After months of anticipation, on March 21, 2022, the U.S. Securities and Exchange Commission (SEC) voted 3:1 to propose climate change-related disclosure rules that would impact a company’s annual reports and registration statements. As indicated previously by the Staff, the proposed climate-related disclosure framework is modeled partially on the Task Force on Climate-related Financial Disclosure’s (TCFD) recommendations and draws upon the Greenhouse Gas (GHG) Protocol. (See our previous blog post discussing the Staff’s consideration of TCFD). The proposed rules, seemingly unprecedented in nature, are significantly more prescriptive rather than “principles-based” disclosure rooted in materiality, and intended to provide stakeholders with “consistent and comparable data.”

Overview

Initially anticipated to come out last year, the 500+ page proposal displays the SEC’s attempts to balance stakeholder demands of greater transparency in the area of climate-related disclosure, the practicalities of diverse registrants accumulating and reporting on this data without undergoing unreasonable burden and expense, and attempting to withstand expected litigation by opponents of the proposed rules. At the same time, we expect many companies to be surprised at the proposed prescriptive reporting obligations, with the required disclosure vastly more extensive than what is required to be filed under existing reporting obligations.

The proposed rules, if passed, would add a new subpart 1500 to Regulation S-K, requiring companies to disclose information about climate-related risks that are reasonably likely to have material impacts on their business or consolidated financial statements, and GHG emissions metrics that could help investors assess those risks. While risk disclosure is required in this new section, companies may also include disclosure about climate-related opportunities. The proposed climate-related disclosure would be presented in a separately captioned section of the registration statement or annual report on Form 10-K, or alternatively, companies could incorporate that information in the separately captioned section by reference from another section, such as Risk Factors, Description of Business, or MD&A. We expect many companies may utilize the option to cross-reference to existing disclosure contained elsewhere in the document.

The proposed rules would also add new rules under Proposed Article 14 of Regulation S-X that require specific climate-related financial statement metrics and related disclosure to be included in a note to a company’s audited financial statements. The proposed financial statement metrics would consist of disaggregated climate-related impacts on existing financial statement line items. As part of a company’s financial statements, the financial statement metrics would be subject to audit by an independent registered public accounting firm and come within the scope of the company’s internal control over financial reporting.

We have summarized the proposed rules below, though in order to get a sense of the sheer breadth of the prescriptive rulemaking we encourage you also to review the actual proposed regulatory text itself.

Required Disclosure under Regulation S-X

Under the proposed rules, companies would be required to disclose in a note to the financial statements certain disaggregated climate-related financial statement metrics that are primarily derived from existing financial statement line items. In particular, the proposed rules would require disclosure under the following three categories of information:

• Financial Impact Metrics.
• Expenditure Metrics.
• Financial Estimates and Assumptions.

The SEC notes that the proposed financial statement metrics disclosures would involve estimations and uncertainties driven by the application of judgments and assumptions, similar to other financial statement disclosures (e.g., estimated loss contingencies, fair value measurement of certain assets, etc.). Therefore, for each type of financial statement metric, the proposed rules would require a company to disclose contextual information to enable a reader to understand how it derived the metric, including a description of significant inputs and assumptions used, and if applicable, policy decisions made by the company to calculate the specified metrics.

The expressed purpose of the proposed financial statement requirements is to “increase the consistency and comparability of such disclosures by prescribing accounting principles for preparing the proposed climate-related financial statement metrics disclosures.” To that end, companies would also have to include financial information from consolidated subsidiaries. The proposed rules would require disclosure for a company’s most recently completed fiscal year and for the historical fiscal year(s) included in the company’s consolidated financial statements in the relevant filing.

• Financial Impact Metrics. Under the financial impact metric disclosure requirements in proposed Rule 14-02 of Regulation S-X, companies would need to disclose the financial impacts of severe weather events, other natural conditions, transition activities, and identified climate-related risks on the consolidated financial statements included in the relevant filing unless the aggregated impact of these items is less than one percent of the total line item for the applicable fiscal year.

