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SEC proposes climate-related disclosures

Climate||Health and Benefits
Climate Risk and Resilience

By Gary Chase , Kenneth Kuk , Steve Seelig and Jonathan D. Weatherly | April 26, 2022

The SEC proposal would require companies to actively measure and disclose climate-related business risks using more standardized methods.

The U.S. Securities and Exchange Commission (SEC) has released a proposal to expand and standardize company disclosures about their carbon emissions and other climate-related metrics. The intent is to provide investors with a more uniform and effective way to analyze a company’s progress on reducing carbon emissions and information about the effects of climate-related risks on its business.

Below is a broad summary of the proposal as well as the related SEC press release and fact sheet.

New Subpart 1500 of Regulation S-K

A new Subpart 1500 of Regulation S-K would require both domestic and foreign private issuers to include climate-related disclosures in annual reports as well as company registration statements and reports. Disclosures would include: (1) certain climate-related information, including information about a company's climate-related risks that are reasonably likely to have material impacts on its business or consolidated financial statements; and (2) greenhouse gas (GHG) emissions metrics that could help investors assess those risks. Companies also may choose to disclose climate-related opportunities.

The proposed climate risk disclosures are aligned with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD); however, companies would be given latitude to determine whether disclosure was needed based on this “reasonably likely to have material impacts” standard rather than having disclosure be mandated.

The GHG metrics are based on the GHG Protocol’s Corporate Accounting and Reporting Standard that provides uniform methods to measure and report the seven greenhouse gasses covered by the Kyoto Protocol: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride and nitrogen trifluoride.

It is notable that the SEC has decided to align with globally utilized and validated Task Force on Climate-Related Financial Disclosures and greenhouse gas metrics structures.

It is notable that the SEC has decided to align with globally utilized and validated TCFD and GHG metrics structures. This provides some clarity for companies as they work out their compliance efforts.

  1. 01

    Climate risk disclosures

    The proposed Regulation S-K would require the following climate-related disclosures to appear in a separate, appropriately captioned section of a company’s registration statement or annual report as the Climate-Related Disclosure. Alternatively, this information could be incorporated in this section by reference to another disclosure section, such as Risk Factors, Description of Business, or Management’s Discussion and Analysis (MD&A).

    (Item 1501) Governance. This disclosure would focus on both the level of board of director expertise and its actual oversight activities relating to climate-related risks. Disclosures would need to detail how these climate-related risks factor into the board’s oversight of business strategy, risk management and financial management. The extent to which the board sets climate-related goals for management, and the specifics of those goals, also would need to be disclosed.

    The governance disclosure also would focus on management’s roles in assessing and managing climate-related risk that mirror those required for the board.

    Companies should not misinterpret this directive to indicate that they need a “climate expert” member of the board of directors.

    This requirement highlights the need for board of director expertise and its actual oversight activities relating to climate-related risks. Companies should not misinterpret this directive to indicate that they need a “climate expert” member of the board of directors. Explicitly, companies do need to have board member(s) with the expertise to understand and help the board govern the climate-related risks to the business.

    (Item 1502) Strategy, business model and outlook. As mentioned above, the key standard by which a company would determine whether a disclosure under this section would be required is whether any climate-related risks are “reasonably likely to have a material impact on a [company], including its business or consolidated financial statements, which may manifest over the short, medium, and long term.” Actual and potential impacts of any climate-related opportunities also could be presented, if applicable.

    These disclosures could fall into one of several categories, including physical risks to property, processes or operations (e.g., flooding) or transitional risks relating to regulatory, technological, market (including changing consumer, business counterparty and investor preferences), liability, reputational or other transition-related factors (e.g., operations in jurisdictions imposing GHG emissions reduction standards). Quantification of relative risks and time horizons would also need to be described.

    Once the climate-related risks are identified, the company would then need to describe the actual and potential impacts of these risks on its strategy, business model and outlook. Impacts could be on the company itself; its suppliers, products and services delivered; how it might mitigate those impacts, including research and development efforts to do so; and any other significant changes or impacts, along with time horizons for impacts and mitigations. The actual and potential impacts of these considerations would also need to be included in both current and forward-looking disclosures as to business strategy, financial planning and capital allocation.

