U.S. Securities and Exchange Commission proposes extensive climate-related disclosure regime covering all SEC registrants

• All registrants would be subject to Scope 1 and Scope 2 disclosure mandate
• Many registrants would be subject to Scope 3 disclosure mandate
• Third-party attestations required for accelerated and large accelerated filers, subject to phase-ins
• Attestation by PCAOB auditor not required
• Additional footnote disclosures in audited financial statements
• Disclosure of use of carbon offsets, carbon pricing models and renewable energy credits

The proposed rule is ambitious in scope and, if adopted, would have widespread impacts across U.S. capital markets. Market participants expect robust public comment both supporting and opposing various elements of the proposal. The SEC has set a deadline for public comments the later of 30 days after the proposal’s publication in the Federal Register or May 20, 2022. We expect the SEC to adopt a final rule in 2022 after reviewing and considering the comments received.

The proposal, captioned The Enhancement and Standardization of Climate-Related Disclosures for Investors, would require SEC registrants, including foreign private issuers (FPIs), to include certain climate-related disclosures in their registration statements and periodic reports, including annual reports on Form 10-K and, in the case of FPIs, Form 20-F. Under the proposal, registrants would be obligated to disclose (i) the impact of climate-related risks on their business, (ii) their climate-related governance and risk management systems, (iii) greenhouse gas (GHG)¹ emissions, including Scope 1 and Scope 2 emissions for all registrants, and Scope 3 emissions for many registrants, (iv) climate-related financial statement metrics and related disclosures, and (v) information regarding climate-related targets and goals, if applicable. Additionally, registrants that are accelerated and large accelerated filers would be required to include a third-party attestation with respect to certain GHG emission metrics.

The proposal follows the SEC’s March 2021 request for public input on climate disclosure and how the SEC could best regulate climate change related disclosures to be more “consistent, comparable, and reliable” as investors become increasingly concerned with environmental impacts and risks when making investment decisions. Many registrants already voluntarily provide climate disclosures based on a variety of frameworks, but inconsistency in approach and standards prompted the SEC to consider the proposal, which draws on the recommendations of the Task Force on Climate-Related Disclosures and The Greenhouse Gas Protocol.

Commissioners approved the proposal by a vote of 3-to-1. Commissioner Hester M. Pierce read a pointed dissent from the SEC’s decision to propose the rule, whereas Commissioner Allison Herren Lee encouraged public comment on whether the SEC should expand or strengthen certain requirements. Each Commissioner’s written statement regarding the proposal is available here. As highlighted by Commissioner Pierce, the rulemaking marks a significant departure from the traditional notions of materiality – such as framed by the Supreme Court in Basic v. Levinson², in which the Court observed that “materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.”

This materiality framework has largely cabined SEC disclosure, and those principles were reflected, for example, in the SEC’s earlier guidance on disclosure related to climate change.³

Phase-in

Compliance deadlines would depend on the registrant’s filing status. If a final rule is adopted as proposed, large accelerated filers would be expected to comply with the proposed disclosures for the fiscal year beginning after adoption of a final rule (i.e., beginning with annual reports due in the period following the end of such fiscal year), accelerated and non-accelerated filers would be expected to comply for the second fiscal year beginning after adoption, and smaller reporting companies for the third fiscal year beginning after adoption.

The rule proposes an additional phase-in period for Scope 3 GHG emission disclosures, which large accelerated filers and accelerated filers may be required to provide with limited assurance and, later, reasonable assurance for the fiscal year after the initial compliance deadline.

Climate-related risks and their impacts 

The proposal would require registrants to identify and disclose climate-related risks, as well as the material impacts these risks have had, or are likely to have, on their business and consolidated financial statements over the short-, medium- and long-term. Registrants must also disclose how these identified risks are likely to affect the strategy, model, and outlook of their business, as well as any plans, including initiatives, goals or targets, to address these risks.

In the proposal, the SEC advises that “[t]he materiality determination that a registrant would be required to make regarding climate-related risks under the proposed rules is similar to what is required when preparing the MD&A section in a registration statement or annual report.” Then, in an apparent effort to provide further guidance, the SEC repeats the prevailing standard for MD&A Item 303(a) known trend disclosures: “[t]he Commission’s rules require a registrant to disclose material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.” The SEC does not embellish on what “similar” is intended to mean or what is dissimilar from prior guidance for the proposed required disclosure of climate-related risks. Historically, the SEC has generally focussed on materiality being economic materiality from the perspective of an investor. The proposal, however, suggests at least some instances of materiality being from the perspective of the registrant on its business. We expect that this item will be a point of emphasis from many market commentators.

Climate-related governance and risk management

The proposal would require registrants to disclose information on the oversight and governance of climate-related risks by their board and management, including information on the process by which the registrant identifies, assesses, and manages these risks and whether such processes are integrated into the registrant’s overall risk management system. The proposal reflects the SEC’s renewed focus on gatekeepers, embracing an approach that relies on reputational intermediaries who provide verification and certification services to investors.

The focus is on full display with the proposal under Item 1501 requiring that a registrant disclose information about the oversight and governance of climate-related risks by the registrant’s board and management. Under the proposal, a registrant would be required to disclose a number of board governance items. Those include the identity of any board members or board committees responsible for the oversight of climate-related risks and whether any member of a registrant’s board of directors has expertise in climate-related risks. The proposal also would require a description of the processes and frequency by which the board or board committees discusses climate-related risks and disclosure about whether and how the board committee considers climate-related risks as part of its business strategy, risk management and financial oversight. The proposal would require further disclosure about whether and how the board sets climate-related targets or goals.

