Alert April 15, 2022

SEC Proposes Sweeping New Climate-Related Disclosure Rules

The U.S. Securities and Exchange Commission (SEC) has proposed amendments that would require domestic and foreign companies to include certain climate-related information in registration statements and periodic reports. Like the recently-proposed cybersecurity amendments, but unlike many SEC rulemaking actions in recent years, the proposed climate-related disclosure amendments would require companies to adhere to prescribed disclosure topics and formats, rather than allowing companies to determine what disclosure would be relevant to investors and are a sharp departure from the SEC’s long-standing approach to climate-related disclosure. The proposed amendments would require a new “Climate-Related Disclosure” section that would include significant, detailed disclosure about the company’s climate-related risks and greenhouse gas (GHG) emissions. The proposed amendments would also require disclosure of climate-related financial metrics in the footnotes to a company’s audited financial statements.

The proposed climate-related rules would represent a fundamental change in SEC disclosure requirements if adopted in their proposed form. For more than a decade, climate-related disclosures have been based primarily on what companies believed was material in the context of the company’s business. The SEC articulated these requirements in 2010 guidance that stated the SEC’s views about how companies should disclose climate change matters within the existing disclosure framework. In 2021, the SEC supplemented the 2010 guidance by publishing a sample comment letter in 2021 to illustrate typical comments that the SEC Division of Corporation Finance was issuing to companies about their climate-change disclosures.

The proposed amendments are summarized in a later section of this alert. Broadly speaking, the proposed amendments differ from current disclosure requirements in two respects. First, the proposed amendments are heavily prescriptive, and will require companies to address disclosure items whether or not material to the company. Second, the proposed amendments include several types of significant new disclosures. One of the most significant new disclosures would be disclosure of Scope 1, Scope 2 and, for some companies, Scope 3 greenhouse gas (GHG) emissions, including attestation by independent experts for Scope 1 and Scope 2 disclosures by large accelerated filers and accelerated filers. Another significant new disclosure requirement would be disaggregation of existing line items in footnotes to audited financial statements for certain climate-related expenditures and impacts, triggered at a 1% level.

It is not clear when the SEC will adopt final climate-related disclosure amendments, nor is it clear how the final rules may differ from the proposed amendments. It is clear that these amendments are a high priority for the SEC, and that the final amendments have the potential to affect companies in many significant ways. With that said, litigation that challenges the final amendments is very likely. If successful, litigation could delay the effectiveness of the final amendments, and could also result in some or all of the final amendments being struck down by a court on grounds ranging from lack of statutory authority – an argument made at length by Commission Hester M. Peirce in her statement dissenting from the vote approving the proposed amendments – to compelling speech in violation of the First Amendment to the U.S. Constitution.

What Companies Should Be Considering Now

The SEC’s Fast Track to Mandatory Compliance in 2023. The compliance dates published in the proposing release suggest that the SEC is proceeding on the assumption that it can adopt final rules before the end of 2022 and make all of the final rules, other than disclosure of Scope 3 GHG emissions and attestation of Scope 1 and Scope 2 GHG emissions, effective for large accelerated filers for calendar year 2023. This would result in large accelerated filers including all but the Scope 3 disclosures and the Scope 1 and 2 attestations in their 2023 Form 10-K and Form 20-F annual reports that will be filed in early 2024. A detailed presentation of the compliance phase-in dates as published in the proposing release is included in a later section of this alert.

The proposed amendments would require many new disclosures that would, in turn, require companies to identify significant internal and external resources that could involve significant expenses. The proposed amendments are also likely to require considerable changes in both disclosure controls and procedures and internal control over financial reporting, and may also result in changes in risk management structures related to climate risks. These and other actions companies would likely need to undertake in order to comply with the proposed amendments will require companies to review the amendments and the company’s current systems and resources and then to structure, implement and test the modified systems and resources, all of which is likely to require a significant amount of time.

