SEC’s Proposed Climate Change Rules: A Sea Change in U.S. Disclosure Requirements and Climate Policy

On March 21, 2022, the Securities and Exchange Commission issued long-awaited proposed rules (“Proposed Rules”) that would require specific new types of climate change disclosures. The purpose of the Proposed Rules is to provide “consistent, comparable, and reliable...information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.”  The SEC also argued that the proposed disclosures “will promote efficiency, competition, and capital formation.”

If adopted as proposed, the Proposed Rules would require extensive, specific disclosures for most public companies, impose third-party verification requirements and establish liability for inaccurate reporting of climate related issues. The Proposed Rules would be phased into effect, commencing for some of the reporting requirements as soon as the year following the issuance of the final rule for the largest companies, and for other requirements and smaller companies, over the course of two or three fiscal years following issuance of the final rules.

Notably, the Proposed Rules take a prescriptive approach to disclosure, arguably departing from materiality principles and disclosure that is aimed at promoting an understanding of a company’s business, financial condition and prospects management and the board of the company. For example, the Proposed Rules specify certain types of disclosure with respect to climate change – for instance, greenhouse gas emissions and certain financial impacts and metrics above a set threshold – regardless of whether those are material. They also impose granular disclosure requirements about company governance and risk management practices regarding climate change that go beyond disclosure requirements for other issues.

The SEC is seeking public comment on the Proposed Rules for a period of up to 30 days after publication in the Federal Register or 60 days after issuance (May 20, 2022), whichever period is longer. We anticipate that significant opposition to the Proposed Rules will be voiced in comments submitted to the SEC and given the cost and extensive requirements of the Proposed Rules, that litigation concerning the final rules is likely.

Summary of the Proposed Rules

The Proposed Rules would require public companies (including foreign private issuers) to provide climate-related disclosure in their registration statements under the Securities Act of 1933 and their annual reports under the Securities Exchange Act 1934 (“Exchange Act”), including information about:

• Greenhouse Gas (“GHG”) Emissions Reporting. The Proposed Rules require public companies to report their GHG emissions. The SEC explained, at its March 21 meeting, that it believes that GHG emissions are directly correlated with the business risks posed by climate change, and that reporting is therefore important to shareholders. The SEC is proposing to require disclosure of emissions of GHG emissions in three categories defined by the Greenhouse Gas Protocol. These categories include direct emissions from a company’s activities (“Scope 1” emissions) and indirect emissions from purchased energy (“Scope 2” emissions) regardless of materiality. Additionally, if material, or if a company has set a GHG emissions reduction target or goal that includes such emissions, a company would also have to disclose all other emissions in its supply chain and following from the sale of its products (“Scope 3” emissions).
• Carbon Intensity. The SEC would also require reporting of GHG intensity (or “carbon intensity”) with respect to Scope 1, Scope 2 and (if applicable) Scope 3 emissions. The Proposed Rules would define GHG intensity (or “carbon intensity”) to mean a ratio that expresses the impact of GHG emissions per unit of economic value (e.g., metric tons of CO₂e per unit of total revenues) or per unit of production (e.g., metric tons of CO₂e per unit of product produced). The Proposed Rules would require disclosure of both measures of GHG intensity. This effectively creates a new accounting system for company performance that revolves around tracking the life-cycle carbon emissions associated with a company’s business.
• Third-Party Assurance of Scope 1 and 2 GHG Emissions Data. The Proposed Rules would require public companies to obtain independent third-party verification, referred to as “assurance,” regarding the accuracy of Scope 1 and Scope 2 GHG emissions calculations. Such third parties would need to be qualified as “having significant experience in measuring, analyzing, reporting, or attesting to GHG emissions” and must not be affiliated with or under the indirect control of the company. The third-party verification would be conducted similarly to audits of financial statements, with varying levels of assurance phasing in over time.

