[This post is Part I of a revision and update of my earlier post primarily reflecting the contents of the proposing release. This post covers background and describes various aspects of the proposal other than the sections on GHG emissions disclosure and attestation, which will be covered in a separate post early next week.]
The SEC describes it modestly as a proposal to “enhance and standardize registrants’ climate-related disclosures for investors.” The WSJ called it “the biggest potential expansion in corporate disclosure since the creation of the Depression-era rules over financial disclosures that underpin modern corporate statements,” and Fortune said it “could be the biggest change to corporate disclosures in the U.S. in decades.” But now you can judge for yourself, after the SEC voted earlier this week, three to one, to propose new rules on climate disclosure regulation. The proposal was designed to require disclosure of “consistent, comparable, and reliable—and therefore decision-useful—information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.” The proposal would require public companies to disclose information about climate-related risks that are reasonably likely to have a material impact on their businesses, results of operations or financial condition, as well as information about the effect of climate risk on companies’ governance, risk management and strategy. The disclosure, which would be included in registration statements and periodic reports, would draw, in part, on disclosures provided for under the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. Compliance would be phased in, with reporting for large accelerated filers due in 2024 (assuming an—optimistic—effective date at the end of this year). The proposal would also mandate disclosure of a company’s Scopes 1 and 2 greenhouse gas emissions, and, for larger companies, Scope 3 GHG emissions if material (or included in the company’s emissions reduction target), with a phased-in attestation requirement for Scopes 1 and 2 data for large accelerated filers and accelerated filers. The proposal would also require disclosure of certain climate-related financial metrics in a note to the audited financial statements. At 510 pages, the proposal is certainly thoughtful, comprehensive and stunningly detailed—some might say overwhelmingly so. If adopted, it would surely require a substantial undertaking for many companies to get their arms around the extensive and granular requirements and comply with the proposal’s mandates. How companies would manage this enormous effort remains to be seen.
According to SEC Chair Gary Gensler,
“[o]ur core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions. Today’s proposal would help issuers more efficiently and effectively disclose these risks and meet investor demand, as many issuers already seek to do. Companies and investors alike would benefit from the clear rules of the road proposed in this release. I believe the SEC has a role to play when there’s this level of demand for consistent and comparable information that may affect financial performance. Today’s proposal thus is driven by the needs of investors and issuers.”
Why does the SEC believe that the rules are necessary? The SEC makes its case as follows:
“Climate-related risks can affect a company’s business and its financial performance and position in a number of ways. Severe and frequent natural disasters can damage assets, disrupt operations, and increase costs. Transitions to lower carbon products, practices, and services, triggered by changes in regulations, consumer preferences, availability of financing, technology and other market forces, can lead to changes in a company’s business model. Governments around the world have made public commitments to transition to a lower carbon economy, and efforts towards meeting those greenhouse gas (‘GHG’) reduction goals have financial effects that may materially impact registrants. In addition, banking regulators have recently launched initiatives to incorporate climate risk in their supervision of financial institutions. How a company assesses and plans for climate-related risks may have a significant impact on its future financial performance and investors’ return on their investment in the company. Consistent, comparable, and reliable disclosures on the material climate-related risks public companies face would serve both investors and capital markets. Investors would be able to use this information to make investment or voting decisions in line with their risk preferences. Capital allocation would become more efficient as investors are better able to price climate-related risks. In addition, more transparency and comparability in climate-related disclosures would foster competition. Many other jurisdictions and financial regulators around the globe have taken action or reached similar conclusions regarding the importance of climate-related disclosures and are also moving towards the adoption of climate-related disclosure standards.”
In its economic analysis, however, the SEC acknowledges the magnitude of the undertaking. For companies that are not already gathering the information required to be disclosed under the proposed rules, they “may need to re-allocate in-house personnel, hire additional staff, and/or secure third-party consultancy services. Registrants may also need to conduct climate-related risk assessments, collect information or data, measure emissions (or, with respect to Scope 3 emissions, gather data from relevant upstream and downstream entities), integrate new software or reporting systems, seek legal counsel, and obtain assurance on applicable disclosures (i.e., Scopes 1 and 2 emissions). The SEC estimates the costs in the first year of compliance, for companies that are not smaller reporting companies, “to be $640,000 ($180,000 for internal costs and $460,000 for outside professional costs), while annual costs in subsequent years are estimated to be $530,000 ($150,000 for internal costs and $380,000 for outside professional costs). For SRC registrants, the costs in the first year of compliance are estimated to be $490,000 ($140,000 for internal costs and $350,000 for outside professional costs), while annual costs in subsequent years are estimated to be $420,000 ($120,000 for internal costs and $300,000 for outside professional costs).” Hmmmm. Only time will tell how accurate those estimates are.
The comment period will be open for 30 days after publication in the Federal Register, or May 20, 2022 (60 days after the date of issuance and publication on sec.gov), whichever period is longer.
