The Situation: The U.S. Securities and Exchange Commission ("SEC") has proposed climate-related disclosure rules (the "Proposed Rules") that, if adopted, would significantly increase U.S. disclosure requirements for foreign private issuers ("FPIs") that are public companies in the United States.
The Result: U.S. public companies, including FPIs, will need to undertake a review of their climate-related disclosure obligations under both the proposed U.S. disclosure rules as well as other applicable regulatory regimes. Some proposed U.S. disclosure rules would be more expansive or prescriptive than other widely adopted frameworks.
Looking Ahead: While the ultimate timing and contents of the final rules are uncertain, the proposal assumes a December 2022 effective date. FPIs should act now to prepare for the new rules and disclosure requirements, while noting divergences from their home jurisdiction's practice.
As discussed in Jones Day's March 2022 Alert, the SEC has proposed climate-related disclosure rules. If adopted as proposed, the Proposed Rules would depart from the SEC's historical regulation of SEC-reporting FPIs, which has largely deferred to applicable home country rules and provided significant phase-in periods for FPIs. Rather, the Proposed Rules would impose prescriptive disclosure obligations on FPIs, potentially resulting in disproportionate burdens to existing U.S.-registrant FPIs already facing multijurisdictional compliance obligations.
We believe these burdens could also have a chilling effect on new entrants to the U.S. public capital markets and may cause existing U.S.-registrant FPIs to reevaluate the costs and benefits of reporting in the United States:
The Proposed Rules are different from and, in many ways, more expansive than certain frameworks adopted by many FPIs and may require FPIs to incur additional costs and face potentially increased liability. Non-U.S. companies, such as FPIs, are more likely to align their disclosure with internationally recognized reporting frameworks such as the Global Reporting Initiative Standards, the Sustainability Accounting Standards Board Standards, the Task Force on Climate-Related Financial Disclosures ("TCFD") framework, or the GHG Protocol. While the Proposed Rules are partially modeled on the TCFD framework, they go beyond the scope of TCFD current recommendations. For example, the Proposed Rules would require disclosure of any internal carbon price used by the reporting company, whereas the TCFD encourages but does not require such disclosure. In addition, the Proposed Rules differ in regard to methodology, including regarding "organizational boundaries," that a company would be required to use when calculating its GHG emissions. While the GHG Protocol uses an "equity share" or "control" approach for the determination of which assets/operations are to be included, the Proposed Rules require the organizational boundary (and any determination of whether a company owns or controls a particular source for GHG emissions) to be consistent with the scope of entities, operations, assets, and other holdings reflected in a company's consolidated financial statements. FPIs currently reporting under alternative frameworks would incur additional costs associated with complying with obligations under multiple disclosure regimes. Additionally, inconsistencies arising from disclosure under multiple regimes may give rise to potentially increased liability associated with those disclosures.
The Proposed Rules may be disproportionately more burdensome on many FPIs than on U.S. domestic registrants. Many jurisdictions, particularly in the European Union, have adopted or proposed regimes that require FPIs to undertake and provide significant disclosure around efforts to reduce their environmental impact. For example, under the proposed EU Corporate Sustainability Due Diligence Directive, COM (2022) 71 ("CSDDD"), certain companies in the European Union will be required to "adopt a plan" to ensure compatibility with the transition to a sustainable economy and limiting global warming to 1.5° C and "take appropriate measures" to identify, prevent, and mitigate actual and potential adverse environmental impacts. While the Proposed Rules do not require companies to establish climate-related transition plans, if a company has done so, it must provide significant disclosure regarding its plan, including the relevant metrics and targets used to identify and manage physical and transition risks. Accordingly, FPIs subject to home-country rules targeting disclosures of environmental impact, many of which may adopt more direct action to combat climate change than their U.S. counterparts, may effectively be burdened with a disproportionately higher disclosure obligation under the Proposed Rules.
Ambiguities in Scope 3 GHG emissions reporting requirements add to the confusion. Scope 3 GHG disclosure requirements under the Proposed Rules raise a number of issues for all companies, but FPIs are likely to bear a heavier burden than U.S. domestic registrants because they would be required to accommodate multiple jurisdictions' regulators and investment climates when applying varying standards of "materiality." While the Proposed Rules apply traditional U.S. securities law concepts of materiality, other frameworks and regulators may apply different and potentially contradictory standards. In addition, FPIs are likely to face practical difficulties associated with accurately collecting information regarding their supply chain since their third-party providers and other members of their value chain are less likely to be subject to U.S. securities laws and therefore may not collect or report their own Scope 1 and 2 GHG emissions data, which may be necessary for FPIs to calculate their Scope 3 GHG emissions.