• Climate Change Goals. The Proposed Rules provide that if a public company has publicly identified climate-related targets or goals, it must disclose the following:

  • The scope of activities and emissions included in the target, the defined time horizon by which the target is intended to be achieved, and any interim targets;
  • How the company intends to meet its climate-related targets or goals; and
  • Relevant data to indicate whether the company is making progress toward meeting the target or goal and how such progress has been achieved, with updates each fiscal year.
• Risks Related to Climate Change. Under the Proposed Rules, public companies would be required to disclose potential risks associated with climate change that have had or are likely to have a material impact on a company’s business and consolidated financial statements. Companies would have to provide particular detail about the risks and whether they are likely to manifest in the short-, medium-, or long-term. The scope of the risk disclosure ranges from physical risks to the business to “transitional” risks associated with adaptation to climate change and  to revised regulatory requirements addressing climate change.
• Financial Statement Metrics. The Proposed Rules would modify Regulation S-X, which prescribes financial reporting requirements, to require separate notes on climate-related costs, capital expenditures and reserves if those exceed a certain threshold. The details on climate-related financial effects would be disclosed in financial statements separately from costs, expenditures and reserves established for other business purposes. Changes to investment planning would also be required to be disclosed, separately, to the extent motivated by climate-change planning and preparation.
• Board and Management Oversight. The Proposed Rules would require a description of the oversight and governance of climate-related risks to a public company by its board of directors and management, including disclosure of director expertise in climate-related risks, how the board is informed about such risks, and how frequently the board considers such risks. It would also require a company to describe its processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into its overall risk management system or processes.

Disclosure Issues

• Liability for Inaccurate Statements. The Proposed Rules include a safe harbor for Scope 3 emissions disclosures. Any statement regarding Scope 3 emissions that is disclosed pursuant to the sections prescribed in the Proposed Rules is deemed not to be a fraudulent statement, unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith. Other than this limited safe harbor, the Proposed Rules do not change existing standards of accountability for the accuracy and completeness of statements made in filings and reports provided to the SEC, although the SEC asks for comment on whether the standards should be modified in relation to the disclosures required by the Proposed Rules. This has implications for the disclosure public companies must make under the final rules, as well as the CEOs and CFOs certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act. Given the inherent difficulty in projecting climate change risks and impacts and the lack of SEC guidance on the content of such disclosure, companies are likely to be concerned about ensuring that the information they disclose is complete and accurate. In some cases, this may mean disclosing less rather than more. Following the experience of registrants responding to the SEC’s climate change comment letters, we expect that there will be a great deal of uncertainty about what the SEC is looking for, which may be filled in by later enforcement actions. Hopefully the SEC will opt instead to provide clarification through interpretative release, staff observations and public statements. Reporting companies may want to begin to implement changes thoughtfully and incrementally to their climate policies and practices and related disclosure strategies based on the major components of the Proposed Rules.

• Disclosure of Climate Change Goals. While many public companies have disclosed climate change targets, it is less common for companies to provide significant disclosure regarding their plans for meeting such targets owing to complexity and the aspirational nature of the goal. The Proposed Rules would require those companies that have established climate change goals to disclose the goals, describe details about their plans and strategies for achieving them, including the financial impacts, and provide ongoing status updates. In particular, the Proposed Rules contemplate disclosure of whether carbon offsets or Renewable Energy Credits (“RECs”) have been used as part of the company’s plan to achieve climate-related targets or goals, and the amount of carbon reduction represented by such offsets or RECs. Companies should consider modifying their climate goals in light of these disclosure requirements, and whether such goals need to be stated in more specific or limited terms. They should also consider how their goals would be achieved and progress tracked, and whether the need to disclose such details should limit the goals they set.
• Reporting of Internal Policies. The Proposed Rules require disclosure of internal policies or procedures adopted by public companies with respect to climate change. For example, if the company has adopted a transition plan as part of its climate-related risk management strategy, it must provide a description of the plan, including the relevant metrics and targets used to identify and manage any physical and transition risks. If the company uses scenario analysis to assess the resilience of its business strategy to climate-related risks, it should include in its disclosure a description of the scenarios used, as well as the parameters, assumptions, analytical choices, and projected principal financial impacts. If a company uses an internal carbon price for decision making or business planning, it should disclose information about the price and how it is set. Against this set of requirements, companies should carefully weigh whether it is advisable to adopt formal and specific climate change polices or metrics, and if such measures are adopted, companies should employ rigorous processes to report such measures and should be prepared to disclose the processes they used.

