Last Wednesday, March 6th, the US Securities & Exchange Commission (SEC) released its final climate disclosure rules, formally known as The Enhancement and Standardization of Climate-Related Disclosures for Investors (the Final Rules). 886 pages long (!), the SEC document sets forth a set of rules that require publicly listed U.S. companies and certain foreign companies to disclose climate-related information in their registration statements and annual reports.
It was a long time in coming, almost two years in fact. As first proposed, they were highly controversial and garnered over 24,000 comment letters, many taking special exception to the proposal that companies would have to disclose Scope 3 greenhouse gas (“GHG”) emissions (emissions from upstream and downstream participants in a company’s “value chain”).
The new regime is considerably less onerous on the reporting companies than the original proposal, but still extremely burdensome.
Seen from 50,00 feet up, these new rules are clearly part of a worldwide pattern of jurisdictions and stakeholders moving in favor of sustainability/ESG.
Although two years seems too long for rules to be finalized, the SEC is to be commended for its efforts and thoughtfulness.
To reduce the dulling effect of technical terminology, we will herein use the term “company” instead of “registrant”.
Five Important Points:
- Scope 3 emissions are not included.
Disclosure of Scope 3 emissions in securities filings made with the SEC will be voluntary.
Many companies, however, will nevertheless be obligated to report Scope 3 emissions in other jurisdictions, such as California and the European Union (“EU”).
- Reporting of Scope 1 and 2 emissions has been made easier.
Whereas the proposed rule required disclosure of Scope 1 and Scope 2 emissions by all companies regardless of materiality, the Final Rules only require disclosure of Scope 1 and Scope 2 emissions by
- large accelerated filers beginning no sooner than 2026, and
- accelerated filers beginning no sooner than 2028.
Disclosure will only be required if their Scope 1 or Scope 2 emissions are “material.” “Materiality” it not defined. The SEC says it intends for a company to “apply traditional notions of materiality under the Federal securities law” in determining whether GHG emissions are material. Moreover, “the guiding principle for this determination is whether a reasonable investor would consider the disclosure of an item of information . . . important when making an investment or voting decision or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.” So, in many cases, it will be unclear whether a company’s Scope 1 or 2 emissions should be deemed “material” to a “reasonable investor.”
Under the Final Rules, disclosure of Scope 1 and Scope 2 emissions is required in the aggregate and in gross terms, excluding the effects of any purchased or generated offsets.
Companies are required to describe the methodology, significant inputs and significant assumptions used to calculate their disclosed Scope 1 and Scope 2 emissions.
Companies will only need to disclose climate-related risks that materially impact or are reasonably likely to materially have an impact on their strategy, results of operation or financial condition. Companies need only disclose information on transition plans, scenario analyses and internal carbon pricing to the extent that such matters have or are reasonably likely to have a material impact on how the company identifies, assesses, evaluates and manages climate-related risks.
Under the Final Rule, information relating to transition plans, scenario analyses, internal carbon prices and climate-related targets or goals, other than historical facts, is considered to be a forward-looking statement for the purposes of the Private Securities Litigation Reform Act safe harbors from private liability for disclosure.
If they have chosen to manage a material transition risk, companies will only be required to disclose transition plans, which are defined as “a registrant’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.” Companies must also update their annual report disclosure about such plans each fiscal year, indicating actions taken that year pursuant to the plan and how such actions have impacted their business, results of operations, or financial condition. Such disclosure will need to include quantitative and qualitative information on the material expenditures incurred and the material impacts on financial estimates and assumptions directly resulting from any actions taken under the plan.
- The Regulation S-X rules that were proposed in 2022 have been mostly cut, leaving only disclosures related to severe weather events and other natural conditions. carbon offsets and RECs.
Companies are required to disclose, in a note to financial statements, the capitalized costs, expenditures expended, charges and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures and sea level rise.
If either carbon offsets or renewable energy certificates (“RECs”) are used as a material component to a registrant’s plan to achieve its climate-related targets or goals, then capital costs, expenditures expended, and losses related to carbon offsets and RECs will be required to be disclosed in a note to the financial statements.
- Compliance Deadlines have been extended, and several phase-ins have been adopted.
There are delayed and staggered compliance dates, depending on a company’s filing status. The earliest date is for large accelerated filers – 2025. Somewhat akin to auditors’ assurance with respect to financial statements, third-party “limited assurance” and “reasonable assurance” rules will phase in depending on company size and type, over several years, beginning with the fiscal year beginning in 2026, with the final phase-in period being fiscal year beginning in 2033.
- Legal challenges to the Final Rules have already been filed.
As expected, soon after the Final Rules were announced, several companies and ten states filed lawsuits challenging them. The outcomes of such cases are not easily predicted. “Our crystal ball is out for repair.”
Recommendations:
We recommend that companies assume that the Final Rules will remain in effect. We suggest that companies begin their compliance planning processes soon. With regard to the quantitative disclosures—and in particular, for large accelerated filers and accelerated filers with respect to Scope 1 and Scope 2 GHG emissions—companies should begin collecting relevant data now.
Think of the SEC Final Rules as one of the so-called “Big Three” climate disclosure laws, the other two being (i) the EU Corporate Sustainability Reporting Directive known as “CSRD” (see Mandatory Reporting of Opportunities under the European Union Corporate Sustainability Reporting Directive (CSRD) – McAlan LC) and (ii) the set of California laws previously reported on herein at Momentous California Climate Accountability Laws Await Governor’s Signature – McAlan LC and New California Anti-Greenwashing Law Is Now in Effect – McAlan LC). Other countries, such as Brazil, have enacted similar laws. (See Brazil Takes the Leap into Mandatory Corporate Sustainability Disclosures – McAlan LC). All these laws are on the books, and you can expect other similar laws to join them.
We therefore recommend that all businesses, of any meaningful size, become informed about, and stay abreast of, this global tsunami of sustainability legislation.