SEC Proposes New Rules for Climate Risk Disclosure
By: David A. Bell , Michael Pilo , Julia Forbess , Ron C. Llewellyn
The U.S. Securities and Exchange Commission has proposed rules and amendments that would require SEC reporting companies and companies filing registration statements to provide certain climate-related information in their annual reports and registration statements, respectively, specifically including information regarding (i) climate-related risks that are reasonably likely to have a material impact on their business, results of operations or financial condition and (ii) a company’s greenhouse gas (GHG) emissions. In addition, certain climate-related financial metrics would have to be disclosed in the company’s audited financial statements, and various other climate-related disclosures—such as climate expertise and board oversight—would be required in annual reports and registration statements.
In Release Nos. 33-11042; 34-94478 (the Proposing Release), the SEC states that disclosure of information regarding climate-related risks and metrics would be in the public interest and would protect investors, as well as promote efficiency, competition and capital formation. According to the Proposing Release, although some companies are already providing some climate-related information, current disclosure practices lack consistency, comparability and reliability, which the SEC states that the proposed rules attempt to address.
The Proposed Release notes that the SEC’s 2010 Guidance related to climate change disclosure still applies and that the current proposals are intended to augment and supplement the disclosures already required in SEC filings.
The proposed rules leverage and refer to the disclosure framework of the Task Force on Climate-Related Financial Disclosures (TCFD), which has developed a climate-related reporting framework, and the Greenhouse Gas Protocol (GHG Protocol), a leading accounting and reporting standard for GHG emissions.
Both frameworks are stated to enjoy widespread use and acceptance by companies, investors, regulators and other stakeholders where such reporting exists, which the SEC believes will mitigate the compliance burden associated with the new proposed disclosures.
The TCFD framework has 11 disclosure topics related to four core themes for the assessment, management and disclosure of climate-related financial risk: governance, strategy, risk management, and metrics and targets.
The GHG Protocol’s Corporate Accounting and Reporting Standards provide methods for reporting the seven principal GHGs covered by the Kyoto Protocol utilizing the GHG Protocol’s concept of “scopes” of emissions. Scope 1 emissions are GHG emissions generated directly by the company and sources owned or controlled by it, whereas Scope 2 emissions are generated indirectly primarily through the purchase and consumption of electricity and other forms of energy. Scope 3 GHG emissions, are defined as all indirect GHG emissions not otherwise included in Scope 2.
As more fully discussed below, under the proposed rules, a new subpart would be added to Regulation S-K which would require a company to disclose climate-related information, including the following:
This information would have to be provided in a separate and appropriately captioned section of the company’s registration statement or annual report captioned “Climate-Related Disclosure.” A company could also incorporate such information by reference in the new Climate-Related Disclosure section to another section of the registration statement or report, such as the Risk Factors, Description of Business or Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), or, in most cases, to another filed or submitted report.
The company would be required to present its climate-related information in a narrative discussion or analysis similar to MD&A disclosure, but focused specifically on climate-related risk.
The proposed rules would also add a new article to Regulation S-X that would require certain climate-related financial statement metrics, including disaggregated climate-related impacts on existing financial statement line items (subject to a de minimis 1% threshold) and related disclosures, to be included in a note to a company’s audited financial statements.
Whether narrative or quantitative, a company would have to tag the required climate-related information using Inline XBRL and, just as with the above proposed disclosures mandated by Regulation S-K, such information would be filed (not furnished).
Proposed Item 1502(a) of Regulation S-K would require companies to identify and disclose climate-related risks that are reasonably likely to have a material impact on their business or financial statements, which may manifest over the short-, medium- and long-term.
While the proposed rules allow each company to self-define these time horizons (providing flexibility to choose time periods that are most appropriate for their circumstances), the proposed rules otherwise use definitions based on those contained in the TCFD framework.
Risks may include those related to the physical impacts on the company or those with which it does business of the climate (physical risk) as well as those related to a transition to a lower carbon economy (transition risk). A company would be required to disclose the nature of the risk, and if it is a physical risk, whether it is acute (i.e., shorter term or event driven, such as a hurricane or flood) or chronic (i.e., subject to longer-term trend, such as drought or rising sea levels). Transition risks may include increased costs such as those stemming from new policies or regulations adopted in the United States and elsewhere, litigation or changing behaviors or demands of consumers, investors, employees and business partners.
The proposed rules would also require a company to disclose the location of its properties that are subject to disclosed physical risks, including a ZIP code or similar information. For a transition risk, a company would have to describe its nature, including whether it relates to regulatory, technological, market, liability, reputational or other factors and how it impacts the company.
Companies may also disclose information about climate-related opportunities when responding to the disclosure requirements.