As summarized in the fact sheet, domestic and foreign public companies would be required to disclose:
- “Climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook;
- The registrant’s governance of climate-related risks and relevant risk management processes;
- The registrant’s greenhouse gas (‘GHG’) emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance;
- Certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements; and
- Information about climate-related targets and goals, and transition plan, if any. “
Of course, the topic is not exactly new to the SEC. In 2010, the staff issued interpretive guidance regarding climate change disclosure, addressing in some detail how then-current disclosure obligations could apply to climate change, such as the Reg S-K requirements for business narrative, legal proceedings, risk factors and MD&A. (See this PubCo post.) Nevertheless, many have viewed the current regulatory regime as ineffective in eliciting appropriate climate disclosure. As described in this 2021 report from the Institute for Policy Integrity at NYU and the Environmental Defense Fund, two years after the issuance of the 2010 guidance, the SEC reported to Congress that it had not seen a noticeable change in disclosure as a result, a conclusion supported by
“outside studies conducted in the first few years after publication of the guidance reached similar conclusions. One examination of disclosures made for fiscal years 2010 to 2013, for example, found that disclosures ‘are very brief, provide little discussion of material issues, and do not quantify impacts or risk,’ and that 41% of corporations did not include any climate-related disclosure in their annual report. Even now, some corporations continue to avoid climate risk disclosures whole cloth. Others provide only boilerplate disclosures that are neither corporation-specific (or even industry-specific) nor decision-useful—that is, they do not help investors understand and assess the risk the corporation faces or how that risk compares to those faced by other corporations.”
And that state of affairs largely continued in periodic reporting, even in the face of the development of numerous voluntary frameworks and standards. Indeed, the SEC contends, to some extent, the proliferation of frameworks under private ordering has made reporting more difficult and contributed to fragmentation. Because they are voluntary, the proposing release contends, “companies that choose to disclose under these frameworks may provide partial disclosures or they may choose not to participate every year. In addition, the form and content of the disclosures may vary significantly from company to company, or from period to period for the same company.” Various studies have “found a lack of transparency and standardization with regard to the methodologies companies apply in disclosing climate-related information.” Because much of the disclosure appears outside of SEC filings, the SEC observed, it is harder for investors to locate and compare this information. In addition, it is not subject to disclosure controls and procedures or to the same level of “additional potential liability, which itself can cause registrants to prepare and review information filed in the Form 10-K more carefully than information presented outside SEC filings.”
What’s more, the 2021 report said, Corp Fin had failed, up to that point, to use the review process to elicit more disclosure. In 2010, according to the report, Corp Fin sent 49 letters to companies that included comments regarding their climate risk disclosure, but sent only three in 2012 and none in 2013. Since 2016, the report could identify only six comment letters with comments on climate risk disclosure. (See this PubCo post.)
That began to change in February 2021, when then-Acting SEC Chair Allison Herren Lee directed the staff of Corp Fin, in connection with the disclosure review process, to “enhance its focus on climate-related disclosure in public company filings,” starting with the extent to which public companies addressed the topics identified in the 2010 interpretive guidance. The staff would also “assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.” (See this PubCo post.) Lee also issued a statement in March 2021 requesting public input on climate disclosure, observing that, since the 2010 guidance, investor demand for climate disclosure has increased dramatically, and questions have arisen about “whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts, and opportunities, and whether greater consistency could be achieved.” According to Gensler, 600 unique comment letters were submitted in response and were beneficial in developing the proposal.
In September last year, Corp Fin posted a sample letter to companies containing illustrative comments regarding climate change disclosures, presumably designed to help companies think about and craft their climate-related disclosure. (See this PubCo post.) And the staff then began to issue more climate-related comments as part of the disclosure review process. Most of these comments, however, related to climate discussions in companies’ voluntary corporate social responsibility reports; the WSJ has reported that about 90% of companies in the S&P 500 publish reports voluntarily disclosing climate-related statistics, such as GHG emissions; however, only “16% report similar metrics in regulatory filings, according to S&P Global Sustainable1….” Many of the comments asked companies to justify—in some detail—why the disclosure in their corporate social responsibility reports wasn’t also in their SEC filings and drilling down on companies’ responses that they did not disclose certain climate information in their SEC filings because the information was not viewed to be material. In many of those cases, the SEC indicated that they viewed the companies’ responses to be conclusory and pressed the companies to drill down in their responses by providing quantitative details or more detailed explanations to justify their conclusions. (See this PubCo post.)
To be sure, investors have also been clamoring for better and more comparable climate information. As Gensler indicated in his statement, “investors with $130 trillion in assets under management have requested that companies disclose their climate risks.” In 2021, a group of 587 institutional investors managing over $46 trillion in assets signed a statement calling on governments to undertake five priority actions to accelerate climate investment, including ‘implementing mandatory climate risk disclosure requirements aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, ensuring comprehensive disclosures that are consistent, comparable, and decision-useful.” (See this PubCo post.) Both State Street Global Advisors (see this PubCo post) and BlackRock (see this PubCo post) have been focused on the systemic risk posed by climate change and promoted disclosure in alignment with TCFD and/or SASB. For example, in his 2021 letter to CEOs, BlackRock CEO Laurence Fink asked companies to disclose a “plan for how their business model will be compatible with a net zero economy” (see this PubCo post), and BlackRock Investment Stewardship has advocated that companies provide disclosure regarding how climate risks and risk mitigation affect their business, including sea level rise and extreme weather events, as well as national emissions goals, carbon taxes, regulations and investment in alternative energy. (See this PubCo post.)
