SEC Passes Climate Disclosure Rules After Two-Year Wait
POMERANTZ MONITOR | MARCH APRIL 2024
On March 6, 2024, the United States Securities and Exchange Commission (“SEC”) approved a set of long-awaited regulations requiring securities issuers to provide climate-related disclosures in their annual reports and registration statements. The final rules significantly scale back the proposal released nearly two years prior, after a comment period that saw record levels of feedback from investors, industry groups, and other stakeholders. SEC Chairperson Gary Gensler, who was joined by two Democratic colleagues in a 3-2 party-line vote approving the regulations, stated that “[t]hese final rules build on past requirements by mandating material climate risk disclosures by public companies and in public offerings. The rules will provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements.”
After the regulations are phased in, the final rule will require many registrants to disclose, among other things: certain greenhouse gas (GHG) emissions, subject to a materiality requirement; climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition; the actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook; and any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks.
In financial statements, registrants will be required to disclose, in the income statement, aggregate expenditures and losses as a result of severe weather events and other natural conditions, as well as to disclose costs and charges recognized on the balance sheet due to severe weather events and other natural conditions. Both of these requirements are subject to a monetary threshold. If carbon offsets and renewable energy credits (“RECs”) are material to a registrant’s plan to achieve disclosed climate-related targets, the registrant must disclose a roll-forward of the beginning and ending balances. Registrants must also disclose whether, and if so, how, severe weather events and other natural conditions, as well as disclosed climate-related targets or transition plans, materially affected estimates and assumptions reflected in the financial statements. Large accelerated filers (issuers with a public float of $700 million or more) must begin making these financial statement disclosures in annual reports or registration statements that include financial statements for the year ending December 31, 2025, while accelerated filers (issuers with a public float greater than $75 million but less than $700 million) have an additional year to comply. The financial statement disclosures will be subject to audit requirements and management’s internal control over financial reporting. For large accelerated filers and accelerated filers other than smaller reporting companies (SRCs) and emerging growth companies (ERGs), the registrant’s auditor will assess controls over these disclosures.
During the comment period after publication of the proposed rule, significant attention was paid to the question of what information companies would be required to disclose outside of the audited financial statements. In particular, the final rule requires registrants to disclose “Scope 1” GHG emissions (i.e., those from the registrant’s owned or controlled operations) and “Scope 2” GHG emissions (i.e., those from purchased or acquired electricity, steam, heat, or cooling). In a change from the proposed rule, these disclosures are only required if they are material. Materiality, the SEC emphasized, is not determined merely by the amount of these emissions, but by whether a reasonable investor would consider the disclosure as having significantly altered the total mix of information made available. For instance, the SEC explained, “[a] registrant’s Scopes 1 and/or 2 emissions may be material because their calculation and disclosure are necessary to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations, or financial condition in the short- or long-term.”
The rule allows registrants to delay Scope 1 and Scope 2 disclosures until the due date of their Q2 quarterly report for the following year. Large accelerated filers must begin including Scope 1 and Scope 2 emissions disclosures in annual reports or registration statements that include financial statements for the year ending December 31, 2026. Accelerated filers have two additional years to comply. SRCs, ERGs, and nonaccelerated filers are exempt from the requirement to provide GHG emission disclosures.
Beginning with fiscal year 2029, large accelerated filers must attest with “limited assurance” as to the accuracy of the Scope 1 and Scope 2 emissions disclosures. Beginning two years later, such filers must attest to the accuracy of these disclosures with “reasonable assurance.” Accelerated filers (other than SRCs and ERGs) need only provide “limited assurance” attestations beginning with fiscal year 2033.
The rule will also require disclosure of processes for identifying, assessing, and managing material climate-related risks; information about any climate-related targets or goals that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition; and any oversight by the board of directors of climate-related risks and any role by management in assessing and managing such risks.
Notably, the final rule does not require disclosure of “Scope 3” GHG emissions, which are those produced along the registrant’s “value chain,” such as by the registrant’s suppliers. Though Scope 3 emissions can be substantial, and even greater than a company’s Scope 1 and Scope 2 emissions, the SEC eliminated this disclosure requirement in the face of vigorous opposition by business groups. This was likely an attempt to head off challenges and the prospect of a court decision invalidating the regulation. Scope 3 disclosures are required by the European Commission’s Corporate Sustainability Reporting Directive (CSRD), as well as by California for certain companies doing business in that state, so many issuers will be obligated to assemble and report such information in any case.
Several lawsuits seeking to invalidate the rule have already been filed by Republican attorneys general of several states, industry groups, and energy companies. Environmental advocates have also sued, arguing that the rule does not go far enough, in particular by removing Scope 3 disclosure requirements. The cases have been consolidated in the United States Court of Appeals for the Eighth Circuit. Many consider the Eighth Circuit a conservative court where the Republican and industry challengers will find a sympathetic ear.
If the final rule eventually becomes effective, investors will surely benefit from the disclosures it requires, despite its pared back scope. A company’s GHG emissions, and any plans to mitigate them or otherwise achieve climate-related targets, are increasingly necessary for investors to evaluate a company’s outlook. Moreover, disclosure of how extreme weather events have affected a company’s financial condition is increasingly material in light of the growing frequency and severity of such events. If the rule becomes effective, lawsuits and investigations regarding alleged violations of the disclosure requirements are likely, and will further clarify company’s obligations under the rule.
The final rules are available on the SEC’s website (https://www.sec.gov/rules/2022/03/enhancement-and-standardization-climate-related-disclosures-investors) and will be published in the Federal Register.