California Governor Gavin Newsom signed into law two watershed climate bills on October 7, 2023 that will require companies with significant revenue to make climate-related disclosures starting in 2026. The stated purpose of the new laws is to enhance transparency, standardize disclosures, align public investments with climate goals, and raise the standards for businesses to drive action on addressing climate change.

The bills—the Climate Corporate Data Accountability Act (SB 253) and Climate-Related Financial Risk Act (SB 261)—lay out new requirements that share similarities with federal rules proposed by the US Securities and Exchange Commission (SEC) and apply to essentially every large company operating in California.

OVERVIEW

GHG Emissions Disclosure Requirements

SB 253 requires US companies with annual revenues exceeding $1 billion and doing business in California to disclose their Scope 1 and 2 greenhouse gas (GHG) emissions data starting in 2026 and their Scope 3 GHG emissions data by 2027 (and annually thereafter). Scope 3 emissions include a broad range of indirect emissions and, accordingly, will require companies to collect emissions data from upstream and downstream third parties.

All emissions data must be made publicly available. Because businesses engaging in even limited activity in California are likely to be deemed to be “doing business in California,” SB 253 will have substantial reach, covering companies with a limited nexus with the State of California.

Climate-Related Financial Risk Disclosure

SB 261 requires “covered entities” with annual revenues exceeding $500 million and doing business in California to publicly disclose their climate-related financial risks in accordance with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, as well as any measures they have adopted to mitigate and adapt to those risks. Those reports must include climate-related vulnerabilities concerning their employees, supply chains, consumer demand, and shareholder value, among others.

Interplay with Proposed SEC Climate Rules

In 2022, the SEC proposed extensive disclosure rules that would elicit climate-related disclosure from all public companies, regardless of industry or size. The proposed SEC rules differ from SB 253 and SB 261 in certain key respects:

• The proposed SEC rules would only require Scope 3 emissions disclosures to the extent material to the company or if the company has set an emissions commitment, goal, or target that includes Scope 3 emissions. By contrast, SB 253 and SB 261 do not impose any such preconditions to trigger a company’s duty to make Scope 3 disclosures.
• SB 261 may require that companies conduct a scenario analysis, which is a process for assessing the resilience of a company’s climate-risk strategy based on different climate-related scenarios. While the SEC’s proposed rule would require disclosure regarding climate-related risks and the potential impact on the company’s business and outlook as well as any mitigating strategies that the company has or intends to employ to counteract such risks, it does not explicitly require a specific analysis as to the validity or likely success of such strategies. If a company were to elect to conduct a scenario analysis, however, then disclosure regarding such analysis and its results would be required by the SEC’s proposed rule.
• Further, whereas the SEC’s proposed rule would only require disclosure from public companies, the new California laws would require disclosures from both private and public companies doing business in the state.
• Finally, the timeline of adoption and implementation for the SEC proposed rule remains unclear, and, while the agency has promised that the final rule is forthcoming, it also indicated in the proposing release that a runway would be provided for companies to fully comply with the new rules. Additionally, there have been signals from the SEC’s chair, Gary Gensler, that modifications to the proposal may be made in the final rules, which could include omitting the requirement for Scope 3 disclosure. If finalized in the near term, it is possible that some public companies will have to comply with the SEC’s disclosure requirements sooner than the new California laws.

Possible Legal Challenges

There may be legal challenges to the California legislation on both state and federal grounds. It is possible that such challenges could include constitutional arguments based on the “dormant Commerce Clause” doctrine and/or “compelled speech” under the First Amendment. While it is too early to predict with any certainty as to the filing or results of such litigation, there is recent precedent that provides a roadmap, including possible pitfalls, for such challenges.

For example, in summer 2023 the US Supreme Court’s decision in National Pork Producers v. Ross rejected a challenge based on the dormant Commerce Clause of California’s ban on the sale of pork that comes from pigs that were raised in a “cruel manner,” regardless of where the pigs were raised. [1]

In 2015, the US Court of Appeals for the District of Columbia Circuit reaffirmed its holding that the SEC’s conflict minerals rule violated the First Amendment by requiring companies to state whether their products had not been found to be “DRC conflict free” and, ultimately, the SEC decided to allow companies to comply with the disclosure obligations without addressing certain aspects of the rule that were the root of such controversary. [2]

SB 253 – THE CLIMATE CORPORATE DATA ACCOUNTABILITY ACT

SB 253 directs the California Air Resources Board (CARB) to develop and adopt regulations by January 1, 2025 detailing how businesses will publicly disclose their annual GHG emissions in conformance with the Greenhouse Gas Protocol standards and guidance (including the Greenhouse Gas Protocol Corporate Accounting and Reporting Standard and the Greenhouse Gas Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard).