One challenge the SEC had to face was the need to craft rules that would survive the political and legal opposition that has emerged. The SEC contends that it has “broad authority to promulgate disclosure requirements that are ’necessary or appropriate in the public interest or for the protection of investors’” and that it has “considered this statutory standard and determined that disclosure of information about climate-related risks and metrics would be in the public interest and would protect investors.” That’s because the SEC believes that the “information can have an impact on public companies’ financial performance or position and may be material to investors in making investment or voting decisions.” The potential direct financial effects of climate risks on businesses and the financial system as a whole, the SEC contends, were well documented in the 2021 Financial Stability Oversight Council’s Report on Climate-Related Financial Risk. (See this PubCo post.) The SEC recognizes that “climate-related risks implicate broader concerns,” but those concerns are subject to various other regulatory schemes—the SEC’s objective is to advance its “mission to protect investors, maintain fair, orderly and efficient markets, and promote capital formation, not to address climate-related issues more generally.”
The WSJ reports that some Republicans argue that “it isn’t the SEC’s job to mandate nonfinancial disclosures.” In addition, the article continues, some industry organizations “told the SEC it didn’t have legal authority to compel disclosures and impose its value judgments.” That view is shared by SEC Commissioner Hester Peirce. (See this PubCo post for a discussion of the views of the commissioners on the proposal.) One Republican state attorney general “wrote that ‘West Virginia will not permit the unconstitutional politicization of the Securities and Exchange Commission. If you choose to pursue this course we will defeat it in court.’” As reported by the NYT, the U.S. Chamber of Commerce “said that it broadly supported the goal of climate disclosure by companies but wanted a more ‘clear and workable’ rule.” The executive vice president of the Chamber’s Center for Capital Markets Competitiveness “said the group was concerned that companies would be forced to disclose information that is not material to investors. ‘We will advocate against provisions of this proposal that deviate from that standard or are unnecessarily broad.’”
Conceptual bases for disclosure
The SEC observes that “the TCFD and the GHG Protocol have developed concepts and a vocabulary that are commonly used by companies when providing climate-related disclosures in their sustainability or related reports.” Accordingly, the proposal incorporates some of these now-familiar concepts and vocabulary, modeling the SEC’s proposed framework in part on the TCFD’s recommendations, which evaluate “material climate-related risks and opportunities through an assessment of their projected short-, medium-, and long-term financial impacts on a registrant. The TCFD framework establishes eleven disclosure topics related to four core themes that provide a structure for the assessment, management, and disclosure of climate-related financial risks: governance, strategy, risk management, and metrics and targets.” (See this PubCo post.) The TCFD framework has been widely endorsed and, as of October 2021, the SEC reports, over “2,600 organizations globally, with a total market capitalization of $25 trillion have expressed support for the TCFD.” Because of widespread adoption of the TCFD framework, companies (and investors) have experience with TCFD disclosures, which should facilitate compliance, reduce the burden for companies and improve global comparability.
GHG emissions data helps investors to assess exposure to “climate-related risks, including regulatory, technological, and market risks driven by a transition to a lower-GHG intensive economy,” as well as progress toward reduction goals. Many commenters indicated that the GHG Protocol, was the “most widely used global greenhouse gas accounting standard.” Accordingly, the proposal regarding disclosure of GHG emissions is based “primarily on the GHG Protocol’s concept of scopes and related methodology.”
The proposal would add an entire new subpart to Reg S-K and a new article to Reg S-X. The new subpart of Reg S-K would require disclosure of information about climate-related risks that are reasonably likely to have a material impact on a company’s business or consolidated financial statements, as well as GHG emissions metrics. The disclosures would be required under a separate caption, “Climate-Related Disclosure,” in registration statements and Exchange Act annual reports (with material updates in Forms 10-Q) and tagged using Inline XBRL. (Companies would also be able to incorporate by reference disclosure from other parts of the filing or from other filed or submitted reports.) Under Reg S-X, companies would be required to provide metrics and related disclosure—disaggregated climate-related impacts on existing financial statement line items—in a note to the audited financial statements. Accelerated filers and large accelerated filers would need to attach to their filings an attestation report regarding Scopes 1 and 2 GHG emissions and to provide certain related disclosures about the service provider. Although the attestation service provider need not be a registered public accounting firm, the proposal imposes “minimum attestation report requirements, minimum standards for acceptable attestation frameworks, and would require an attestation service provider to meet certain minimum qualifications.” (GHG emissions disclosure and related attestation requirements will be discussed in Part II of this update.)
