG Protocol because it is recommended by the EPA and incorporated into TCFD and other widely used sustainability reporting frameworks.
The TCFD framework is used by many companies, though it is not currently the most-used framework in the US. More companies use other frameworks, such as CDP, GRI, CDSB and SASB, and of the companies that do use TCFD and the GHG Protocol, many do not entirely follow those frameworks.
- Phase-In Periods:
The proposed rules will provide a phase-in period depending on the company’s filer status. The earliest disclosure requirements will come into effect in 2024 (filing for fiscal year 2023) for Large Accelerated Filers. Smaller Reporting Companies, on the other hand, will not have any required disclosures until 2026 (filing for fiscal year 2025).
Because a majority of S&P 500 companies are disclosing ESG information outside of SEC submissions and very few are obtaining assurance from a public auditing firm regarding ESG information, a two or three year phase-in period means that most companies will need to take prompt action to prepare for compliance.
- Safe Harbors:
The proposed rules discuss two types of safe harbors. The first is an entirely new safe harbor for Scope 3 emissions disclosures. This safe harbor addresses Scope 3 disclosure liability concerns for inaccurate statements based on information provided by third parties, as long as such statements are reaffirmed with reasonable basis and in good faith.
The second is a pre-existing safe harbor pursuant to the Private Securities Litigation Reform Act (PSLRA) for forward-looking statements. While the proposed rules incorporate this safe harbor, it is important to note that there are limitations to its protection. This safe harbor will not apply to forward-looking statements made in connection with an IPO, or to MLPs and other non-corporate entities. It also will not limit the SEC’s ability to bring enforcement actions.
Smaller Reporting Companies are exempted from Scope 3 emissions disclosure requirement.
However, the proposed rules do not contain any exemption for newly public issuers, and so would require the mandated disclosures in registration statements for IPOs. The proposed rules also would not exempt foreign issuers.
In anticipation of the new rules adoption, companies should be prepared to address the following:
- Board and management structures, controls and procedures for assessing and reporting climate-related risks across short-, medium-, and long-term horizons.
- How climate-related expertise will be integrated into board and management oversight.
- Methodology for preparing and contextualizing financial statements to include climate-related financial impact metrics, climate-related expenditure metrics, and climate-related financial estimates and assumptions.
- Methodology for calculating GHG emissions and engaging an independent and expert third-party to serve as an attestation provider, if required.
- Controls and procedures for providing historical fiscal year climate-related disclosures on consolidated financial reports.
- Discussions reserved for climate-related risks at board meetings.
The SEC has been tightening comment periods, so comments on the proposed rules are due on the later of May 20, 2022 or 30 days after their publication in the Federal Register.
If you have any questions about these or related topics, your regular Locke Lord contact or any of the authors can discuss these matters with you.
For a more detailed discussion, see our QuickStudy: SEC Proposes Climate-Related Disclosure Rules – What You Need to Know.