The definition of materiality for purposes of the disclosure requirements that are qualified in that way would be based on the standard definition under securities laws (i.e., information that a reasonable investor would consider important in making an investment or voting decision) – rather than “double” (expanded) materiality concepts that have been advanced for climate-related disclosure elsewhere.
Companies would also be able to rely on the forward-looking statement safe harbors provided pursuant to the Private Securities Litigation Reform Act (PSLRA) for any forward-looking statements made, except with respect to such statements where the statutory safe harbor would not apply, such as those made in initial public offering registration statements.
Proposed Item 1502(b) of Regulation S-K would require companies to describe the actual and potential impact of climate-related risks on their strategy, business model and outlook for the material risks required to be disclosed by Item 1502(a). In particular, the proposed item would require a company to disclose the impacts of such material risks (including the time horizon) on its:
The proposed rules would require a company to disclose how it has considered the identified impacts as part of its business strategy, financial planning and capital allocation. A company would be required to provide both current and forward-looking disclosures to make clear whether the implications of the climate-related risks have been integrated into its business model or strategy, including how resources are being used to mitigate climate-related risks.
This disclosure must also discuss how any of the financial statement and GHG emissions metrics (referenced in proposed Rule 14-02 of Regulation S-X and proposed Item 1504 of Regulation S-K) and targets (referenced in proposed Item 1506 of Regulation S-K) relate to its business model or strategy.
The proposed rules would also require disclosure if a company uses carbon offsets or renewable energy credits or certificates (RECs) as part of its climate-related business strategy and their potential impact on its short- and long-term costs and risks.
If applicable, a company would be required to include information about any estimated cost of carbon emissions used internally (internal carbon price) that it uses, including the price of the reporting currency per metric ton of carbon dioxide equivalent (CO2e), the total price (including how it is estimated to change over time), the boundaries for measurement of overall CO2e on which the total price is based (if different from the GHG emission organizational boundary included in proposed Item 1504(e)), and the rationale for selecting the carbon price.
The proposed rules would require a company to describe how it uses its disclosed internal carbon price to evaluate and manage climate-related risks. If a company uses more than one internal carbon price, it would have to provide disclosures for each internal carbon price, and disclose its reasons for using different prices.
As described in the Proposing Release, a scenario analysis is a “process for identifying and assessing a potential range of outcomes of future events under conditions of uncertainty.” Under the proposed rules, a company would be required to describe any analytical tools, such as scenario analysis, that it uses to assess the impact of climate-related risks on its business and consolidated financial statements, or to support the resilience of its strategy and business model in light of foreseeable climate-related risks. Disclosure of the scenarios considered, including parameters, assumptions, and analytic choices, and the projected principal financial impacts on the company’s business strategy under each scenario would have to be provided. Notably, a company that does not employ scenario analysis or any other analytical tools to assess the impact of climate-related risks on its business and consolidated financial statements would not have to comply with this requirement.
Under the proposed rules, companies would also have to provide information regarding their governance structure for climate-related risks including the role of the board and management. With respect to its board, a company would have to disclose the board members or committees responsible for the oversight of climate-related risks, whether any board member has expertise in climate-related risks (with a detailed description of such expertise), the processes and frequency by which the board or board committee is informed of and discusses such risks, and how the board or board committee considers climate-related risks as part of its business strategy, risk management and financial oversight.
In addition, the company would be required to disclose how the board sets climate-related targets or goals and how it oversees progress against them, including the establishment of any interim targets or goals.
Similarly, companies would need to identify and disclose management positions or committees responsible for assessing and managing climate-related risks, including the relevant expertise of such personnel in sufficient detail.
In addition, the proposed rules would require the disclosure of management’s processes for monitoring and staying informed of climate-related risks and the nature and frequency of reporting to the board.
The proposed rules would require a company to describe any processes it has established for identifying, assessing and managing climate-related risks. This would include whether and how climate-related risks are integrated into its overall risk system management systems and processes. The proposed rules offer several questions for consideration in identifying, assessing and managing these risks that, if applicable, a company would be required to disclose, including how it:
The proposed rules define a transition plan as a company’s strategy and implementation plan to reduce climate-related risks. A company that has adopted a transition plan would be required to describe the relevant metrics and targets used to identify and manage physical and transition risks. In addition, it would have to disclose plans to mitigate or adapt to any identified physical and transition risks. Companies would be required to update their transition plan disclosures annually.
To the extent the discussion of a company’s transition plans under the proposed rules would constitute forward-looking statements, such discussion would be eligible for the PSLRA forward-looking statement safe harbors, assuming all other statutory requirements for those safe harbors are satisfied.