The proposal includes several phase-ins and other accommodations. The general compliance phase-in would be based on filer status, with additional phase-ins for disclosure of Scope 3 emissions as well as for the assurance requirement and the level of assurance. As proposed, accelerated filers and large accelerated filers would have one fiscal year to phase-in limited assurance and two additional fiscal years to transition to providing reasonable assurance, starting with the respective compliance dates for Scopes 1 and 2 disclosure described below. Smaller reporting companies would be exempt from the Scope 3 emissions disclosure requirement, but for those subject to it, there would be a safe harbor from liability for Scope 3 emissions disclosure. The safe harbor under the PSLRA would also be available (except for IPO registration statements) for disclosures that include forward-looking statements, provided that companies comply with the requirements of the safe harbor.
Disclosure framework under Reg S-K
The SEC’s framework under Reg S-K, like the TCFD, would require disclosure of information about any material climate-related impacts on strategy, business model, and outlook; governance of climate-related risks; climate-related risk management; GHG emissions metrics; and climate-related targets and goals, if any. Note that new Item 1500 of Reg S-K would provide definitions, and, in some cases, much of the extensive detail is contained in the definitions. For example, the rule directs companies to provide the location of material physical risks. But “location” is a defined term meaning “a ZIP code or, in a jurisdiction that does not use ZIP codes, a similar subnational postal zone or geographic location.”
Disclosure regarding climate-related impacts on strategy, business model and outlook (Item 1502)
Disclosure of climate-related risks
Definitions. Under the proposal, a company would be required to disclose “any climate-related risks reasonably likely to have a material impact on the registrant’s business or consolidated financial statements.” As defined, “climate-related risks” are broadly defined as “the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole. ‘Value chain’ would mean the upstream and downstream activities related to a registrant’s operations.” “Upstream activities include activities by a party other than the registrant that relate to the initial stages of a registrant’s production of a good or service (e.g., materials sourcing, materials processing, and supplier activities). “Downstream activities” would be defined to include activities by a party other than the registrant that relate to processing materials into a finished product and delivering it or providing a service to the end user (e.g., transportation and distribution, processing of sold products, use of sold products, end of life treatment of sold products, and investments).”
Risks can refer to physical risks (e.g., fires, hurricanes, sea level rise, drought and floods, including both “acute and chronic risks to a registrant’s business operations or the operations of those with whom it does business” ) and transition risks, meaning “the actual or potential negative impacts on a registrant’s consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks.” These might include increased costs attributable to regulatory changes, reduced market demand for carbon-intensive products or competitive pressures associated with new technologies or even reputational effects.
Description. To describe the proposal as highly prescriptive in mandating specific detailed disclosures is something of an understatement. For example, companies would be required to indicate whether the risk identified is a physical or transition risk. For physical risks, the company would be required to describe the nature of the risk, whether it is acute or chronic, the “location” (zip code) and the “nature of the properties, processes, or operations subject to the physical risk.” For material flood risks, the description would also need to include the percentage of buildings, plants or properties (square meters or acres) that are located in flood hazard areas. For assets in regions of high or extremely high water stress risk, the company would also need to disclose “the amount of assets (e.g., book value and as a percentage of total assets) located in those regions,” as well as the percentage of the company’s “total water usage from water withdrawn in those regions.” The SEC notes later that, to the extent loss of insurance coverage or increases in premiums is reasonably likely to have a material impact, the company would be required to disclose that risk under this Item. There are a number of requests for comment that refer to other potential specific information that could be required.
With regard to transition risks, companies would be required to disclose “the nature of transition risks, including whether they relate to regulatory, technological, market (including changing consumer, business counterparty, and investor preferences), liability, reputational, or other transition-related factors, and how those factors impact the registrant.”
The company could also describe opportunities, such as “cost savings associated with the increased use of renewable energy, increased resource efficiency, the development of new products, services, and methods, access to new markets caused by the transition to a lower carbon economy.”
Time horizons. Under the proposed rules, a company would need to disclose any climate-related risk that is reasonably likely to have a material impact on the company, its business or consolidated financial statements, “which may manifest over the short, medium and long term,” as those terms are defined by the company. The company would need to describe its definitions of those terms, “including how it takes into account or reassesses the expected useful life of the registrant’s assets and the time horizons for the registrant’s climate-related planning processes and goals.”
Materiality. An impact would be “material” if “there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote.” The materiality determination “is largely fact specific and one that requires both quantitative and qualitative considerations,” and, with respect to future events, requires “an assessment of both the probability of the event occurring and its potential magnitude, or significance” to the company over the short, medium and long term. The SEC suggests that the analysis might be similar to the analysis required for MD&A. The disclosure would include a discussion of the company’s risk-materiality assessment over the short, medium and long term. Any forward-looking statements could be protected under the PSLRA (although not in IPO registration statements).
Disclosure of material impacts
The proposal would also require a description of “the actual and potential impacts” of the material climate risks identified above on the company’s strategy, business model and outlook. More specifically, disclosure would be required regarding the risks’ impact on the company’s
- “Business operations, including the types and locations of its operations;
- Products or services;
- Suppliers and other parties in its value chain;
- Activities to mitigate or adapt to climate-related risks, including adoption of new technologies or processes;
- Expenditure for research and development; and
- Any other significant changes or impacts.”
