There needs to be clear rules of the road for disclosing climate risk.” SEC Chair Gary Gensler
“We are not the Securities and Environment Commission – at least not yet.” Commissioner Hester M. Peirce
On March 21, 2022, the U.S. Securities and Exchange Commission (“SEC”) proposed its long-awaited and groundbreaking rules intended to standardize and enhance climate-related disclosures for domestic and foreign public companies. The proposal is extensive, complex, and comprehensive. It represents a landmark disclosure initiative. The proposing release was over 500 pages, and the SEC adopted it by a 3-to-1 vote. The SEC has received over 3,400 comment letters on the proposal.
The climate disclosure rules would require SEC companies to include mandated climate-related information in registration statements and periodic reports. If adopted, the rule would require three general types of disclosure: material climate impacts, greenhouse-gas (“GHG”) emissions, and any emissions targets or transition plans.
The proposal contains detailed disclosure requirements that include disclosures related to:
- Board and management oversight and governance of climate-related risks and climate-related disclosure;
- How any identified climate-related risks have had or likely would have a material impact on the company’s business and consolidated financial statements, which may manifest over the short, medium, or long-term;
- How any identified climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook;
- The impact of climate-related events (severe weather events and other natural conditions) and transition activities (regulatory, technological, market, and reputational) on the line items of a company’s consolidated financial statements, as well as the financial estimates and assumptions used in the financial statements;
- Audited Scope 1 and Scope 2 emissions. These are GHG emissions that a company generates through its own operations and through the energy it purchases; and
- Scope 3 emissions involving direct upstream and downstream emissions along the company’s entire value chain, if these emissions are material or if the company has set an emission 3 reduction target or goal that includes Scope 3 GHG emissions.
The proposal has generated significant debate as to whether or not the SEC exceeded its mission and statutory authority. Congress gave the SEC a three-part mission – protect investors, facilitate capital formation, and foster fair, orderly, and efficient markets. In her opposition statement dated March 21, 2022, on the proposal, Commissioner Peirce stated “[t]his proposal steps outside our statutory limits by using the disclosure framework to achieve objectives that are not ours to pursue and by pursuing those objectives by means of disclosure mandates that may not comport with First Amendment limitations on compelled speech.” She further stated that the “calls for enhanced climate disclosure are not motivated by an interest in financial returns from an investment in a particular company, but by deep concerns about the climate or, sometimes superficial concerns expressed to garner goodwill.” She further notes that “the objective of Congress’s instruction for us to regulate in the public interest and for the protection of investors is to protect investors in their pursuit of returns not in other capacities. For this reason, to qualify as uncontroversial and thereby to stay within First Amendment bounds, [the SEC’s] disclosure mandates must be limited to information that is material to the prospect of financial returns.”
On March 21, 2022, SEC Chair Gensler stated in his statement in support of the proposal that because “investors….recognize that climate risk can pose significant financial risk to companies, investors need reliable information about climate risk to make informed investment decisions.” He added that “[t]oday, investors representing literally tons of trillions of dollars support climate-related disclosures because they recognize that climate risks pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions.”
Related to this debate is whether the mandatory climate-risk disclosures would change the materiality framework for disclosure (principles-based disclosure) to mandatory disclosure even if the climate risk is not material (prescriptive disclosure). Being prescriptive in nature, some of the proposed disclosure requirements apply without a materiality qualifier which deviates from the time-tested materiality standard.
Many believe that the SEC will adopt a mandatory climate-related disclosure framework this fall. The SEC could make changes to the proposal in response to public comment and debate. However, it is more likely that the SEC will implement the significant climate-related disclosure requirements substantially similar to those in the proposal. It is also likely that the SEC’s statutory authority will be challenged in court. Notwithstanding the unknowns as to the nature and extent of the final climate-related disclosure regime, the result of any challenges, and the timing of final adoption and implementation, companies should prepare now for the new requirements.
If the SEC adopts the proposal this fall, phase-in will likely require large companies to disclose most of the information as of fiscal year 2023 meaning filing year 2024 and smaller companies as of fiscal year 2024 meaning filing year 2025. Scope 3 emissions would have an additional year beyond these deadlines. Due to the work and costs involved (estimated by the SEC as $420,000 per year for small public companies and $530,000 per year for larger public companies), companies need to begin planning now for the new climate-related disclosure requirements.