Under proposed Article 14 of Regulation S-X, if a company is required to file audited financial statements with its registration statement or annual report, it must provide certain disaggregated climate-related financial statement metrics that are mainly derived from existing financial statement line items, including financial impact metrics, expenditure metrics and financial estimates and assumptions.
The proposed rules would also require disclosure to be provided for the company’s most recently completed fiscal year and for the historical fiscal year(s) included in its consolidated financial statements in the applicable filing. The financial impact metric disclosure requirement would require a company to disclose the financial impacts of severe weather events, other natural conditions, transition activities, and identified climate-related risks on the consolidated financial statements included in the relevant filing unless their aggregated impact is less than 1% of the total line item for the relevant fiscal year. As proposed, the expenditure metrics would require a company to separately aggregate amounts of (i) expenditure expensed and (ii) capitalized costs incurred during the fiscal years presented and would be subject to the same 1% disclosure threshold as financial impact metrics.
Finally, a company would have to disclose if the financial estimates and assumptions used to produce its consolidated financial statements were impacted by risks and uncertainties due to climate-related events.
Item 1504 of the proposed rules would require companies to separately disclose their Scope 1 and Scope 2 GHG emissions for their most recently completed fiscal years, irrespective of whether they are material. A company would only be required to disclose Scope 3 GHG emissions if they are material or if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.
For each of its Scopes 1, 2 and 3 emissions, the proposed rules would require a company to disclose the emissions both disaggregated by each constituent greenhouse gas (e.g., by carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), nitrogen trifluoride (NF3), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6)) and in the aggregate. GHG emissions would have to be expressed in CO2e, the common unit of measurement of the GHG Protocol.
Companies would also be required to disclose the GHG intensity of their emissions (including Scope 3 emissions if applicable), which represents metric tons of CO2e per unit of total revenue and per unit of production for the fiscal year. Further, for all scopes of GHG emissions, the proposed rules would require a company to disclose GHG emissions data in gross terms, excluding any use of purchased or generated offsets.
The proposed rules would require disclosure to be provided for the company’s most recently completed fiscal year and for the historical fiscal years included in its consolidated financial statements in the applicable filing, to the extent such historical GHG emissions data is reasonably available. The methodology, significant inputs and significant assumptions used to calculate its GHG emissions metrics, including its organizational and operational boundaries, calculation approach and any calculation tools, would also have to be disclosed.
The SEC notes that GHG emissions data compiled for the EPA’s own GHG emissions reporting program would be consistent with the proposed rules, and therefore a company may use that data in partial fulfillment of its GHG emissions disclosure obligations pursuant to the proposed rules.
In addition to the materiality threshold noted above, companies would have to disclose Scope 3 emissions if they have set GHG emissions reduction targets or goals that include Scope 3 emissions. While the SEC has not proposed a quantitative threshold for determining materiality, it noted that some companies rely on, or support reliance on, a quantitative threshold such as 40% when assessing the materiality of Scope 3 emissions.
However, the SEC asserts that even when Scope 3 emissions do not represent a relatively significant portion of overall GHG emissions, a quantitative analysis alone would not suffice for purposes of determining whether Scope 3 emissions are material. In cases where Scope 3 emissions require disclosure, the company would have to identify the categories of upstream and downstream activities that have been included in the calculation and disclose emissions data for each category separately and in the aggregate.
A company would also be required to disclose the data sources for emissions, including emissions and data regarding specific activities reported by parties in its value chain and data derived sources outside of its value chain such as published databases, economic studies or government statistics. When determining whether its Scope 3 emissions are material, and when disclosing those emissions, in addition to emissions from activities in its value chain, a company would have to include GHG emissions from outsourced activities.
In addition, if there was any significant overlap in the categories of activities producing the Scope 3 emissions, a company would be required to describe the overlap, how it accounted for the overlap, and its disclosed total Scope 3 emissions.
Due to the potential difficulty for many companies in calculating Scope 3 emissions, the proposed rules provide certain accommodations related to Scope 3 disclosure. First, the rules provide for a targeted safe harbor from liability under federal securities laws for Scope 3 emissions data. In particular, disclosure of Scope 3 emissions pursuant to proposed subpart 1500 of Regulation S-K by or on behalf of a company in a document filed with the SEC would be deemed not to be a fraudulent statement unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.
Second, the proposed rules exempt smaller reporting companies (SRCs) from providing Scope 3 emissions disclosure. In addition, the proposed rules provide for a delayed compliance date for reporting Scope 3 emissions, as described below.
Finally, companies would be able to avail themselves of Rule 409 under the Securities Act of 1933 and Securities Exchange Act of 1934 Rule 12b-21, which allow for conditional omission of required information when such information is unknown and not reasonably available to the company, for their Scope 3 emissions disclosure.