The time horizon would also need to be discussed for each described impact. Under the proposal, the company would need to discuss “whether and how” any of the identified impacts are considered as part of the company’s business strategy, financial planning and capital allocation, including both current and forward-looking disclosures. The intent is to help investors understand “whether the implications of the identified climate-related risks have been integrated into the registrant’s business model or strategy, including how resources are being used to mitigate climate-related risks.” The discussion must also include how any of the required metrics (GHG emissions metrics or other metrics contained in the new climate note to the financial statements) or disclosed targets relate to the company’s business model or strategy. An example would be the limitations on GHG emissions imposed under the Paris Climate Agreement that might require various targeted reductions over time. In that instance, the company could face material transition risks arising out of the estimated costs of the operational changes necessary to achieve these goals, which should be disclosed as transition risks, along with their impact on the company’s strategy, business model and outlook. Other risks might involve the need to acquire new technology to curb operational emissions or a change to a less carbon-intensive product. Drought might have an impact on product mix or require increased expenses for additional water; rising sea levels could affect property and property value.
The company would also need to provide a narrative discussion, similar to MD&A, of how these risks have or are reasonably likely to affect the company’s financials, including the financial statement metrics discussed in the new climate note (discussed below). The discussion should address short-, medium- and long-term effects, as applicable.
Carbon offsets or renewable energy credits if used. If, as part of the company’s strategy, it uses carbon offsets (an “emissions reduction or removal of greenhouse gases in a manner calculated and traced for the purpose of offsetting an entity’s GHG emissions”) or renewable energy credits or certificates (a “credit or certificate representing each purchased megawatt-hour of renewable electricity generated and delivered to a registrant’s power grid”) to meet its goals, the company would be required to discuss the role that carbon offsets or RECs play in the company’s climate-related business strategy, including short- and long-term costs and risks, such as the ‘risk that the availability or value of offsets or RECs might be curtailed by regulation or changes in the market.”
Maintained internal carbon price. An internal carbon price is an “estimated cost of carbon emissions used internally within an organization.” An internal carbon price may be used as a “planning tool to help identify climate-related risks and opportunities,” or as an “incentive to drive energy efficiencies,” among other purposes. If the company uses an internal carbon price, the proposed rules spell out a number of specific detailed disclosures that would be required, including how the company uses the internal carbon price to evaluate and manage climate-related risks and the rationale for the price selected. The disclosure is intended to “help investors understand the rationale and underlying assumptions for a registrant’s internal carbon price and help them assess whether the registrant’s use of an internal carbon price as a planning tool is reasonable and effective.” The SEC indicates that the “carbon price applied should not be viewed as a promise or guarantee with regard to the future costs to the registrant of GHG emissions.”
Resilience and disclosure of scenario analyses, if used. The proposal requires the company to describe “the resilience” of its business strategy “in light of potential future changes in climate-related risks” and any analytical tools that it uses “to assess the impact of climate-related risks on its business and consolidated financial statements, and to support the resilience of its strategy and business model.” One analytical tool that some companies use is the scenario analysis—a process for “identifying and assessing a potential range of outcomes of various possible future climate scenarios, and how climate-related risks may impact a registrant’s operations, business strategy, and consolidated financial statements over time.” Scenario analyses may be used to test the resilience of company strategies under future climate scenarios that might assume various global temperature increases. If the company uses scenario analyses, the proposal would require disclosure of the scenarios considered (e.g., an increase of no greater than 3 º, 2 º, or 1.5 ºC above preindustrial levels), “including parameters, assumptions, and analytical choices, and the projected principal financial impacts on the registrant’s business strategy under each scenario. The disclosure should include both qualitative and quantitative information.” The SEC suggests that companies may want to use as a basis for its own scenario analysis some of the publicly available, widely accepted climate-related scenarios, a number of which have been summarized by the TCFD. However, although several commenters requested that the SEC require companies to perform scenario analyses at several assumed temperatures, the SEC declined to go that far, at least in the proposal. Once again, the PSLRA safe harbor should apply to forward-looking statements in most circumstances.
Governance disclosure (Item 1501)
Again building on the TCFD framework, the proposal would require the company to disclose information concerning “the board’s oversight of climate-related risks, and management’s role in assessing and managing those risks.” The SEC believes that this disclosure is necessary to help investors assess the extent to which the company is “adequately addressing the material climate-related risks it faces, and whether those risks could reasonably affect the value of their investment.” According to the TCFD, few companies actually disclose climate-related governance information aligned with TCFD.
The proposal would require the company to describe the board’s oversight of climate-related risks, including the following (to the extent applicable):
- The identity of any board members or board committee responsible for the oversight of climate-related risks, such as the audit committee or risk committee, or a separate committee focused on climate-related risks;
- Whether any member of the board has expertise in climate-related risks, including a full description of the nature of the expertise;
- The processes by which the board or board committee discusses climate-related risks, including how the board is informed about climate-related risks, and the frequency of these risk discussions;
- Whether and how the board or board committee considers climate-related risks as part of its business strategy, risk management and financial oversight, such as how the board “considers climate-related risks when reviewing and guiding business strategy and major plans of action, when setting and monitoring implementation of risk management policies and performance objectives, when reviewing and approving annual budgets, and when overseeing major expenditures, acquisitions, and divestitures”; and
- Whether and how the board sets climate-related targets or goals (e.g., to achieve net-zero carbon emissions for all or a large percentage of its operations by 2050), and how it oversees progress against those targets or goals, including the establishment of any interim targets or goals. The SEC believes that this proposed requirement “would help investors evaluate whether and how a board is preparing to mitigate or adapt to any material transition risks, and whether it is providing oversight for the registrant’s potential transition to a lower carbon economy.”
