“[C]limate-related risks have present financial consequences that investors in public companies consider in making investment and voting decisions.”
The Securities and Exchange Commission (SEC) has proposed a sweeping new disclosure requirement relating to registered companies’ climate-related information (“SEC Proposed Rule” or “Proposed Rule”). Additionally, the California Senate passed SB 260 (Weiner), the Climate Corporate Accountability Act (CCAA), and it is now pending in the Assembly. Both the SEC Proposed Rule and SB 260, if adopted, will be the first laws in the United States that mandate companies that meet the reporting requirement to disclose their greenhouse gas emissions. This article provides an overall review of both the SEC Proposed Rule and the CCAA.
THE SEC’S PROPOSED “ENHANCEMENT AND STANDARDIZATION OF CLIMATE-RELATED DISCLOSURES FOR INVESTORS”
In late March 2022, the SEC proposed new rules that for the first time would mandate public companies to report their greenhouse gas emissions and climate change-related performances. The information would be required in registration statements and annual reports, and it generally falls into three categories:
- "climate-related risks that are reasonably likely to have a material impact on [the registrant’s] business, results of operations, or financial condition”
- “disclosure of a registrant’s greenhouse gas emissions," both direct and indirect
- “certain climate-related financial metrics . . . in a registrant’s audited financial statements”
The SEC’s mantra throughout the Proposed Rule is “consistent, comparable, and reliable.” It contends that many of the disclosures required by the Proposed Rule are already voluntarily being made by companies in various contexts. A major intent of the Proposed Rule, repeatedly underscored by the SEC, is standardization: consistent, comparable, and reliable disclosures and data sets.
The Proposed Rule states that it is building on prior rules and guidance by the SEC that date back to the 1970s with an “interpretive release” that encouraged registrants to disclose to the SEC the financial impact of compliance with environmental laws. More recently, SEC guidance from 2010 highlighted existing disclosure requirements for registrant companies. Specifically, the 2010 Guidance emphasized that climate change disclosure might, depending on the circumstances, be required in a company’s annual 10-K report. Investors have been consistently calling for increased disclosure mandates, according to the Proposed Rule.
As evidence of the increased investor interest and demand for more comprehensive disclosure, the Proposed Rule cites to existing initiatives by institutional investors designed to facilitate inclusion and consideration of climate risk in investment selection processes.
Disclosure Framework: TCFD and the GhG Protocol
The SEC points to “two significant developments” that drive both the timing and content of the Proposed Rule. The first has to do with recommendations by the Task Force on Climate-Related Financial Disclosures (TCFD). The second is the Greenhouse Gas Protocol (GhG Protocol), a leading accounting and reporting standard for greenhouse gas emissions.
As to the TCFD, its framework, according to the Proposed Rule, “has been widely accepted by issuers, investors, and other market participants.” The TCFD came into being when the Group of 20 Finance Ministers directed the Financial Stability Board (FSB) to consider how the financial sector could address concerns over climate. The result was creation of the TCFD, “an industry-led task force charged with promoting better-informed investment, credit, and insurance underwriting decisions.”
A framework of disclosure recommendations by the TCFD issued in 2017 establishes 11 disclosure topics related to four core themes: governance, strategy, risk management, and metrics and targets. The G7 Finance Ministers and Central Bank Governors endorse the TCFD.
As to the GhG Protocol, it is the product of a partnership between the World Resources Institute and the World Business Council for Sustainable Development. The GhG Protocol’s Corporate Accounting and Reporting Standard gives a uniform method to quantify and report the Kyoto Protocol’s seven greenhouse gases: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride and nitrogen trifluoride. Differentiating between “direct” and “indirect” emissions by a company, the GhG Protocol designates three “scopes” of emissions:
- “Scope 1 emissions are direct GhG emissions that occur from sources owned or controlled by the company”
- “Scope 2 emissions are those emissions primarily resulting from the generation of electricity purchased and consumed by the company”
- “Scope 3 emissions are all other indirect emissions not accounted for in Scope 2 emissions”
Inclusion of Scope 3 emissions has been one of the most controversial and criticized aspects of the Proposed Rule. “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 registrant purchases from third parties, employee commuting or business travel, and the processing or use of the registrant’s products by third parties.”
Summary of SEC Proposed Rule
Drawing on both the TCFD framework and the GhG Protocol, the Proposed Rule requires a registrant to disclose the following information:
- The oversight and governance of climate-related risks by the registrant’s board and management
- How any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short, medium or long term
- How any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model and outlook
- The registrant’s 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
- The impact of climate-related events (severe weather events and other natural conditions as well as physical risks identified by the registrant) and transition activities (including transition risks identified by the registrant) on the line items of a registrant’s consolidated financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities
- Scope 1 and Scope 2 GHG emissions metrics, separately disclosed, expressed in both of the following ways:
- By disaggregated constituent greenhouse gases and in the aggregate
- In absolute and intensity terms
- Scope 3 GHG emissions and intensity, if material, or if the registrant has set a GHG emissions reduction target or goal that includes its Scope 3 emissions
- The registrant’s climate-related targets or goals, and transition plan, if any
Compliance With the Proposed Rule
As to presentation of the noted information, the Proposed Rule requires a registrant (both domestic and foreign private issuers):
- To provide the climate-related disclosure in its registration statements and Exchange Act annual reports
- To provide the Regulation S-K mandated climate-related disclosure in a separate, appropriately captioned section of its registration statement or annual report, or alternatively to incorporate that information in the separate, appropriately captioned section by reference from another section, such as Risk Factors, Description of Business, or Management’s Discussion and Analysis (MD&A)
- To provide the Regulation S-X mandated climate-related financial statement metrics and related disclosure in a note to the registrant’s audited financial statements
- To electronically tag both narrative and quantitative climate-related disclosures in Inline XBRL
- To file rather than furnish the climate-related disclosure
Attestation of Scope 1 and Scope 2 Emissions Disclosure
The Proposed Rule also requires an “accelerated filer” or “large accelerated filer” to include an attestation report covering, at least, its Scope 1 and Scope 2 emissions disclosures and to provide certain related disclosures about the service provider. Furthermore, at a minimum, public companies in those two statuses must be at the following assurance level for the indicated fiscal year for the required GHG emissions disclosure.