The proposed one percent threshold is intended to provide a bright-line standard for companies. A company would be required to determine the impacts of the severe weather events, other natural conditions, transition activities, and identified climate-related risks on each consolidated financial statement line item. Additionally, within each category (i.e., climate-related events or transition activities), impacts would be required to be disclosed on an aggregated, line-by-line basis for all negative impacts and, separately, on an aggregated, line-by-line basis for all positive impacts. To determine whether the disclosure threshold has been met, a company would be required to aggregate the absolute value of the positive and negative impacts on a line-by-line basis.

• Expenditure Metrics. The proposed expenditure metrics would refer to the positive and negative impacts associated with the same climate-related events, transition activities and identified climate-related risks as the proposed financial impact metrics. The expenditure metrics would require a company to separately aggregate amounts of (1) expenditure expensed and (2) capitalized costs incurred during the fiscal years presented. For each of these categories, a company would be required to disclose separately the amount incurred during the fiscal years presented (1) toward positive and negative impacts associated with the climate-related events (i.e., severe weather events and other natural conditions and identified physical risks) and (2) toward transition activities, specifically, to reduce GHG emissions or otherwise mitigate exposure to transition risks (including identified transition risks). The company may also choose to disclose the impact of efforts to pursue climate-related opportunities associated with transition activities. If a company chooses to disclose the impact of an opportunity, it must follow the same presentation and disclosure threshold requirements applicable to the required disclosures of expenditure metrics associated with transition risks.
• Financial Estimates and Assumptions. The proposed rules would require a company to disclose whether the estimates and assumptions used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with, or known impacts from, climate-related events (including identified physical risks and severe weather events and other natural conditions), such as flooding, drought, wildfires and extreme temperatures. If they were impacted, the company would be required to provide a qualitative description of how such events have impacted the development of the estimates and assumptions it used to prepare such financial statements. Similar to the other proposed financial statement metrics, the proposed rules would include a provision that would require separate disclosure focused on transition activities (including identified transition risks). If a company chooses to disclose the impact of an opportunity on its financial estimates and assumptions, it must follow the same presentation and disclosure requirements described herein.

If the estimates and assumptions a company used to generate the consolidated financial statements were impacted by risks and uncertainties associated with, or known impacts from, a potential transition to a lower carbon economy or any climate-related targets it has disclosed, the company would be required to provide a qualitative description of how the development of the estimates and assumptions were impacted by such a potential transition or the company’s disclosed climate-related targets.

Since these financial statement metrics would be required in the financial statements, they would be:

1. Included in the scope of any required audit of the financial statements in the relevant disclosure filing;
2. Subject to audit by an independent registered public accounting firm; and
3. Fall within the scope of the company’s internal control over financial reporting.

The financial statement metrics would present financial data derived from the company’s consolidated balance sheets, income statements, and statements of cash flows and would be presented in a “similar way” to existing financial statement disclosures.

Required Disclosure under Regulation S-K

Under a proposed subpart 1500 of Regulation S-K, a registrant would be required to disclose specific information about climate-related matters within the body of the annual report on Form 10-K or registration statement. Some of the specific mandated climate-related disclosure is summarized below.