The law also provides for the state to engage an “emissions reporting organization” to develop a reporting program, which program will publicly post covered entities’ Scope 1, 2, and 3 emission disclosures on a digital platform. SB 251 also creates a Climate Accountability and Emissions Disclosure Fund, funded and maintained by an annual fee that CARB will impose on each disclosing company.

Covered Entities

SB 253 applies to any “reporting entity,” defined as any “U.S.-based company with total annual revenues in excess of [$1 billion] and that does business in California.” Total revenues will be determined by the company’s revenues the prior fiscal year.

The Senate floor analysis notes that existing California law “[d]efines ‘doing business’” in California as “engaging in any transaction for the purpose of financial gain within California, being organized or commercially domiciled in California, or having California sales, property or payroll exceed specified amounts: as of 2020 being $610,395, $61,040, and $61,040, respectively.” (Revenue and Tax Code § 23101.)

Hence, even companies with only limited business activity in California are likely to be deemed to be “doing business” in California and thus subject to SB 253.

SB 253 does not impose a minimum emissions threshold to trigger reporting duties. Rather, those reporting duties are based on company revenue—not emission levels.

Required Disclosure of Scope 1, 2, and 3 Emissions

As discussed, SB 253 requires covered entities to disclose their Scope 1 and 2 GHG emissions data starting in 2026 (for emissions in the prior fiscal year) and their annual Scope 3 GHG emissions by 2027 (for emissions in the prior fiscal year).

Scope 1 emissions include all direct GHG emissions that stem from sources that a company owns or directly controls, regardless of location, including fuel combustion activities.

Scope 2 emissions include all indirect GHG emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a company.

Scope 3 emissions encompass all indirect upstream and downstream GHG emissions (other than Scope 2 emissions) from sources that the reporting entity does not own or directly control. These may include purchased goods and services, business travel, employee commutes, and processing and use of sold products.

Other Required Disclosures

A company’s disclosures must consider acquisitions, divestments, mergers, and other structural changes that could affect GHG emissions reporting. Disclosures must be consistent with Greenhouse Gas Protocol standards and guidance. SB 253 also includes measures for ensuring publicly reported data is “easily understandable and accessible.”

To avoid duplicative emissions disclosures, companies are permitted to submit “reports prepared to meet other national and international reporting requirements, including any reports required by the federal government, as long as those reports satisfy all of the requirements” under SB 253. Thus, harmonizing compliance with SB 253 and any future SEC regulatory requirements will be critical for covered companies.

As part of mandatory disclosures, companies also must obtain, and submit to regulators, third-party assurance for their emissions reporting, at a limited assurance level, beginning in 2026 for Scopes 1 and 2 emissions, and at a more stringent reasonable assurance level in 2030.

“Limited assurance” is the baseline level of assurance, whereby an independent auditor obtains sufficient and appropriate evidence, limiting assurance to specific aspects of the reporting. By contrast, “reasonable assurance” is the highest level of assurance and is more rigorous, requiring evidence demonstrating that the reporting is free of material misstatements.

In 2026, CARB will be required to evaluate the feasibility of obtaining assurance for Scope 3 emissions and, on or before January 1, 2027, establish an assurance requirement for Scope 3 emissions beginning in 2030—though companies would be required to obtain limited assurance.

The assurance provider must have “significant experience in measuring, analyzing, reporting, or attesting to the emissions of greenhouse gasses” and must possess “sufficient competence and capabilities necessary to perform engagements in accordance with professional standards and applicable legal and regulatory requirements” and to issue appropriate, independent reports.

Penalties

SB 253 authorizes CARB to promulgate rules imposing administrative penalties of up to $500,000 per year for violations. The penalties imposed must consider all relevant circumstances, including past and present compliance, and whether the entity undertook good-faith measures to comply with the requirements.