|Fiscal years 2 and 3 after Scope 1 and Scope 2 emissions disclosure compliance date
||Fiscal years 4 and beyond after Scope 1 and Scope 2 emissions disclosure compliance date
Phase-In Periods and Accommodations for the Proposed Disclosures
In the Proposed Rule, the SEC also designed the phase-in periods and accommodations to mitigate the burdens on public companies. These include:
- A phase-in for all registrants, with the compliance date dependent on the registrant’s filer status
- An additional phase-in period for Scope 3 emissions disclosure
- A safe harbor for Scope 3 emissions disclosure. That is, to the extent that the proposed climate-related disclosures constitute forward-looking statements, the forward-looking statement safe harbors under the Private Securities Litigation Reform Act (PSLRA) will apply
- An exemption from the Scope 3 emissions disclosure requirement for a registrant meeting the definition of a smaller reporting company (SRC)
- A provision permitting a registrant, if actual reported data is not reasonably available, to use a reasonable estimate of its GHG emissions for its fourth fiscal quarter, together with actual, determined GHG emissions data for the first three fiscal quarters, as long as the registrant promptly discloses in a subsequent filing any material difference between the estimate used and the actual, determined GHG emissions data for the fourth fiscal quarter
As for the phase-in periods, assuming that the Proposed Rule will be adopted with an effective date in December 2022 and the public companies making the filings have a December 31 fiscal year-end, the following table summarizes the 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 in 2024)
|Fiscal year 2024
(filed in 2025)
|Accelerated Filer and Non-Accelerated Filer
||Fiscal year 2024
(filed in 2025)
|Fiscal year 2025
(filed in 2026)
|Small Reporting Company
||Fiscal year 2025
(filed in 2026)
Early Objection to the Proposed Rule – “Mission Creep”?
Clearly anticipating a litigation challenge to any final rule adopted arguing that climate concerns are outside the SEC’s regulatory purview, the Proposed Rule repeatedly states that the SEC has both the authority and responsibility to promulgate the Proposed Rule. “The Commission has broad authority to promulgate disclosure requirements that are ‘necessary or appropriate in the public interest or for the protection of investors.’ We have 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.”
With regard to allegations of “mission creep,” the SEC says its intention is “to protect investors, maintain fair, orderly and efficient markets, and promote capital formation . . . .” To underscore the point, the SEC states that its mission is “not to address climate-related issues more generally.”
In addition to the mandates of the Proposed Rule, the SEC notes what it refers to as “features designed to mitigate the burden on registrants . . . .” These include:
- Phase-in periods for the proposed climate-related disclosure requirements
- A safe harbor for certain emissions disclosures (i.e., “Scope 3” emissions)
- An exemption from certain emissions reporting requirements for smaller reporting companies
The Proposed Rule has not yet been published in the Federal Register, though comments on the Proposed Rule will be due on the later of May 20, 2022, and 30 days following the publication of the proposed rules in the Federal Register.
CALIFORNIA’S SB 260 (WEINER) – THE CLIMATE CORPORATE ACCOUNTABILITY ACT
This groundbreaking legislation requires the California Air Resources Board (CARB) to develop and adopt regulations requiring any “reporting entity” to disclose and verify specified categories of greenhouse gas emissions to the California Secretary of State. The bill defines “reporting entity” as any “partnership, corporation, limited liability company, or other business entity formed under the laws of this state, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the United States with total annual revenues in excess of one billion dollars ($1,000,000,000) and that does business in California.”
Reporting Requirement Under SB 260 (WEINER)
The reporting requirement would kick in as soon as 2025 and, like the SEC Proposed Rule, requires disclosure and verification of Scope 1, 2 and 3 emissions. As defined in SB 260:
- “Scope 1 emissions” means all direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities
- “Scope 2 emissions” means indirect greenhouse gas emissions from electricity purchased and used by a reporting entity, regardless of location
- “Scope 3 emissions” means indirect greenhouse gas emissions, other than Scope 2 emissions, from activities of a reporting entity that stem from sources that the reporting entity does not own or directly control and may include, but are not limited to, emissions associated with the reporting entity’s supply chain, business travel, employee commutes, procurement, waste and water usage, regardless of location
As with the SEC Proposed Rule, the classification system and reporting protocols derive from the GhG Protocol.
The Current Status of SB 260 (WEINER)
The bill requires CARB to prepare a report of the public disclosures made with specified analyses. The Secretary of State is required to create a digital platform housing all reports from reporting entities that shall be accessible to the public. SB 260 passed the Senate on January 26, 2022, and is pending in the Assembly.