The company could also describe the board’s oversight of climate-related opportunities, if applicable.
The proposal would also require the company to describe management’s role in assessing and managing climate-related risks, including the following (to the extent applicable):
- Whether members of management or committees are responsible for assessing and managing climate-related risks and, if so, the identity of these positions or committees and the relevant expertise of the position holders or members, including a full description of the nature of their expertise;
- The processes by which these members of management or committees are informed about and monitor climate-related risks, such as whether there are “specific positions or committees responsible for monitoring and assessing specific climate-related risks, the extent to which management relies on in-house staff with the relevant expertise to evaluate climate-related risks and implement related plans of action, and the extent to which management relies on third-party climate consultants for these same purposes”; and
- Whether and how frequently these positions or committees report to the board or a committee of the board on climate-related risks. This requirement is intended to “help investors evaluate whether management has adequately implemented processes to identify, assess, and manage climate-related risks.”
The company could also describe management’s role in assessing and managing climate-related opportunities.
Risk management disclosure (Item 1503)
Processes for identifying, assessing, and managing climate-related risks
Under the proposal, the company would be required to describe any processes it has for “identifying, assessing, and managing climate-related risks.” The SEC believes that more granular information about climate-risk management could “permit investors to ascertain whether a registrant has made the assessment of climate-related risks part of its regular risk management processes” and help investors evaluate the adequacy of a company’s risk management processes. The company could also describe any processes for identifying, assessing and managing climate-related opportunities.
More specifically, in describing its processes for identifying and assessing climate-related risks, the company should disclose, as applicable, how it:
- “Determines the relative significance of climate-related risks compared to other risks;
- Considers existing or likely regulatory requirements or policies, such as GHG emissions limits, when identifying climate-related risks;
- Considers shifts in customer or counterparty preferences, technological changes, or changes in market prices in assessing potential transition risks; and
- Determines the materiality of climate-related risks, including how it assesses the potential scope and impact of an identified climate-related risk, such as the risks identified in response to [Item 1502 (discussed above)].”
In addition, when describing any processes for managing climate-related risks, the company would be required to disclose, as applicable, how it:
- “Decides whether to mitigate, accept, or adapt to a particular risk;
- Prioritizes whether to address climate-related risks; and
- Determines how to mitigate any high priority risks.”
The proposed rules would also require the company to disclose whether and how the processes regarding climate-related risks are integrated into the company’s overall risk management system or processes. If a separate board or management committee is responsible for assessing and managing climate-related risks, the company must disclose how that committee interacts with the board or management committee governing risks. These disclosures are designed to help investors assess whether the company has “centralized the processes for managing climate-related risks, which may indicate to investors how the board and management may respond to such risks as they unfold.”
The company may also need to describe any insurance or other financial products used to manage its exposure to climate-related risks.
Transition plans to mitigate or adapt to climate-related risks may be a key component of a company’s climate risk management strategy. A transition plan is defined as a company’s ”strategy and implementation plan to reduce climate-related risks, which may include a plan to reduce its GHG emissions in line with its own commitments or commitments of jurisdictions within which it has significant operations,” such as the Paris Climate Agreement. Transition plans could also address transition risks that arise out of changes in customer or business counterparty preferences, technological change or changes in market prices.
If the company has adopted a transition plan, it would be required to describe the plan, including the relevant metrics and targets used to identify and manage any physical and transition risks. To provide insight into the company’s progress to meet the plan’s targets, a company would be required to “update its disclosure about the transition plan each fiscal year by describing the actions taken during the year to achieve the plan’s targets or goals.”
The company would also be required to describe how it plans to mitigate or adapt to any identified risks. With regard to physical risks, such as risks related to energy, land or water use and management, the discussion might include relocation of vulnerable operations or reinforcement of physical facilities. The company would also need to describe how it plans to mitigate or adapt to any identified transition risks, such as laws, rules or policies that restrict GHG emissions or products with high GHG footprints or require the protection of high conservation value land or natural assets; imposition of a carbon price; or changing demands or preferences of consumers, investors, employees, and business counterparties.
The company could also describe how it plans to achieve any identified climate-related opportunities, such as through the introduction of products that may facilitate the transition to a lower carbon economy; the generation or use of renewable power; the production or use of low waste, recycled or other less carbon-intensive consumer products; the setting of conservation goals and targets to reduce GHG emissions; and the provision of services related to any transition to a lower carbon economy.