SB 253 precludes imposition of penalties “for any misstatements with regard to scope 3 emissions disclosures made with a reasonable basis and disclosed in good faith.” Penalties assessed for Scope 3 reporting between 2027 and 2030 are limited to disclosure failures.

Implications

SB 253 is the first widely applicable law in the United States to require the assurance of Scope 1 and Scope 2 emissions reporting. Accordingly, companies must not only develop the infrastructure to gather and report emissions data, but also consider potential options for obtaining the required GHG emissions attestation, including through an external auditor.

Failure to comply with reporting obligations could create significant legal exposure for companies. Further, plaintiffs can be expected to scrutinize company’s reported emissions data for any inconsistency with the company’s prior public statements.

Approximately 5,000 companies that do business in California have been identified as potentially subject to SB 253. Many of these companies already track Scope 1 and 2 GHG emissions but may need to consider how they will implement systems to track their Scope 3 GHG emissions earlier than they had anticipated.

To do so, covered companies also may require upstream and downstream companies to collect emissions data. As a result, SB 253 may have far-reaching consequences beyond the entities immediately covered by the law.

SB 261 – THE CLIMATE-RELATED FINANCIAL RISK ACT

SB 261 requires any US-based company with total annual revenues exceeding $500 million and that is “doing business” in California to prepare and submit climate-related financial risk reports. Reports must be submitted by January 1, 2026, and biennially thereafter.

The reports must be published on the company’s website and disclose the company’s climate-related financial risks as well as any measures implemented to mitigate those risks. “Climate-related financial risk” is defined as “material risk of harm to immediate and long-term financial outcomes due to physical and transition risks.”

Climate-related financial risks include, but are not limited to, “risks to corporate operations, provision of goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health.” Risk disclosures must accord with TCFD framework and guidance.

If a company cannot provide all required disclosures in its report, it must submit a detailed explanation of any reporting gaps, describe the steps it is taking to comply, and provide complete disclosures in the future.

A parent company may consolidate any subsidiary company’s report with its own even if it otherwise qualifies as a covered entity. Additionally, a company may satisfy its SB 261 requirements by preparing a publicly available risk disclosure as required under other laws, regulations, or listing requirements issued by an exchange, national government, or governmental entity that is consistent with SB 261.

Similar to SB 253, CARB will contract with a climate reporting organization to prepare a public report on climate-risk disclosures and update those disclosures consistent with TCFD guidance. A biennial public report will be prepared by the climate reporting organization based on those disclosures that identifies potential climate-related financial risks in California and lists companies that provided inadequate or insufficient reports.

Penalties

The new law authorizes CARB to promulgate rules imposing penalties of up to $50,000 per year for any company that “fails to make the report required by this section publicly available on its internet website or publishes an inadequate or insufficient report.” Factors impacting the ultimate penalty imposed include the company’s past and present compliance and whether the company undertook “good faith measures to comply” and “when those measures were taken.”

Implications

Due to its lower revenue threshold, SB 261 is expected to apply to approximately 10,000 companies doing business in California. SB 261 and SB 253 make California the first state to mandate GHG emissions and climate risk reporting from large companies. Plaintiffs can be expected to scrutinize a company’s published reports for any inconsistency with the company’s prior public statements.

We will be following the development of the regulations pursuant to these laws.

GOVERNOR NEWSOM’S CONCERNS

Although he signed them into law, Governor Newsom expressed similar concerns about both bills. He articulated an initial concern that the “implementation deadlines in [SB 253] are likely infeasible, and the reporting protocol specified could result in inconsistent reporting across businesses subject to the measure.” The governor announced that his administration will work with legislature over the next year to address the issues.

Additionally, Governor Newsom expressed concern about “the overall financial impact of [SB 253] on businesses,” and is placing some of the burden on CARB to “closely monitor the cost impact as it implements this new bill and to make recommendations to streamline the program.”

[1] See 598 U.S. 356 (2023) (upholding the California law concerning such sales).

[2] See, e.g., Division of Corporation Finance, SEC, Statement: Updated Statement on the Effect of the Court of Appeals Decision on the Conflict Minerals Rule (Apr. 7, 2017).