• Oversight and governance of climate-related risks by a company’s board and management. New Item 1501 of Regulation S-K would require a company to disclose its oversight and governance of climate-related risks, including, among other matters, whether any directors have expertise in climate-related risks, the processes and frequency of board committee discussions of these risks, whether management positions are responsible for assessing and managing climate-related risks, the relevant expertise of individuals filling such positions, as well as the frequency with which they report to the Board on climate-related risks.Companies would also be permitted to disclose oversight of climate-related opportunities. While we note a number companies recently started adding related disclosure within their annual report on Form 10-K or proxy statements in response to an increased focus by shareholders and other stakeholders on Board risk oversight, few, if any, companies have opted to disclose the level of detail required by the proposed rules. New Item 1501 of Regulation S-K would be in addition to existing Item 407 disclosure of Regulation S-K, under which companies report on general governance-related matters.
• Strategy, business model and outlook. Companies would be required to disclose how any identified climate-related risks have affected or are likely to affect a company’s strategy, business model, and outlook. Specifically, new Item 1502 would require a company to disclose any climate-related risks identified by the company that have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short, medium or long term. As proposed, the rules do not define a time for “short,” “medium” or “long-term,” though the SEC has particularly asked for feedback as to whether these terms should be defined. In this discussion, a company would be required to specify whether there are any physical or transition risks related to transitioning to a less carbon-intensive economy.A number of companies started considering related risks when raised in the Staff’s sample climate change letter posted in September 2021, though it appears the majority of companies that received the Staff’s comment letter responded that they had already considered and disclosed material climate change risks or that such risks were not material to the company. Physical risks can include harm arising from natural disasters such as floods and wildfires, while transition risks can include matters related to litigation, regulatory policies and consumer demands. In this section, a company would also be required to provide current and forward-looking disclosures to communicate whether potential ramifications of the identified climate-related risks have been incorporated into a company’s business model. Such disclosure may inevitably result in forward-statements, which would be subject to the safe harbors of the Private Securities Litigation Reform Act to the extent companies include them in Exchange Act Reports.
• Risk Management. To create additional transparency around climate-related risk management, Proposed Item 1503 of Regulation S-K would require companies to describe processes around identifying, assessing and managing climate-related risks. Specifically, companies would need to disclose, among other matters, how they determine the relative significance of climate-related risks as compared to other risks, consideration of regulatory requirements and policies as well as changes in consumer preferences, technology and market prices for potential transition risks, and determination of materiality of climate-related risks. Under this item, companies would be required to disclose a transition plan if adopted and would have to disclose how to mitigate, accept or adapt to a particular risk.
• GHG Emissions Metrics. Under the proposed rules, new Item 1504 of Regulation S-K would require companies to disclose separately Scopes 1 and 2 GHG emissions metrics, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute and intensity terms. A company would be required to disclose Scope 3 GHG emissions and intensity, if material, or if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions. While some companies do not consider Scope 3 emissions and intensity material, they have voluntarily set GHG emissions reductions target for Scope 3 emissions in response to requests by shareholders and other stakeholders. With respect to the materiality of Scope 3 emissions, the proposed rules indicate that solely a quantitative analysis is not sufficient – the materiality threshold may be more amorphous. Scope 3 emissions may still be material where they represent a significant risk or “if there is a substantial likelihood that a reasonable [investor] would consider it important.” Smaller reporting companies would be exempt from the Scope 3 disclosure requirement. Additionally, a proposed safe harbor would be provided specifically for Scope 3 disclosure. Under this safe harbor, Scope 3 emissions by a company would not be deemed a fraudulent statement unless it is shown that the statement in question was made without a “reasonable basis” or was disclosed “other than in good faith.”

Note: With respect to the materiality standard articulated in the proposing release related to Scope 3 emissions disclosures, Commissioner Hester Peirce in her dissenting statement notes, “the Commission also maintains the fiction that it is not departing from the materiality standard….The materiality limitation is not especially helpful because the Commission suggests that such emissions generally are material and admonishes companies that materiality doubts should “‘be resolved in favor of those the statute is designed to protect,’ namely investors.’” That admonition does not work as the Supreme Court intended it when “investors” are redefined to mean “stakeholders,” for whom the cost of collecting and disclosing information is irrelevant.”

If actual reported data for the GHG emissions is not reasonably available to include in time for the report requiring such disclosure, companies would be permitted to use a reasonable estimate of GHG emissions for the fourth fiscal quarter, together with actual, determined GHG emissions data for the first three fiscal quarters. If any material difference between the estimate used and the actual, determined GHG emissions data for the fourth fiscal quarter exists, a company would be required to file an update in a subsequent filing.