In turn, the proposal would require disclosures related to management oversight. The proposal would require a registrant to disclose a number of items about management’s role in assessing and managing any climate-related risks. In particular, an item would require disclosure about the processes by which the responsible managers or management committees are informed about and monitor climate-related risks.

Targets and Goals Disclosures

The proposal would require registrants to disclose information about their climate-related targets, goals, or transition plan, if applicable. This information would include time horizons for any transition plans, as well as data indicating progress toward established targets. Furthermore, if a registrant uses carbon offsets or renewable energy credits or certificates as part of its net emissions reduction strategy, the proposal would also require such registrants to disclose the role these play. Similarly, registrants that use any internal carbon price when planning climate-related risks and opportunities would be required to disclose how these prices are estimated and applied. 

Climate-related financial statement metrics

The proposal would require registrants to include the impact of climate-related events (e.g., severe weather events, other natural conditions, and physical risks) and transition activities on corresponding line items in their consolidated financial statements, and to discuss related estimates and assumptions. Registrants would need to include any expenditures related to mitigating these risks, as well as how severe weather or other natural conditions affect the assumptions used in preparing the financial statements.

GHG emissions

The proposal would require registrants to report Scope 1⁴ and Scope 2⁵ GHG emission metrics, both in terms of aggregate emissions and constituent GHGs. All filers except smaller reporting companies would also be required to disclose Scope 3⁶ GHG emissions metrics if the Scope 3 emissions are material, or if the registrant has a target or goal that includes Scope 3 emissions, though the proposal also includes safe harbor provisions from certain liability with respect to Scope 3 GHG emissions disclosures.

As a result, the proposed changes may require registrants to disclose emissions from upstream and downstream partners involved in material acquisition, pre-processing, distribution, storage, use and end-of-life treatment of products.

Attestation of Scope 1 and Scope 2 GHG emissions disclosure

In addition to requiring the disclosure of Scope 1 and Scope 2 GHG emission metrics, the proposal would require any registrant that is an accelerated filer or a large accelerated filer, including foreign private issuers, to include in any relevant filing a third-party attestation report covering certain disclosures of its Scope 1 and Scope 2 GHG emissions. The attestation would be subject to limited assurance during a phase-in period, followed by reasonable insurance thereafter. As currently drafted, the proposal would not require that the third-party attestation be delivered by a Public Company Accounting Oversight Board (PCAOB)-registered audit firm, but such third party would need to meet certain independence and expert criteria. Registrants should consider the time and cost to engage an attestation report provider ahead of any requirements. 

International context

The SEC’s proposal is the latest in a long line of proposals based on the TCFD framework to emerge around the globe.

The UK was the first to include the TCFD concept in regulatory policy via the Bank of England, which introduced requirements for regulated firms to integrate climate financial risk into their governance and strategy, risk management and disclosure in 2019. The pioneering approach was subsequently endorsed by the Network for Greening the Financial System (NGFS), an international alliance of central banks and prudential supervisors which the U.S. Federal Reserve joined last year. The European Central Bank subsequently introduced a similar set of supervisory expectations that extended the principle to include environmental as well as climate risk.

TCFD has also underpinned the UK post-Brexit sustainability policy strategy. Mandatory TCFD-aligned disclosure requirements have been introduced for certain public companies, large private companies, limited liability partnerships, and certain asset managers and asset owners. This is set to expand under a new Sustainability Disclosure Requirements (SDR) framework, which aims to introduce broader sustainability reporting requirements across the economy, including mandatory net zero transition plan reporting. The UK government has also been a key funder of the equivalent of TCFD for biodiversity loss and ecosystem destruction, the Taskforce on Nature-related Financial Disclosures (TNFD), which released its prototype recommendations last week.

The European Union is also expanding its sustainability reporting requirements. The European legislators are currently considering a proposal for a new Corporate Sustainability Reporting Directive (CSRD), which would potentially have extraterritorial impact. The CSRD would build on the sustainability disclosure regime first introduced by the Sustainable Finance Disclosure Regulation.

This represents only a small snapshot of the array of countries that are looking into implementing climate and other sustainability reporting requirements. The number is expected to increase when the newly established International Sustainability Standards Board, which sits alongside the International Financial Reporting Standards board, publishes its new global baseline for sustainability reporting.

Footnotes

_{1 The proposed rule defines “greenhouse gases” as: carbon dioxide (CO_2); methane (CH_4); nitrous oxide (N_2O); nitrogen trifluoride (NF_3); hydrofluorocarbons (HFCs); perfluorocarbons (PFCs); and sulfur hexafluoride (SF_6).
2 485 U.S. 224 (1988).
3 SEC, Interpretation, Releases 33–9106; 34–61469, Commission Guidance Regarding Disclosure Related to Climate Change, 75 Fed. Reg. 6290 (February 8, 2010). Roberta Karmel, a former SEC Commissioner, has written an article that addresses in detail the various approaches to materiality in the social welfare context. Roberta S. Karmel, Disclosure Reform - The SEC Is Riding off in Two Directions at Once, 71 Bus. Law. 781 (2016). 
4 Scope 1 emissions are defined as, “direct GHG emissions from operations that are owned or controlled by a registrant”
5 Scope 2 emissions are defined as, “indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant”
6 Scope 3 emissions are defined as, “all indirect GHG emissions not otherwise included in a registrant’s Scope 2 emissions, which occur in the upstream and downstream activities of a registrant’s value chain. Upstream emissions include emissions attributable to goods and services that the registrant acquires, the transportation of goods (for example, to the registrant), and employee business travel and commuting. Downstream emissions include the use of the registrant’s products, transportation of products (for example, to the registrant’s customers), end of life treatment of sold products, and investments made by the registrant”}