On Monday, March 21, 2022 the Securities and Exchange Commission (“SEC”) voted three to one to propose a substantial set of new securities regulations that would, for the first time, impose detailed, mandatory requirements on domestic and foreign registrants to make a wide range of climate-related disclosures to the public. While the SEC has discussed such a possibility since the start of the Biden Administration, this marks the first time the SEC has offered the substance of such disclosures and kicks off the public comment and rulemaking process. The key takeaways from the proposed rules and next steps are discussed in more detail below.

The SEC vote to proceed with the climate-related disclosure rules is grounded by multiple considerations. First, the SEC has repeatedly cited a sense that investors, shareholders, and the public are increasingly pushing companies to greater transparency and accountability around climate-related risks. The proposed rules, the SEC argues, will require disclosure of such information in a way that is “consistent, comparable, and decision-useful” so that it can better drive investment decisions across the market. Second, the SEC notes that a number of companies already voluntarily report such information, and otherwise publicly discuss climate-related goals and “transition plans” (i.e., activities to align a company’s operations with those goals). These proposed rules, the SEC argues, will make such disclosures—and the decisions underpinning them—more reliable and visible. Finally, the proposed rules align with President Biden’s Executive Orders that every agency should renew their focus on climate change and environment, social and governance (“ESG”) issues, and specific direction by the Administration to financial regulators to weigh climate-related risks.

Once finalized, these proposed rules may carry significant costs by requiring each registrant to integrate additional internal controls, financial reporting, emissions tracking, disclosures, and in some cases, third-party attestation. Companies should also be aware that increased climate-related disclosures in public filings bring with them the threat of SEC enforcement, civil litigation that challenges those disclosures, and the potential use of such disclosures against the company.

Highlights of Proposed SEC Rules on Climate-Related Disclosures

The proposed rules would mandate a number of new climate-related disclosures by a registrant (whether domestic or foreign) in its registration statements and annual reports filed with the SEC. The risk-related disclosures and emissions reporting would need to be separately captioned, while the climate-related financial statement metrics and disclosure would be included in a note to the registrant’s audited financial statements. The proposed climate-related disclosure framework is modeled primarily on the Task Force on Climate-Related Financial Disclosures (“TCFD”) recommendations, while the proposed emissions reporting requirements are based on the GHG Protocol’s concept of scopes and related methodology. Below is a summary of the key new disclosure obligations proposed by the SEC.

• Greenhouse Gas (“GHG”) Emissions Reporting: The proposed rules mandate disclosures on an annual basis of the registrant’s direct GHG emissions (commonly referred to as “Scope 1” emissions) and separately, disclosures of indirect GHG emissions from the purchase of electricity and other forms of energy (“Scope 2” emissions). These disclosures would need to be expressed both as disaggregated constituent GHGs and GHG emissions in the aggregate, as well as in absolute terms (i.e., excluding carbon offsets) and in terms of intensity (i.e., per unit of economic value or production). GHG Scope 1 and Scope 2 emissions reporting would be required without regard to materiality.


• Attestation of Scope 1 and Scope 2 Emissions Reporting: In addition to the mandated reporting for all filers, the proposed rules require third-party attestation for Scope 1 and Scope 2 disclosures for accelerated filers or large accelerated filers. The attestation would be provided by an independent GHG emissions attestation provider who meets certain requirements, i.e., is an expert in this area and makes the attestation based on publicly available standards. The attestation requirement would be phased in with a fiscal year transition period to achieve “limited assurance,” followed by an additional two fiscal years to scale up to “reasonable assurance.”


• Scope 3 Emissions Reporting: The proposed rules also may require similar disclosure of indirect upstream and downstream emissions from a registrant’s value chain (“Scope 3” emissions). These Scope 3 disclosures are required only if the emissions are “material” quantitatively or qualitatively, or if the company has set a GHG emission reduction target that includes Scope 3 emissions. Scope 3 emissions totals may be provided as a range and are to be calculated using a non-exclusive list of upstream and downstream activities based on GHG Protocol methodology. The proposed rules provide an extended phase-in period for Scope 3 disclosures and provide safe harbor for Scope 3 emissions disclosures. Small reporting companies are exempted from this Scope 3 disclosure requirement under the proposed rules.


