While the highly anticipated adoption of proposed rules on climate risk disclosure by the US Securities and Exchange Commission (SEC) appears to be on hold (the SEC’s recently revised regulatory agenda indicates possible adoption no sooner than the second quarter of 2024), expansive international and subnational regulation of climate risk disclosure by both public and private companies is well underway. SEC Chairman Gary Gensler has warned that the absence of US climate risk disclosure rules might mean that US companies could face more onerous disclosure requirements without an opportunity for the SEC to negotiate “substituted compliance” with non-US regulators on the basis of mandatory comparable regulation in the United States.
Internationally, as discussed in depth in our International News: Spotlight on ESG, Impact and Sustainability report, new climate risk disclosure requirements include the European Union’s reporting standards that were adopted last summer and specify the sustainability information that will be required to be reported under the EU Corporate Sustainability Reporting Directive, including by non-European companies with significant European operations, and the climate-related and general sustainability standards of the International Sustainability Standard Board (ISSB), which were also adopted this past year.
In the US, on October 7, 2023, California Governor Gavin Newsom signed three new climate disclosure bills detailed below. In one instance, the legislation notes the pendency of the SEC’s proposed rules, stating that “California has an opportunity to set mandatory and comprehensive risk disclosure requirements for public and private entities to ensure a sustainable, resilient and prosperous future for our state.”
IN DEPTH
The new laws—Senate Bill (SB) 253: Climate Corporate Data Accountability Act, SB 261: Greenhouse gases: climate-related financial risk and Assembly Bill (AB) 1305: Voluntary carbon market disclosures—will require certain entities doing business in California to:
- Measure and report their greenhouse gas (GHG) emissions
- Report their climate-related financial risks, governance, strategies, goals and metrics
- Disclose information about the basis of any published statements regarding net zero or carbon neutrality goals or achievements.
In their totality, these laws will have the effect of mandating comprehensive reporting of climate-related information to the public. There will likely be changes to these groundbreaking climate disclosure laws for several reasons: the California Air Resources Board (CARB) will promulgate regulations, Governor Newsom pledged to work with the legislature during the 2024 legislative session to amend the implementation requirements to provide more time for compliance, and litigation challenging the laws is expected.
SB 253
SB 253 requires reporting entities to measure and report their GHG emissions. A reporting entity is defined as any business entity doing business in California that has a total annual revenue of more than $1 billion. The statute, as currently enacted, appears not to contemplate any exemptions based on whether a parent company is a reporting entity, suggesting the possibility that multiple affiliated entities could be required to each make separate individual reports. This issue may be addressed in CARB’s forthcoming regulations. While SB 253 does not define “doing business in California,” a definition or reference to one in another California law is likely to be included in regulations promulgated by CARB prior to January 1, 2025, as the legislative history of SB 253 notes that “doing business in California” is already defined in existing law as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”
Scope 1, scope 2 and scope 3 GHG emissions are defined by SB 253 as follows:
- Scope 1 means all direct GHG emissions stemming from sources that a reporting entity owns or directly controls, regardless of location, including (but not limited to) fuel combustion activities.
- Scope 2 means indirect GHG emissions from consumed electricity, steam, heating or cooling purchased or acquired by a reporting entity, regardless of location.
- Scope 3 means indirect upstream and downstream GHG emissions, other than scope 2 emissions, from sources that the reporting entity does not own or directly control, including (but not limited to) purchased goods and services, business travel, employee commutes and processing and use of sold products.
SB 253 requires that starting in 2026, on or by a date to be determined by CARB and annually thereafter, reporting entities must measure and publicly report their scope 1 and scope 2 GHG emissions in conformance with the protocol standards and guidance in “The Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard” and the “Greenhouse Gas Protocol: Corporate Value Chain (Scope 3) Accounting and Reporting Standard,” developed by the World Resources Institute and the World Business Council for Sustainable Development. Further, SB 253 requires that starting in 2027 and annually thereafter, reporting entities must disclose their scope 3 GHG emissions no later than 180 days after disclosure of their scope 1 and scope 2 GHG emissions.
Third-party assurance must be provided with respect to the GHG emissions disclosures required by SB 253. Starting with the scope 1 and scope 2 disclosures in 2026, limited assurance must be performed by a third-party assurance provider who has significant experience in measuring, analyzing, reporting or attesting to the GHG emissions. Scope 1 and scope 2 disclosures will require reasonable assurance starting in 2030. SB 253 currently requires that limited assurance be obtained for scope 3 disclosures starting in 2030, however, SB 253 allows CARB to require limited assurance for scope 3 disclosures at any time after January 1, 2027.
As currently enacted, SB 253 does not define what constitutes “limited” or “reasonable” assurance. CARB could include clarification in forthcoming regulations. The SEC’s proposal would require public companies to report GHG emissions and includes explanations of “limited” and “reasonable” assurance, which may provide guidance in the absence of a specific regulatory definition in California. The SEC, in proposed rulemaking, noted that reasonable assurance “is equivalent to the level of assurance provided in an audit of a registrant’s consolidated financial statements included in a Form 10-K.”[1] The SEC’s proposal also suggested that limited assurance “is equivalent to the level of assurance (commonly referred to as a ‘review’) provided over a registrant’s interim financial statements included in a Form 10-Q.”[2]
SB 253 authorizes administrative penalties of up to $500,000 per year for non-filing, late filing or other failures to meet the requirements (including misstatement of scope 1 and scope 2 disclosures as described below). No penalties may be assessed for any “misstatements with regard to scope 3 emissions disclosures made with a reasonable basis and disclosed in good faith.” With respect to scope 3 emissions, only non-filing penalties may be assessed between 2027 and 2030. Again, no regulations have yet been issued on this subject, but the statutory limits on penalties assessed for misstatements of scope 3 disclosures suggests that penalties could be assessed against misstatements of scope 1 and scope 2 disclosures.