While it is not clear what new disclosures the final amendments may require and when – or even if – some or all of the final amendments may become effective, the significant new disclosures and the SEC’s compliance dates may prove challenging for many companies. As a result, many companies – especially large accelerated filers – may wish to start evaluating the potential impacts of the proposed amendments now.

Board Recruitment. There is no bad time for companies to increase their efforts to recruit director candidates who have expertise in climate-related matters. The proposed amendments would require companies to identify directors with climate-related expertise and describe their qualifications. This would likely accelerate the demand for such experts, but companies already face considerable pressure from investors, corporate governance interests and the media to attract directors with climate-related expertise. This pressure will continue, whether or not the proposed amendments become final. The same considerations apply equally to director candidates with cybersecurity expertise, for all the same reasons.

Current Public Disclosures. Some of the disclosures that would be required by the proposed amendments are triggered by the company’s external disclosures. For example, if a company publicly discloses GHG emissions reduction targets or goals, the proposed amendments would require the company to disclose its progress. Further, if any company other than an SRC publicly discloses Scope 3 emissions as part of its GHG emissions reduction targets or goals, the proposed amendments would require the company to disclose Scope 3 emissions, even if not material to the company. Companies may wish to consider these requirements in the context of current and future disclosures of GHG emissions reduction targets or goals.

Current ESG Framework. If the company currently discloses GHG emissions or targets and is not using (or at least familiar with) the framework established by the Task Force on Climate-Related Financial Disclosures (TCFD), the company may wish to review the TCFD framework and evaluate how it differs from the framework currently used by the company. The proposed amendments are similar in many respects to the TCFD framework, so understanding any major differences may be helpful.

Current Risk Management Processes. Review the company’s current processes for the identification, assessment and management of climate-related risks. The proposed amendments would require companies to disclose these processes in considerable detail. When disclosed as required by the proposed amendments, do they appear appropriate and reasonably designed for these purposes? 

Internal Financial Reporting and Recordkeeping Systems. Will the company’s current internal financial reporting and recordkeeping processes support review and disclosure, if necessary, of the impact of climate-related events and conditions on individual line items in the company’s audited financial statements? The proposed amendments include requirements to disclose climate-related impacts on the company’s financial statements in footnotes to the audited financial statements. Many companies, especially smaller companies and companies that are not engaged in manufacturing products, may not have systems in place that will support auditable review at this level. Discussions with the company’s independent audit firm may be helpful.

Disclosure Controls and Procedures. What changes would compliance with the proposed amendments require in the company’s disclosure controls and procedures? The proposed amendments would require substantial new disclosures. Even for disclosure items that did not require disclosure by the company, the prescriptive nature of the proposed amendments will require many companies to review a significantly expanded range of expenditures, results and reasonably likely future results, risks and internal processes. Many, if not most, companies are likely to need to update their disclosure controls and procedures to comply with the final amendments if they are similar to the proposed amendments.

As a separate matter, how well integrated are the company’s current environmental, social and governance (ESG) disclosures, including climate-related disclosures, with its disclosure controls and procedures? In many cases, climate-related disclosure and other ESG disclosures are not subject to the company’s disclosure controls and procedures or are subject only in part. To the extent that these disclosures appear in SEC filings, the lack of disclosure controls and procedures creates risk of violation of SEC requirements for disclosure controls and procedures as well as potential for SEC enforcement action and securities litigation by private plaintiffs.

Internal Control Over Financial Reporting. What changes in the company’s internal control over financial reporting (ICFR) would be required to support the required disclosure in the footnotes to the company’s audited financial statements that would be required by the proposed amendments? As noted above, the proposed amendments would require disaggregation of individual line items that had a 1% or greater impact, either positive or negative, without giving effect to netting. This disclosure in the footnotes to the company’s audited financial statements would need to satisfy applicable auditing standards.

