By Allen Campbell, JD, MBA
This is another blog post in our series on Value Chain Sustainability.
California is enacting two mandatory climate disclosure laws – together called the California Climate Accountability Package. They have been passed in both chambers of the state legislature and now are awaiting the Governor’s signature. These laws are the first of their kind to be adopted at any level – state or federal – in the US. Given the size of the state’s economy, these laws will impel many companies throughout the US to comply with the California scheme. There will be global effects; these laws will align much of the US economy with those of advanced nations committed to slow down or stop climate change.
The two bills are the Climate Corporate Data Accountability Act (CCDAA) (SB253) and the Climate-Related Financial Risk Act (CRFRA) (SB 261) The passage of these bills puts California in the position to implement first-of-its-kind mandatory climate disclosure in the US. They will apply to thousands of U.S. public and private companies “doing business in California”. SB 253 will require in-scope companies to file annual reports that will publicly disclose their Scope 1, 2 and 3 greenhouse gas (GHG) emissions. SB 261 will require in-scope companies to prepare biennial reports disclosing climate-related financial risk and describing measures adopted to mitigate and adapt to that risk.
When signed into law, these two laws will be examples of what I call “The Expanding Universe of ESG” – in terms of geographic application and content.
Reports must conform to the Greenhouse Gas Protocol (GHG Protocol) standards and guidance. As a reminder:
- “Scope 1 emissions” means all direct GHG emissions that stem from sources that a company owns or directly controls, not just fuel combustion activities.
- “Scope 2 emissions” means indirect GHG emissions from consumed electricity, steam, heating or cooling purchased or acquired by a company.
- “Scope 3 emissions”, sometimes called “full value chain emissions”, means indirect upstream and downstream GHG emissions, other than Scope 2 emissions, from sources that a company does not own or directly control, and may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.
By requiring disclosure of Scope 2 and (especially) Scope 3 emissions, the two California laws place the burden on companies to take account of their value chains’ emissions.
Worth noting:
- California has acted – while lawyers and commentators have anxiously awaited the climate rule proposed by the Securities and Exchange Commission (SEC) in March 2022.
- The California laws show some convergence with EU law concepts and processes For example, the California laws apply to both public and private companies, as do the European Union’s recently enacted CSRD and the impending CSDDD.
- Large companies will likely demand more information from their suppliers and customers.
- While many companies are already publishing some GHG emissions data or are reporting as per the Task Force on Climate-Related Financial Disclosure (TCFD, such reporting may not meet the new California requirements, particularly with regard to Scope 3 or methodological requirements. In addition to conducting a careful gap analysis of existing reporting against these new rules, companies may want to consider other changes to account for the shift from voluntary to regulated disclosure – including adopting additional controls, improving data quality and refining methodological approaches.
SB 253:
- SB 253 applies to US companies “doing business in California” with annual global revenues exceeding $1 billion. Public and private companies are subject to SB 253.
- Companies must publicly disclose each year their Scope 1, 2 and 3 GHG emissions for the prior fiscal year in conformity with the Greenhouse Gas Protocol standards and guidance.
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- Companies need to start reporting their Scope 1 and Scope 2 emissions beginning in 2026. Reporting for Scope 3 emissions will not begin until 2027.
- GHG emissions will need to be verified. Companies must obtain third-party assurance for their emissions reporting, at a “limited assurance” level, beginning in 2026 for Scopes 1 and 2 emissions, and at a “reasonable assurance” level in 2030. The third-party assurance for Scope 3 emissions shall be performed at a limited assurance level in 2030.
- “Limited assurance” means that an independent auditor obtains sufficient and appropriate evidence, limiting assurance to specific aspects of the reporting.
- “Reasonable assurance” is the higher level of assurance and is more rigorous and intensive, requiring evidence to demonstrate that the reporting is free of material misstatements.
- To implement this new disclosure regime, the California Air Resources Board will develop and adopt regulations on or before January 1, 2025. The rules are to be reviewed in 2029 and updated by 2030.
- A company that fails to report or reports inadequately may face a penalty of up to $500,000.
SB 261:
- SB 261 applies to public and private large US companies “doing business in California” with annual revenues exceeding $500 million (calculated on a global basis).
- Companies will be required to publish a biannual climate-related financial risk report that discloses their:
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- climate-related financial risk, built upon recommendations of the TCFD or a comparable disclosure regime, and
- measures adopted to mitigate and adapt to the disclosed climate-related financial risk.
- “Climate-related financial risk” is very broadly defined to include all material risk of harm to immediate and long-term financial outcomes due to physical and transitional risks, such as risks to business operations, obtaining goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health. The exact nature of alignment with TCFD recommendations is unclear and will likely be clarified by future implementing regulations.
- In an effort to minimize the burden on companies that are already publishing climate risk reports either voluntarily or to comply with a mandatory requirement, such as future SEC or EU Corporate Sustainability Reporting Directive (CSRD) rules, the bill provides that companies may satisfy the biannual reporting requirement with a comparable climate-related financial risk reporting framework, such as the International Sustainability Standards Board (ISSB) framework.
- Climate-related financial risk reports may be consolidated at the parent company level.
- On or before January 1, 2026, companies will need to publish an initial climate-related financial risk report. Reports will be required every two years after the initial report. Reports must be posted publicly on the company’s website and filed with the California Air Resources Board. If a company cannot provide all of the required disclosures in its report, it must provide a detailed explanation of any reporting gaps, describe the steps it is taking to comply and provide complete disclosures in the future.
- A company that fails to report or that reports inadequately may face an administrative penalty of up to $50,000.
Noteworthy:
- It is likely that regulators, investors, lenders and other “stakeholders” will place all companies under ongoing pressure to reduce their carbon footprints, and companies are well-advised to “do ESG” accordingly.
- The GHG Protocol remains pre-eminent. However, while many companies are already publishing some GHG emissions data or TCFD-aligned climate reporting, these disclosures may not fully comply with the new California requirements, particularly with regard to Scope 3 or methodological requirements.
- As we have noted with respect to other Value Chain Sustainability laws, this California Package is best understood in the global context of “soft law becoming hard law.”
Recommended actions:
Begin by educating your board and senior management about climate reporting. They need to know that GHG reporting is only one many tasks encompassed by sustainability/ESG management and/or, better still, risk/compliance/ESG management, The entirety of risk/compliance/ESG management is beyond the scope of this article.
All of this requires cross-functional teamwork, and it is advisable to develop your team’s structure, functions and membership early on. The team should include outside advisors, notably including an emissions accounting firm with industry expertise.
In addition to conducting a gap analysis of existing reporting against these new rules, your company may want to consider other changes to account for the shift from voluntary to regulated disclosure – including adopting additional controls, improving data quality and refining methodological approaches.