    Climate-related risks described above would also need to be included into a narrative on how they have affected or are reasonably likely to affect the presentation of the company’s consolidated financial statements.

    (Item 1503) Risk management. In this section, a company would describe its 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. For example, if a company uses an internal carbon price, it must disclose information about the price and how it is set.

    In making this philosophic decision on whether to be market-leading, disclosing the minimum or landing at any point in between, management and the board must spend time building consensus on what the approach should be.

  2. 02

    GHG emissions metrics

    (Item 1504) GHG emissions metrics. While this section is part of the Regulation S-K disclosures section, the proposal requires these disclosures for Scope 1 and 2 emissions for all companies without regard to the materiality standard referenced above. Scope 3 emission disclosures would be subject to a materiality standard in determining the need for disclosure.

    Scope 1 emissions are direct GHG emissions that occur from sources owned or controlled by the company. These might include emissions from company-owned or controlled machinery or vehicles, or methane emissions from petroleum operations.

    Scope 2 emissions are those emissions primarily resulting from the generation of electricity purchased and consumed by the company. Because these emissions derive from the activities of another party (the power provider), they are considered indirect emissions.

    Scope 3 emissions are all other indirect emissions not accounted for in Scope 2 emissions. 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 company purchases from third parties, employee commuting or business travel, and the processing or use of the registrant’s products by third parties.

    Determining whether Scope 3 emissions must be disclosed is generally subject to a materiality threshold. To mitigate potential liability for relying on a third-party source for this information, the proposal provides that companies would not be deemed to make a fraudulent statement on Scope 3 emissions unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.

    The Scope 3 rule also would require, without regard to materiality, that a company disclose its Scope 3 emissions if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.

    (Item 1505) Attestation of Scope 1 and Scope 2 emissions disclosure. This rule would require a third party — called a GHG emissions attestation provider — to attest to certain assurance levels that ramp up over time covering these disclosures for large accelerated and accelerated filers. The SEC does not include the standards for those attestations in its proposal but contemplates they could be set by a governing body that will authorize so-called GHG emissions attestation providers to perform these services.

    (Item 1506) Targets and goals. The proposal would require disclosure if a company has set any targets or goals related to reducing GHG emissions, or any other climate-related target or goal (e.g., regarding energy usage, water usage, conservation or ecosystem restoration, or revenues from low-carbon products), such as actual or anticipated regulatory requirements; market constraints; or other goals established by a climate-related treaty, law, regulation, policy or organization. These disclosures would include the scope of activities and emissions included in the target, how the company intends to meet its targets and goals, updates in each fiscal year on progress toward the target or goal and how such progress has been achieved, and if carbon offsets or renewable energy certificates detailed information on how they helped to meet the targets or goals.

Article 14 of Regulation S-X

The SEC also proposed to add a new Article 14 of Regulation S-X that would require certain of the above-referenced climate-related financial statement metrics and related disclosure to be included in a note to a company's audited financial statements. These would consist of what are known as disaggregated climate-related impacts on existing financial statement line items. These financial statement metrics would be subject to audit by an independent registered public accounting firm and would come within the scope of the registrant’s internal control over financial reporting.

Effective date and phase-in periods

The proposed rules would include:

  • A phase-in period so that the compliance date is dependent on filer status
  • An additional phase-in period for Scope 3 emissions disclosure
  • A phase-in period for the assurance requirement and the level of assurance required for accelerated filers and large accelerated filers
  • A safe harbor for liability for Scope 3 emissions disclosure
  • An exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies
  • Forward-looking statement safe harbors pursuant to the Private Securities Litigation Reform Act, to the extent that proposed disclosures would include forward-looking statements and all conditions of those safe harbor provisions are met

Going forward

The comment period will remain open until least May 20, 2022. The earliest that disclosures would be required is for fiscal year 2023, to be filed in 2024, so it is possible companies with June 30, September 30 and October 31 fiscal year-ends would face the earliest compliance with this new rule; however, several business groups have taken issue with the scope and breadth of the proposed regulations, so possible legal challenges could be brought after the regulations are finalized.


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