Attestation Expert Firms. If the company currently obtains third party reports on climate-related matters, it may wish to discuss with that firm whether it would be able to continue doing so, and on what terms, if the proposed amendments are adopted in their current form. The proposed amendments require disclosure regarding the qualifications of the firm as an expert as defined in the amendments, the basis for its independent status and whether the firm is subject to any oversight inspection program. Companies may also wish to discuss the impact of potential liabilities under the federal securities laws on the engagement terms of any firm currently providing third-party attestation.

Financial Statement Audit Impacts. How would the financial statement disclosures in the proposed amendments affect audits of the company’s financial statements? The proposed amendments are very likely to require new or revised internal reporting and increased audit-related time by company personnel and the independent audit firm. This is likely to increase the internal financial reporting costs and the costs associated with engagement of the company’s independent audit firm. Companies may wish to discuss the potential impact of the proposed amendments in these areas, especially considering the apparent desire of the SEC to fast-track adoption and effectiveness of final amendments.

Scope and Timing

Companies Subject to the Proposed Rules. The proposed amendments would apply to all domestic operating companies, including smaller reporting companies (SRCs) and emerging growth companies (EGCs), as well as to foreign private issuers (FPIs). As discussed below, SRCs would be exempt from the requirement to obtain independent expert attestation for Scope 3 greenhouse gas (GHG) emissions. The proposed amendments would apply to EGCs and IPO registration statements with no exemptions other than the exemption for Scope 3 GHG emissions for SRCs.

SEC Forms Affected by the Proposed Rules. The proposed amendments would require the new disclosures in periodic reports (Form 10-Q, Form 10-K and Form 20-F) and registration statements (Form S-1, Form S-3, Form F-1 and Form F-3).

Timing: Comment Period, Adoption, Effectiveness and Phase-In. The SEC’s timeline for adoption of final rules is uncertain. The proposed amendments are subject to a public comment period through at least May 20, 2022. The SEC published phase-in dates for the proposed amendments that are based on an assumption that the SEC adopts final rules by December 2022, which may suggest that the SEC intends to expedite adoption of final rules. These phase-in dates, which are based on a December 31 fiscal year end, are shown in the table below. Note that FPIs would become subject to the final rules based on their filer status.

Disclosure Requirement Large Accelerated Filers  Accelerated Filers Non-Accelerated Filers  Smaller Reporting Companies 
All proposed disclosures, including Scope 1 and Scope 2 GHG emissions metric and associated intensity metrics (not Scope 3) Fiscal year ended 12/31/2023
(filed in 2024)
Fiscal year ended 12/31/2024
(filed in 2025)
 
Fiscal year ended 12/31/2025
(filed in 2026)
Scope 3 GHG emissions metrics and associated intensity metrics Fiscal year ended 12/31/2024
(filed in 2025)
Fiscal year ended 12/31/2025
(filed in 2026)
 
Exempt
Attestation of Scope 1 and Scope 2 GHG emissions – limited assurance Fiscal year ended 12/31/2024
(filed in 2025)
Fiscal year ended 12/31/2026
(filed in 2027)
Not Applicable
Not Applicable
Attestation of Scope 1 and Scope 2 GHG emissions – reasonable assurance Fiscal year ended 12/31/2026
(filed in 2027)
Fiscal year ended 12/31/2027
(filed in 2028)
Not Applicable
Not Applicable

Summary of the Proposed Rules

The proposed amendments fall into three categories:

  • Disclosure that would be primarily textual disclosure about climate-related matters; 
  • Scope 1, Scope 2 and Scope 3 GHG emissions disclosure, with independent expert attestation for Scope 1 and Scope 2 GHG emissions, depending on filer status; and
  • Financial statement footnote disclosure.

The first two categories would be included in a new separately-captioned “Climate-Related Disclosure” section of periodic reports and registration statements. The third category would be required in the footnotes to the audited financial statements.