• Attestation Requirements. Proposed new Item 1505 of Regulation S-K would include an attestation requirement for accelerated filers and large accelerated filers regarding certain proposed GHG emissions metrics disclosures. Specifically, these filers would be required to include an attestation report covering the disclosure of the filer’s Scope 1 and Scope 2 emissions along with certain related disclosures about the provider of attestation services. A transition period of one fiscal year for limited assurance and two additional fiscal years to transition to providing reasonable assurance would be permitted for these filers. Please see the end of this post for information regarding transition periods under the proposed rules, assuming they pass as proposed in December 2022. While the proposed rules provide minimum attestation report requirements, minimum standards for acceptable attestation frameworks, and for the attestation service provider to meet certain minimum qualifications, they do not require an attestation service provider to be a registered public accounting firm.
• Any Climate-Related Targets or Goals and Transition Plan of the Company. While the proposed rules do not require a transition plan or climate-related target or goal, companies often set such targets and if they do, disclosure would be required under proposed new Item 1506 of Regulation S-K. The disclosure required by this proposed item would include the scope of activities and emissions included in the target, the defined timeframe by which the target is intended to be achieved and whether that timeframe is consistent with a particular treaty, law, policy or organization (e.g., The Paris Agreement), interim targets set by the company, baseline time period and baseline emissions to track progress and how the company intends to meet its climate-related targets or goals. Additionally, companies would be required to disclose annual data to indicate whether they are progressing toward the particular target or goal.
• Interactive Data Requirement. Pursuant to new Item 1507 of Regulation S-K, companies must electronically tag both narrative and quantitative climate-related disclosures in Inline XBRL.

Phase-In Periods and Accommodations for the Proposed Disclosures

The proposed rules would be phased in for all filers, with the compliance date depending on the status of the filer (e.g., large accelerated filer versus smaller reporting company, etc.) and the content of the item of disclosure (e.g., Scope 1 and 2 emissions versus Scope 3 emissions).

Assuming that the effective date of the proposed rules occurs in December 2022 and that the filer has a December 31st fiscal year-end, the compliance date for the proposed disclosures in annual reports, other than the Scope 3 disclosure, would be:

• For large accelerated filers, fiscal year 2023 (filed in 2024).
• For accelerated and non-accelerated filers, fiscal year 2024 (filed in 2025).
• For smaller reporting companies, fiscal year 2025 (filed in 2026).

Companies subject to the proposed Scope 3 disclosure requirements would have one

additional year to comply with those disclosure requirements. The SEC provided the chart below summarizing the hypothetical scenario’s transition phase.

Next Steps for Filers

While the proposed rules come as no surprise given how the Staff has spoken at length about its plan to issue the rules, the extensive scope of the rules will likely surprise many companies. Also unsurprising are the complexities involved with mandating such climate-related disclosure. Attempting to make sense of the 500+ pages of text is a process for many, and, if passed, implementing them will present a separate set of challenges. The SEC has asked for comment on virtually all aspects of the proposed rules, and we encourage our clients and friends to review the proposal and participate in the comment process in whatever form they deem appropriate. Additionally, the SEC has attempted to distinguish between requiring disclosure of Scopes 1 and 2 GHG emissions and Scope 3 emissions, which has drawn a large number of questions and differences of opinion from the public and reportedly amongst the Commissioners. See our blog post summarizing some of the Staff’s activity last year leading up to these proposed rules.

Companies are encouraged to begin looking at existing disclosure (contained within and outside of EDGAR filings) and controls and procedures if they have not already started in response to other factors such as an increased focus by stakeholders, the 2010 Climate Guidance and the sample climate change comment letter issued by the Staff in September 2021 (along with actual comment letters received by registrants regarding the same).

While the proposed rules articulate required disclosure in a registrant’s annual report and registration statement, companies will need to consider how their existing climate-related goals, disclosure and processes will be impacted by the required disclosures. Companies that have voluntarily set targets and plans to reduce GHG emissions should consider how they would need to adjust internal controls, procedures and tracking mechanisms to provide on an annual basis, data indicating progress towards those goals under the proposed rules. Additionally, companies publishing sustainability reports or website disclosure regarding climate-related data should consider whether a separate report will be necessary on a going-forward basis or if the required disclosure under the proposed rules would take the place of any such report.

Companies should also continue regular, robust stakeholder engagement on climate-related matters to understand their expectations in this regard. While the proposed rules have come at least partially in response to the demand of some investors and other stakeholders, they may not fulfill all their expectations. For example, the proposed rules do not mandate a reduction in GHG emissions generally or pursuant to a specific treaty or accord. On the other hand, shareholders have made specific calls for companies to do just that. Finally, companies are encouraged to inventory existing climate-related expertise amongst management and Board members and prioritize training and developing (or recruiting) expertise in the area to the extent such expertise is lacking. Whether the rules pass as proposed, or a scaled down version makes it to the end, companies must focus on the topic in response to increasing pressure from regulators, investors and other stakeholders alike