SB 261
SB 261 requires covered entities to prepare, publish and submit a climate-related financial risk report on or before January 1, 2026, and biennially thereafter. The definition of a “covered entity” tracks the definition of a “reporting entity” under SB 253. A covered entity under SB 261 is a business entity that is doing business in California and has a total annual revenue exceeding $500 million. The lower revenue threshold implies greater applicability of SB 261. Much like in SB 253, the applicability of SB 261 will hinge largely upon the phrase “doing business in California,” which SB 261 does not define. While this criterion applies to individual legal entities, if a subsidiary of a covered entity also qualifies as a covered entity, the subsidiary does not need to prepare a separate report.
The reporting obligation that SB 261 imposes on covered entities is twofold: the covered entity must publish the report on its website and file the report with CARB. Reports prepared pursuant to SB 261 must disclose (1) climate-related financial risks[3] and (2) measures adopted to address the risks disclosed. The climate-related financial risks must be disclosed in accordance with either:
- The disclosure framework set forth in the Task Force on Climate-Related Financial Disclosures’ (TCFD) Final Report of Recommendations or any successor frameworks
- Any other reports required by law in other jurisdictions that incorporate disclosure requirements consistent with the TCFD’s framework or any successor frameworks
- Under SB 261 as enacted and in the absence of CARB regulations, it is unclear how consistent these other reports must be with the TCFD framework to satisfy the reporting obligation.
- ISSB’s International Financial Reporting Standards (IFRS) Sustainability Disclosure Standards.
- With the publication of ISSB Standards IFRS S1 and IFRS S2, which fully incorporated the TCFD recommendation, the Financial Stability Board noted that the standards were the “culmination of the work of the TCFD” and moved to disband the TCFD, passing monitoring responsibilities to ISSB starting in 2024. The ISSB Standards may be viewed as a successor framework to the TCFD.
Under SB 261, CARB is authorized to promulgate regulations authorizing the assessment of penalties of up to $50,000 per year for failure to report or for reporting inadequate or insufficient information.
AB 1305
Beginning January 1, 2024, AB 1305 requires reporting for entities “operating in”[4] California that make claims within California that include (Covered Claims):
- Statements regarding the achievement of net zero emissions[5]
- Statements that the entity, a related or affiliated entity, or a product is “carbon neutral”
- Statements implying the entity, a related or affiliated entity, or a product does not add net carbon dioxide (CO2) or GHG emissions to the climate or has made significant reductions to its CO2 or GHG emissions.
Under AB 1305, entities must disclose “all information” documenting how a Covered Claim was determined to be accurate and how interim progress toward such goal stated in the Covered Claim is being measured. AB 1305 suggests that such information may include:
- Disclosure of independent third-party verification of all of the entity’s GHG emissions
- Identification of the entity’s science-based targets for its emissions reduction pathway
- Disclosure of the relevant sector methodology and third-party verification used for the entity’s science-based targets and emissions reduction pathway
- Any third-party verification of the data listed and of the Covered Claim.
Notably, AB 1305 does not apply to entities that do not “operate in” California or to claims not made “within” California.[6] Disclosures related to Covered Claims must be updated annually. Violations of AB 1305 are subject to potential monetary penalties of up to $500,000. Additionally, AB 1305 requires disclosure from entities that market, sell, purchase or use voluntary carbon emissions offsets in California.
HOW TO PREPARE
Evaluate Statements With Respect to Net Zero, Carbon Neutrality or Emissions Reduction
AB 1305’s reporting requirements take effect on January 1, 2024. Given the immediacy of this approaching effective date, any statements relating to an entity’s emissions, emissions reduction or carbon neutrality should be identified. To the extent any statements are identified, all information related to the making of such statements should be collected and be made publicly available. Policies requiring public statements to be reviewed for Covered Claims can help to ensure compliance going forward.
Develop Internal Expertise Regarding Climate Reporting
California’s new laws, as well as proposed and enacted rules from the SEC and in other jurisdictions, will require some level of climate disclosure. Reporting entities will need to be familiar not only with the multitude of frameworks and standards (Greenhouse Gas Protocol, TCFD, ISSB, etc.), but also how these frameworks and standards are applied differently across each jurisdiction. This reporting will require measuring emissions of various climate warming gasses and analyzing climate-related risks such as physical risks and transition risks. Entities required to report under one or more reporting regimes can start building competence around climate information now, allowing them to meet upcoming disclosure obligations.
Prepare to Coordinate Collection and Consistent Reporting of Climate Data
Coordinating the data that is collected and reported will be crucial as companies begin to comply with multiple reporting regimes. Cross-functional teams should be formed, and policies should be developed to ensure that data is collected as efficiently and accurately as possible and that reports are consistent in using that information. For example, SB 253 requires disclosure of scope 3 emissions, however, the SEC’s proposed rules require scope 3 emissions to be disclosed if they are material. Entities reporting scope 3 emissions that are significantly greater than scope 1 and scope 2 emissions may struggle to claim that these are immaterial in SEC filings.
Identify Third-Party Assurers and Advisors With Relevant Expertise
Given that SB 253 requires assurance of disclosures, third-party assurance providers should be identified and engaged on a timely basis. These assurance providers and other third-party providers can assist in controls and structures to support climate disclosure as well as with developing data collection mechanisms.
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