Like the recent cybersecurity rules proposed by the SEC, the proposed climate-related disclosure rules are heavily prescriptive. The proposed amendments would require companies to address an extensive list of disclosure subjects, in many cases in specified presentation formats, regardless of whether the disclosure is relevant or material to the company. This is a significant change from the principles-based amendments to many other disclosure requirements adopted by the SEC in recent years and is presumably intended to facilitate greater comparability between companies and across different industries and businesses.

Textual Disclosures. The proposed amendments would require new textual disclosure of a spectrum of material climate-related impacts, including risks and opportunities, about the following, among others:

  • Board and management oversight and related governance matters;
  • Identification of any directors who have expertise in climate-related risks;
  • Risk management, including identification, assessment and management of risks;
  • Impacts on strategy, business model and outlook;
  • If the company publicly discloses climate-related targets or goals, information about how the company plans to meet the targets or goals and the time horizon for achievement of the targets or goals, and other related information; 
  • Transition plans adopted by the company;
  • Carbon offsets and renewable energy credits, if used;
  • Internal carbon price, if used; and
  • Scenario analysis, if used.

The proposed amendments would require these disclosures for material impacts over short, medium and long terms. The proposed amendments do not define these time horizons. Materiality for these purposes would be consistent with existing materiality standards, under which a matter is material if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote and, in the case of potential future events requires the company to assess both the probability of the event occurring and its potential magnitude, or significance to the company.

Disclosure and Expert Attestation of GHG Emissions. Proposed Regulation S-X amendments would require disclosure of GHG emissions based on a framework similar to the Task Force on Climate-Related Financial Disclosure. The proposed amendments would require the following, to the extent reasonably available:

  • Disclosure of Scope 1 and Scope 2 GHG emissions by all companies, including smaller reporting companies (SRCs);
  • Independent expert attestation of Scope 1 and Scope 2 GHG emissions by accelerated filers and large accelerated filers; and
  • Disclosure of Scope 3 GHG emissions (e.g., emissions by suppliers, vendors and customers, as well as transportation of goods ) by all filers other than SRCs, if material to the company or, whether or not material to the company, if the company has set a GHG emissions target or goal that includes Scope 3 GHG emissions.

Scope 3 GHG emissions disclosure can be reported as a range under certain circumstances, and would be subject to a safe harbor if the company has a reasonable basis for the disclosure and makes the disclosure in good faith.

“Experts” for purposes of the attestation requirements would not be limited to firms registered with the Public Company Accounting Oversight Board, but experts would be required to satisfy the conditions required by the proposed amendments for expert status. The proposed amendments would also require that experts satisfy independence requirements and require disclosure of certain information about the expert and the terms of its engagement. The proposed amendments would also require companies to disclose any oversight inspection program to which the expert is subject. At present, there are no such functional programs for firms other than registered public accounting firms. It is not clear what impact this disclosure requirement would have on selection of engineering firms or others to perform these attestations.

Audited Financial Statement Disclosure. Proposed amendments to Regulation S-X would require new footnote disclosure in audited financial statements of certain climate-related financial statement metrics and related disclosures. These disclosures would be subject to a company’s internal control over financial reporting. Because these would be included in the company’s audited financial statements, they would also be subject to the auditing standards applicable to the company’s financial statements. These proposed amendments include impacts of the following:

  • Climate-related events and natural conditions on any line item in the company’s financial statements; 
  • Company expenditures related to mitigation of severe weather and natural conditions risks;
  • Expenditures related to transition activities related to reduction of GHG emissions and the financial impact of these expenditures; and 
  • Qualitative disclosure about the impact of estimates and assumptions related to severe weather events and natural conditions or transition activities used to produce the company’s consolidated financial statements.

The proposed amendments would require disaggregation of positive and negative impacts and a requirement to break out individual financial statement line items, triggered at the 1% level (regardless of materiality standards). Consistent with the prescriptive nature of the proposed amendments, the proposal includes a large number of examples of potential disclosures that companies would need to evaluate even if disclosure is ultimately not required.