Targets and goals disclosure (Item 1506)
If the company has set any climate-related targets or goals—such as reduction of GHG emissions or energy or water usage or increases in revenue from low-carbon products—the company would be required, under the proposal, to provide specified information about those targets or goals. The proposal doesn’t appear to limit the requirement to targets or goals that have been publicly disclosed. Many companies have made commitments to reduce GHG emissions, but do not always provide investors with sufficient information to understand how they intend to achieve those commitments or even to assess the progress made toward achieving them. The disclosure is intended to help investors understand the scope of a company’s climate-related targets or goals and assess its progress. The SEC advises that this information could be included as part of the information responsive to Items 1502 (strategy, business model and outlook) or 1503 (risk management).
Specifically, if companies have set targets or goals, they would be required to disclose:
- “The scope of activities and emissions included in the target;
- The unit of measurement, including whether the target is absolute or intensity based;
- The defined time horizon by which the target is intended to be achieved, and whether the time horizon is consistent with one or more goals established by a climate-related treaty, law, regulation, policy, or organization;
- The defined baseline time period and baseline emissions against which progress will be tracked with a consistent base year set for multiple targets;
- Any interim targets set by the registrant; and
- How the registrant intends to meet its climate-related targets or goals.”
For example, if the company has set a goal of reducing its freshwater needs, to describe how it intends to meet its goal, it could describe its strategy to increase the water efficiency of its operations, such as by recycling wastewater; if the target is to reduce net GHG emissions, the company could describe its “strategy to increase energy efficiency, transition to lower carbon products, purchase carbon offsets or RECs, or engage in carbon removal and carbon storage.” Even if the company has not yet developed a strategy, the SEC wants investors to be informed of the company’s “plans and progress wherever it is in the process of developing and implementing its plan.”
The company would also be required to disclose relevant data to show its progress toward the target or goal and “how such progress has been achieved,” and must update this disclosure annually describing actions taken during the year.
If the company’s plan has included the use of carbon offsets or RECs, the company must, “disclose the amount of carbon reduction represented by the offsets or the amount of generated renewable energy represented by the RECs, the source of the offsets or RECs, a description and location of the underlying projects, any registries or other authentication of the offsets or RECs, and the cost of the offsets or RECs.” The SEC observes that a “reasonable investor could well assess differently the effectiveness and value to a registrant of the use of carbon offsets where the underlying projects resulted in authenticated reductions in GHG emissions compared to the use of offsets where the underlying projects resulted in the avoidance, but not the reduction, in GHG emissions or otherwise lacked verification.”
The SEC advises that disclosure of climate-related targets or goals “should not be construed to be promises or guarantees.” To the extent that the disclosure involves forward-looking statements, the PSLRA safe harbors should be available (except for IPO registration statements).
Financial statement metrics under Reg S-X (Items 14.01 and 14.02)
In a highly unusual move (see this Bloomberg article), the SEC is itself proposing changes to Reg S-X that would require a company to disclose in a note to its audited financial statements specified disaggregated climate-related financial statement metrics that are mainly derived from existing financial statement line items. Disclosure would be required for the company’s most recently completed fiscal year, and for the historical fiscal years included in the consolidated financial statements in the filing (e.g., with some exceptions, two years of the climate-related metrics that correspond to balance sheet line items and three years of the climate-related metrics that correspond to income statement or cash flow statement line items). To calculate the metrics, companies would be required to apply the same set of accounting principles and use financial information that is consistent with the scope of the rest of the consolidated financial statements included in the filing. Because the disclosures would be included in the audited financial statements, the disclosures would be (i) included in the scope of the audit, (ii) subject to audit by an independent registered public accounting firm, and (iii) within the scope of the company’s internal control over financial reporting.
The proposed rules would require disclosure under the following three categories of information: financial impact metrics; expenditure metrics; and financial estimates and assumptions. The proposed metrics disclosures involve “estimation uncertainties that are driven by the application of judgments and assumptions,” and, as a result, the company would be required to disclose contextual information for each type of metric to enable a reader to understand how it derived the metric, including a description of significant inputs and assumptions used, and if applicable, policy decisions made by the registrant to calculate the specified metrics.”
Financial impact metrics
To complement the requirement to provide a narrative discussion, under Item 1502, of the impact of “climate-related risks” on the financial statements, the proposal would require a company to include disaggregated information about the impact of climate-related conditions and events (including those identified under Item 1502(a) discussed above), and transition activities, on the consolidated financial statements included in the filing, unless the impact, on an aggregated basis, is less than 1% of the total line item for the relevant fiscal year. The proposal would require companies to disclose “the impact of severe weather events and other natural conditions, such as flooding, drought, wildfires, extreme temperatures and sea level rise on any relevant line items” in the financials, presented, at a minimum, on an aggregated line-by-line basis for all negative impacts and, separately, at a minimum, on an aggregated line-by-line basis for all positive impacts. Disclosure would also be required of the impacts of any climate-related risks identified under proposed Item 1502(a), including both physical risks and transition risks (including any efforts to reduce GHG emissions or otherwise mitigate exposure to transition risks) on any relevant line items. Impacts from physical risks could include, for example, changes to revenues or costs from business disruptions, impairment charges and changes to the carrying amount of assets, changes to loss contingencies or reserves or changes to total expected insured losses due to flooding or wildfire patterns. Transition impacts could include changes to revenue or costs due to the loss of a contract as a result of new emissions pricing or regulations; changes to operating, investing, or financing cash flow from changes in upstream costs, such as transportation of raw materials; changes to the carrying amount of assets due to a reduction of the asset’s useful life or a change in the asset’s salvage value by being exposed to transition activities; and changes to interest expense driven by financing instruments such as climate-linked bonds issued where the interest rate increases if certain climate-related targets are not met. Companies could also disclose the impact of opportunities, provided they do so consistently. To determine whether the disclosure threshold has been met, the company would be required to aggregate the absolute values of the positive and negative impacts on a line-by-line basis. The release contain charts illustrating how the threshold would be calculated and the disclosure would be presented.