Smaller FPIs may not be exempt from Scope 3 GHG emissions reporting, unlike their U.S. domestic peers. The Proposed Rules exempt "smaller reporting companies" ("SRCs") (defined as having a public float of less than $250 million, or less than $100 million in annual revenues and a public float of less than $700 million) from Scope 3 GHG emissions disclosure. FPIs are not eligible to use the more lenient requirements for "smaller reporting companies" unless they use the forms and rules designated for domestic registrants and provide financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles. Accordingly, FPIs excluded from the definition of an SRC for this reason would be subject to the Scope 3 GHG emissions disclosure requirements under the Proposed Rules, notwithstanding that such FPIs may have the same resource constraints as many U.S. domestic SRCs.
Attestation requirements apply to FPIs and may differ from applicable home country rules. Proposed Regulation S-K, Item 1505 would require accelerated filers and large accelerated filers—categories that include many FPIs—to include an attestation report from an independent attestation service provider covering Scope 1 and Scope 2 GHG emissions disclosures. Such assurance obligations would apply to all data presented, including data for historical periods. Assuming that the Proposed Rules became effective by the end of 2022, this means that an FPI that is a large accelerated filer must include a limited assurance attestation report in its Annual Report on Form 20-F for fiscal year 2024 filed in 2025. That limited assurance attestation report would cover disclosures regarding Scope 1 and Scope 2 GHG emissions for fiscal years 2024, 2023, and 2022 and would be replaced by a reasonable assurance attestation report starting for disclosures regarding fiscal year 2025. The Proposed Rules' phase-in schedule, which requires companies (including FPIs), to receive "reasonable assurance" in the following year of the phase-in (for large accelerated filers, starting with filings in fiscal year 2026), goes beyond the proposed initial requirements of the European Union's draft Corporate Sustainability Reporting Directive, COM (2021) 189 final ("CSRD"). FPIs subject to the CSRD currently would be required to receive limited assurance only, forcing many FPIs to assess their service providers to ensure preparedness to receive "reasonable assurance" in anticipation of the Proposed Rules ultimately being adopted.
The Proposed Rules are duplicative of existing and proposed IFRS rules. The Proposed Rules would require companies to disclose, in a footnote to their consolidated financial statements, the impact of climate-related events and transition activities (including efforts to reduce GHG emissions or otherwise mitigate exposure to climate-related risk). These rules will need to be compared to, and would be cumulative with (and potentially duplicative of), both existing and forthcoming International Financial Reporting Standard ("IFRS") guidance relating to sustainability disclosures, imposing an additional and unnecessary burden on FPIs that prepare their financial statements under IFRS. The Proposed Rules contain no carve-out for companies that report under IFRS, even though the International Sustainability Standards Board is set to issue new draft guidance on climate-related disclosure in the second half of 2022 and a future IFRS Sustainability Disclosure Standard thereafter.
Additional burden on Canadian filers in the United States. As proposed, FPIs in Canada that do not report under the Canada–U.S. multijurisdictional disclosure system will be subject to both the Canadian proposed rule, NI 51-107, as well as the Proposed Rules. Pursuant to NI 51-107, Canadian companies will be required to disclose certain climate-related information in compliance with the TCFD recommendations, including metrics and targets that require Scope 1, Scope 2, and Scope 3 GHG emissions disclosure and the related risks, or the company's reasons for not disclosing this information. The NI 51-107 requirements substantially overlap with the Proposed Rules' disclosure requirements, imposing redundancies on companies required to comply with both multiple regimes.
It is possible that the burdens of compliance with the Proposed Rules will be alleviated if they are amended by the SEC or successfully challenged in litigation. On June 16, 2022, Jones Day submitted a comment letter to the SEC on the Proposed Rules, in which we made a number of proposals to the SEC to address the above issues. We further pointed out that the Proposed Rules are vulnerable to a judicial finding that the agency has exceeded the scope of its delegated authority.
On June 30, 2022, in the widely anticipated decision West Virginia v. Environmental Protection Agency, the U.S. Supreme Court demonstrated skepticism of agency claims that general or vague statutory language confers broad authority to regulate climate-related matters. It held that Congress must clearly state its intention to delegate "major questions," such as climate policy, to an agency—a ruling that will further encourage challenges to the SEC's Proposed Rules broadly mandating climate-related disclosures.
However, given the rapidly changing regulatory landscape, and increased risk for private litigation and regulatory action with respect to ESG matters, FPIs are advised to begin preparing now in anticipation of having to comply with the Proposed Rules (or a version thereof) in the near future.
Two Key Takeaways
- FPIs should hold board-level discussions now to address new and pending disclosure rules and oversight of ESG risk generally (including climate risk), assess the compatibility of the Proposed Rules with IFRS with their accounting firms, and develop a plan to generate and validate the information called for by the Proposed Rules.
- The final rules, when adopted, are likely to contain significant new disclosure requirements that will have an immediate impact on companies that make securities filings in the United States, including FPIs.