• Climate-Related Risk, Impacts, and Governance: Additionally, the proposed rules would implement a new climate-related risk disclosure framework modeled on guidance published by the TCFD and also relies on the GHG Protocol. The required disclosures would include:
  
  
  • Oversight and governance of climate-related risks by the company’s board and management;
  
  
  • How the company identifies climate-related risks, how those risks have materially impacted or are likely to materially impact its business and financial statements in the short-, medium-, and long-term; 
  
  
  • How those climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook; 
  
  
  • The company’s process for identifying, assessing, and managing the climate-related risks and whether (and how) those processes are integrated into overall risk management systems; and
  
  
  • If applicable, information regarding the role of carbon offsets or renewable energy certificates (“RECs”) and the use of an internal price on carbon and scenario analysis in a company’s climate-related business strategy.
  
  
  A reporting company may also choose to disclose information regarding any climate-related opportunities.


• Climate-Related Targets, Goals and Transition Plans: The proposed rules would mandate further disclosure of information related to a registrant’s publicly announced climate-related targets, goals, and/or “transition plans.” Critically, the proposed rules would require disclosure of the scope of such goals, the company’s timeline to meet those goals, how the company intends to meet those goals, and any relevant metrics and progress. To the extent that a company relies on carbon offsets or RECs to meet its goals, the proposed rules require additional specific information regarding the amount of carbon reduction represented by those offsets and RECs. This information would be required to be updated each fiscal year.


• Climate-Related Items in Financial Statements: Finally, the proposed rules require registrants to analyze and disclose whether and how climate-related events (i.e., severe weather events as well as physical risks) and transition activities impact line items above a threshold amount on its consolidated financial statement, as well as impact the financial estimates and assumptions used. The proposed rules also require disclosure of how the company derived its metrics and made policy decisions. These new financial statement reporting requirements would be subject to existing auditing requirements and internal controls.


• Timing: The proposed rules would be phased-in based on the size of the registrant. The SEC provided the following table, assuming an effective date of December 2022:

What’s Next & Potential Issues

The SEC will initiate the rulemaking process by publishing the proposed rules in the Federal Register, which is anticipated to occur within the next few days. The rules request comments in response to more than 200 specific questions regarding aspects of the new requirements, but also welcomes comments on any aspect of the rules, including potential impacts, costs, and alternatives. The public will have until at least May 20, 2022 to provide comments on the rules before they are finalized and voted on by the current four SEC Commissioners.

It is clear from Monday’s meeting that some SEC Commissioners may seek for the final rules to go further than currently proposed by requiring even greater disclosures of emissions, methods, and risks.

However, Commissioner Hester Peirce, the sole Republican Commissioner at the SEC, indicated that she was against the proposed rules and voted “no” on proceeding with the rulemaking. In her statement, she questioned whether the proposed rules exceed the SEC’s authority by using disclosures to advance climate change policy objectives, possibly in violation of First Amendment limits on compelled speech. Commissioner Peirce also expressed concerns that the proposed rules depart from the long-standing materiality constraint on disclosures, by dispensing with it all together or broadly recasting it to be more expansive. Yet another concern she raised is whether the proposed rules will truly be effective, and whether the SEC’s proposed rules are duplicative given how much of this information is already disclosed.

Finally, overall compliance costs are front and center with the SEC’s proposal. While the proposal is designed to be easily socialized due to its heavy reliance on terminology and work done globally in this arena, particularly by the TCFD, the demands required of reporters in order to comply with the proposal will be a topic of significant debate.

Whatever the outcome of the rulemaking process, the final rules will most certainly be subject to legal challenges.

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