Under the proposal, the company would be required to disclose separately the aggregate amount of expenditure expensed and the aggregate amount of capitalized costs incurred during the fiscal years presented to mitigate the risks from severe weather events and other natural conditions, other climate-related risks identified under Item 502(a) and transition activities, subject to the same 1% threshold. For example, for climate-related physical risks, the company could be required to disclose the amount of expense or capitalized costs, as applicable, to increase the resilience of assets or operations, retire or shorten the estimated useful lives of impacted assets, relocate assets or operations at risk, or otherwise reduce the future impact of severe weather events and other natural conditions on business operations. For transition risks, the company could be required to disclose the amount of expense or capitalized costs incurred related to research and development of new technologies, purchase of assets, infrastructure, or products that are intended to reduce GHG emissions, increase energy efficiency, offset emissions (purchase of energy credits) or improve other resource efficiency.
For each of those categories (expenses and capitalized costs), the company would be required to disclose separately the amount incurred during the fiscal years presented (i) toward positive and negative impacts associated with the climate-related events (i.e., severe weather events and other natural conditions and identified physical risks under Item 1502(a)) and (ii) toward transition activities, specifically, to reduce GHG emissions or otherwise mitigate exposure to transition risks (including identified transition risks). The company could also disclose opportunities. To determine if the disclosure threshold has been met, the company “would be permitted to separately determine the amount of expenditure expensed and the amount of expenditure capitalized; however, a registrant would be required to aggregate expenditure related to climate-related events and transition activities within the categories of expenditure (i.e., amount capitalized and amount expensed).”
Financial estimates and assumptions
Under the proposal, the company would need to disclose whether the estimates and assumptions used to produce the financials were affected by “exposures to risks and uncertainties associated with, or known impacts from, climate-related events (including physical risks identified under Item 1502(a) and severe weather events and other natural conditions), or by transition activities and risks (including transition risks under Item 1502(a)). The company would be required to provide separate qualitative descriptions of how the climate-related events or transition activities have impacted the development of those estimates and assumptions. For example, if climate events or risks or transition activities affected asset values resulting in asset impairments, the “effect on asset values and the resulting impairments could, in turn, affect a registrant’s assumptions when calculating depreciation expenses or asset retirement obligations associated with the retirement of tangible, long-lived assets.” If the company elects to disclose the impact of an opportunity on its financial estimates and assumptions, it must do so consistently and must follow the same presentation and disclosure requirements.
Companies subject to the climate-related disclosure rules and affected forms and liability
The disclosure requirements would apply to Securities Act and Exchange Act registration statements and Exchange Act annual reports filed by domestic and foreign issuers. A company would also have to disclose any material change to the climate-related disclosure in its Form 10-Q (or 6-K). Under the proposal, SRCs would be exempt from the Scope 3 emissions disclosure requirement and would also have a longer transition period to comply with the proposed rules. The SEC requests comment on whether it should adopt an alternative reporting provision for foreign private issuers that are subject to the climate-related disclosure requirements of an alternative reporting regime and whether IPO registration statements should be excluded from the disclosure requirement.
The proposed required climate-related disclosures would be considered “filed” and therefore subject to potential liability under Exchange Act Section 18 (except for disclosures furnished on Form 6-K), and to potential liability under Section 11 if included in a Securities Act registration statement.
Structured data requirement
The proposed rules would require a company to tag the proposed climate-related disclosures using Inline XBRL, including block text tagging and detail tagging of narrative and quantitative disclosures.
The SEC has proposed phase-in dates for compliance as set forth in the table below. The proposed compliance dates would apply to both annual reports and registration statements. The table assumes, for illustrative purposes, that the proposed rules will be adopted with an effective date in December 2022, and that the company has a December 31 fiscal year end. There is also an additional one-year phase-in period for the Scope 3 emissions disclosure requirements.
|Registrant Type||Disclosure Compliance Date||Financial Statement Metrics Audit Complicance 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 in 2024)||Fiscal year 2024 (filed in 2025)||Same as disclosure compliance date|
|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|
If a non-accelerated filer with a December 31 fiscal year end filed a registration statement that was not required to include audited financial statements for fiscal 2024, it would not be required to comply with the proposed climate disclosure rules in that registration statement. A company with a different fiscal year end that results in the commencement of its fiscal 2023 before the effective date of the rules would not be required to comply until the following fiscal year.