If actual reported data is not reasonably available for the fourth quarter, a company may use an estimate of its GHG emissions, together with the actual data from its first three quarters, provided that it promptly discloses in a subsequent filing any material differences between its estimated amount and the actual amount of GHG emissions for the fourth quarter once that information becomes available. Other disclosure provisions related to GHG emissions disclosure would include:
Item 1505 of the proposed rules would require an accelerated filer or large accelerated filer to include in the relevant filing an attestation report covering the disclosure of its Scope 1 and Scope 2 emissions and to provide certain related disclosure about the attestation service provider.
Existing accelerated and large accelerated filers would have one year to provide limited assurance and two additional fiscal years to provide reasonable assurance, beginning with their respective compliance dates.
The Proposing Release includes the table below to illustrate the application of the transition period for compliance assuming the proposed rules are adopted with an effective date in December 2022 and the company has a December 31 year end:
Filer Type |
Scopes 1 and 2 GHG Disclosure Compliance Date |
Limited Assurance |
Reasonable Assurance |
Large Accelerated Filer |
Fiscal year 2023 (filed in 2024) |
Fiscal year 2024 (filed in 2025) |
Fiscal year 2026 (filed in 2027) |
Accelerated Filer |
Fiscal year 2024 (filed in 2025) |
Fiscal year 2025 (filed in 2026) |
Fiscal year 2027 (filed in 2028) |
Accelerated filers or large accelerated filers would have the option to obtain a level of assurance over their climate-related disclosures that surpasses the requirements under the proposed rules (e.g., obtaining limited assurance for Scope 3 emissions even though not required). In a limited assurance engagement, the service provider would express a conclusion about whether it is aware of any material modifications that should be made to the subject matter (e.g., the Scopes 1 and 2 emissions disclosure) in order for it to be fairly stated or in accordance with the relevant criteria. A reasonable assurance engagement, which provides a higher level of assurance compared to a limited engagement, would express an opinion on whether the subject matter is in accordance with the relevant criteria in all material respects.
The proposed rules would require the GHG emissions attestation to be prepared and signed by a GHG emissions attestation provider, which is defined as a person or a firm that is an expert in GHG emissions with significant experience in measuring, analyzing, reporting or attesting to GHG emissions and is independent from a company and any of its affiliates.
The proposed rules would require the attestation report be included in the separately-captioned “Climate-Related Disclosure” section in the relevant filing and provided pursuant to standards that are publicly available at no cost and are established by a body or group that has followed due process procedures, including the broad distribution of the framework for public comment.
The report must disclose several items specified in proposed Item 1504 of Regulation S-K. The attestation service provider would not have to be a registered public accounting firm.
In addition to the minimum attestation report requirements, a company would also be required to disclose certain additional matters related to the attestation of its GHG emissions, including whether the:
Proposed Item 1506 would require that if a company has publicly set climate-related targets or goals, it must disclose them and, as applicable, provide information about:
The proposed rules provide for a phase-in period for companies to comply with the proposed disclosure requirements as set forth in the table below. Assuming the proposed rules are adopted with an effective date in December 2022 and a company has a December 31 fiscal year-end, deadline for compliance would be as follows:
Filer Type |
Disclosure Compliance Date |
|
All proposed disclosures, including GHG emissions metrics: Scope 1, Scope 2, and associated intensity metric, but excluding Scope 3 |
GHG emissions metrics: Scope 3 and associated intensity metric |
|
Large Accelerated Filer |
Fiscal year 2023 (filed 2024) |
Fiscal year 2024 (filed 2025) |
Accelerated Filer and Non-Accelerated Filer |
Fiscal year 2024 (filed in 2025) |
Fiscal year 2025 (filed in 2026) |
SRC |
Fiscal year 2025 (filed in 2026) |
Exempted |
The proposed rules, if adopted, would substantially expand climate-related disclosures for many companies and result in significant expenditures of time and resources. Despite some of the accommodations under the proposed rules, it is likely that many smaller public companies that have not been reporting climate-related risk because they did not deem them to be material under current securities law requirements, will find compliance with the mandatory reporting requirements to be very burdensome.
In addition, some private companies may decide to reevaluate or delay their plans to go public given the potentially significant burdens and costs to comply with the proposed rules. It is also possible that even if the proposed rules are adopted, their implementation may be delayed as a result of litigation or other challenges. Still, companies should consider taking the following actions to prepare for compliance:
The SEC has established a deadline of the later of 30 days after publication in the Federal Register or May 20, 2022, as the deadline for the public to submit comments regarding the proposed rules.