• Climate-Related Opportunities. Although the Proposed Rules do not require a public company to make any disclosure regarding “climate-related opportunities,” to the extent that the company chooses to make such disclosures, they must be done using the same framework used for climate-related risks. The Proposed Rules do not define “climate-related opportunities,” but instead refer to the Task Force on Climate-related Financial Disclosures (“TCFD") framework, suggesting that climate-related opportunities involve activities designed to mitigate and adapt to climate change, utilizing various technology and financing strategies, such as “resource efficiency and cost savings, the adoption of low-emission energy sources, the development of new products and services, access to new markets, and building resilience along the supply chain. Companies electing to disclose climate-related opportunities should subject these disclosures to the same rigorous review applied to statements that address climate-related risks.
• Scope 3 Emissions. In recognition of the inherent challenge and complexity of assessing Scope 3 emissions, the Proposed Rules would only require disclosure of Scope 3 emissions if emissions are material or if companies set climate-related targets that include Scope 3 emissions. Companies may want to consider developing appropriate data and reporting structures to collect and report on these emissions, particularly if the company intends to adopt GHG emissions goals which include Scope 3 emissions.
• Attestation Engagement Requirements for Third-Party Assurance. The proposed attestation requirements of the Proposed Rules will create demand for independent experts that are sufficiently qualified and sufficiently independent of public companies to provide those attestations. The SEC has not provided specific guidance on how such experts would be qualified or identified, and it is possible that there will be an insufficient numbers of such experts to meet such demand. As a result, companies may want to consider solidifying relationships with potential attestation providers, and making sure that such providers qualify for independent status.

Other Key Takeaways

• Potential Implementation Challenges. The Proposed Rules are based in large part on the TCFD recommendations, a voluntary climate disclosure framework which recommends companies disclose their approach to climate governance, their climate strategy, their climate risk management efforts, and related goals and metrics. The TCFD is one of the most widely used environmental reporting frameworks in the United States; however, while many public companies prepare a report that references the TCFD, only a small percentage of registrants provide robust climate-related information that is fully aligned with the TCFD’s recommendations. This suggests a potential gap between market practice and what would be required for compliance with the Proposed Rules. Between now and the effective date of the final rules, companies that have made a disclosure aligned with the TCFD should review any gaps or differences between their previous reports and consider what would be required under the Proposed Rules.
• Director Skills and Expertise. An obvious consequence of requiring disclosure about board members with expertise in cybersecurity and now, in climate risk will be a potential reshaping of the composition of public company boards. For both rules, as well, the SEC also contemplates that the public companies will disclose the reasons for its conclusions that individual directors have this expertise, an unprecedented level of disclosure. The SEC’s approach may fundamentally change the way companies compose their boards and plan for director succession. Moreover, identifying what constitutes expertise in climate change risk, and finding director candidates who possess it, will likely prove even more difficult than for cybersecurity, which is a much more developed industry. Public companies may want to begin thinking about what climate change risk expertise may look like at the director level, and whether any of their existing directors possess it. They might also look into nontraditional director recruitment strategies, such as those targeting academia, NGOs and thinktanks. .
• Board Processes. The Proposed Rules also would require disclosure of detailed information about how the board of directors operates, including the frequency and nature of its oversight. The Proposed Rules also seek specific information about the board’s role in climate goal setting and oversight of progress against goals. We expect that many will question the benefits of the degree of disclosure required under the Proposed Rules on the basis that it is an unnecessary intrusion into the boardroom with limited corresponding benefit to investors. Many boards are already focused on climate risk, but companies should work with their advisors to consider whether the Proposed Rules warrant further evolution of their existing practices, particularly with respect to the board’s role in goal setting and oversight of progress against goals.

• Management Processes. In addition to detail about board governance, the Proposed Rules would require detailed disclosure about the management personnel and committees involved in overseeing climate risk, and the processes by which they are informed by climate risks, the frequency of reporting to the board of directors of climate risks, and any role in assessing climate-related opportunities. While this may be less of an issue for companies that currently maintain ESG management “steering committees” that oversee climate change risk and related initiatives, this is an emerging practice and many companies have not adopted such committees. In anticipation of the Proposed Rules, companies that have not yet formed such a committee should consider whether it would be appropriate to do so.
• Risk Management. The proposed requirement to describe how climate-related risks are weighed against other risks, whether such risks may manifest over the short, medium and long-term, and how they are integrated in a public company’s overall risk management system would open a broader window into issuer enterprise risk management (“ERM”) programs than has previously existed under any prior disclosure rule. While the SEC already requires proxy disclosure of how a board oversees risk, the existing rule was deliberately focused on requiring disclosure of board risk oversight rather than company risk management. This shift, if reflected in the final rules, would expose ERM programs to a level of public scrutiny they have not previously faced. Companies should consider whether any changes to their ERM program are necessary to meet new interests raised by climate disclosure requirements because we believe the trends reflected in the Proposed Rules will continue to shape risk management regardless of whether the final rules are adopted as proposed.