Recently, the Securities and Exchange Commission (“SEC”) proposed a new rule concerning the disclosure of “certain climate-related information in their registration statements and annual reports” as well as “certain climate-related financial metrics . . . in a registrant’s audited financial statements.”[1] If the proposed rule is adopted, it would provide investors with relatively standardized disclosures on climate-related information.
Regulatory Background
Under federal law, the SEC is responsible for promulgating rules and regulations concerning the information that entities are required to disclose in registration statements—for the offering of securities—as well as reports for those entities that issue securities (“registrants”).[2] The SEC’s Regulation S-X covers the financial statement portions of these reports and registration statements, while Regulation S-K covers the non-financial statement portions.[3] Topics covered by Regulation S-X include general instructions for these statements, rules for the accountants auditing these statements, as well as instructions for specific types of entities—like insurance companies.[4] Topics covered by Regulation S-K include descriptions of the business and the securities as well as disclosures for particular types of registrants—like those engaged in oil and gas production—as well as particular types of securities—like asset backed securities.[5]
Prior to this proposed rule on climate-related disclosures, the SEC released interpretive guidance in 2010 explaining its view “with respect to our existing disclosure requirements as they apply to climate change matters.”[6] Since then, the SEC has noted that there has been more demand from investors for climate-related information as well as fragmentation in the way that companies have reported this type of information—as a result of different third-party frameworks.[7] As a result, the SEC proposed a new rule, on March 21, 2022, aimed at creating climate-related disclosures that are consistent, comparable, and reliable; this would hopefully allow investors to make more informed investment and voting decisions.[8]
Proposed Rule on Climate Related Information
In its current form, SEC proposal would, broadly speaking, “require a registrant to disclose certain climate-related information, including information about its climate-related risks that are reasonably likely to have material impacts on its business or consolidated financial statements, and [quantitative greenhouse gas (“GHG”)] emissions metrics that could help investors assess those risks” in new subpart of Regulation S-K.[9] In addition, the SEC noted that “[a] registrant may also include disclosure about its climate-related opportunities.”[10]
The SEC based the disclosure framework for this information, in part, on the recommendations from the Task Force on Climate-Related Financial Disclosure as well as the Greenhouse Gas Protocol.[11] Of note, the proposed framework requires the disclosure of what the Greenhouse Gas Protocol defines as Scope 1 and Scope 2 emissions for all registrants.[12] Scope 1 emissions “are direct GHG emissions that occur from sources owned or controlled by the company,” while Scope 2 emissions “are those emissions primarily resulting from the generation of electricity purchased and consumed by the company.”[13] Registrants that do not fall under the definition of a smaller reporting company also have to disclose Scope 3 emissions under the proposed rule;[14] Scope 3 are “are all other indirect emissions not accounted for in Scope 2 emissions.”[15]
As to financial statements, the proposed rule “would require certain climate-related financial statement metrics and related disclosure to be included in a note to a registrant’s audited financial statements” in a new article to Regulation S-X.[16] The proposed metrics “would consist of disaggregated climate-related impacts on existing financial statement line items” and “would be subject to audit by an independent registered public accounting firm.”[17]
Implementation of the Proposed Rule
Currently, the SEC is seeking comments on the proposed rule, with the deadline set for 30 days after the date of publication in the Federal Register or May 20, 2022 (whichever period is longer).[18] Based on feedback from an earlier request for public input, it is likely that this rule will be challenged, inter alia, on the grounds that it exceeds the SEC’s statutory authority.[19] If the proposed rule is promulgated in its current form, there would be phase-in periods for the registrants, a safe harbor for Scope 3 emissions, and a provision allow for registrants to use a reasonable estimate for fourth fiscal quarter data (if the actual data is not reasonably available) with prompt disclosure of any material differences later on.[20] This blog will continue to monitor the proposed rule on climate-related disclosures as well as other regulatory developments in the securities space.
[2] See, e.g., 15 U.S.C. § 77f; see also 15 U.S.C. § 78m
[4] See 17 C.F.R. §§ 210.2–210.3 (2022); see also 17 C.F.R. § 210.7 (2022).
[5] See 17 C.F.R. §§ 229.100–229.200 (2022); see also 17 C.F.R. §§ 229.1100–229.1200 (2022)
[7] Proposed Rule, supra note 1 at 25 –35
[8] See generally Proposed Rule , supra note 1 at 7–15.
[9] Propose Rule, supra note 1 at 42–43. The SEC summarized the content of the proposed disclosures in a fact sheet released along with the proposed rule. U.S. Securities & Exch. Comm’n, Fact Sheet. Enhancement and Standardization of Climate-Related Disclosure (March 21, 2022). https://www.sec.gov/files/33-11042-fact-sheet.pdf. The fact sheet noted that the “[t]he proposed rules would require a registrant to disclose information about:
- The oversight and governance of climate-related risks by the registrant’s board and management;
- How any climate-related risks identified by the registrant 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;
- How any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook;
- The registrant’s processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into the registrant’s overall risk management system or processes;
- If the registrant has adopted a transition plan as part of its climate-related risk management strategy, a description of the plan, including the relevant metrics and targets used to identify and manage any physical and transition risks;
- If the registrant uses scenario analysis to assess the resilience of its business strategy to climate-related risks, a description of the scenarios used, as well as the parameters, assumptions, analytical choices, and projected principal financial impacts;
- If a registrant uses an internal carbon price, information about the price and how it is set;
- The impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as the financial estimates and assumptions used in the financial statements;
- The registrant’s direct GHG emissions (Scope 1) and indirect GHG emissions from purchased electricity and other forms of energy (Scope 2), separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute terms, not including offsets, and in terms of intensity (per unit of economic value or production);
- Indirect emissions from upstream and downstream activities in a registrant’s value chain (Scope 3), if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions, in absolute terms, not including offsets, and in terms of intensity; and
- If the registrant has publicly set climate-related targets or goals, information about:
- The scope of activities and emissions included in the target, the defined time horizon by which the target is intended to be achieved, and any interim targets;
- How the registrant intends to meet its climate-related targets or goals;
- Relevant data to indicate whether the registrant is making progress toward meeting the target or goal and how such progress has been achieved, with updates each fiscal year; and
- If carbon offsets or renewable energy certificates (“RECs”) have been used as part of the registrant’s plan to achieve climate-related targets or goals, certain information about the carbon offsets or RECs, including the amount of carbon reduction represented by the offsets or the amount of generated renewable energy represented by the RECs.”
Fact Sheet at 1–2.
[10] Propose Rule, supra note 1 at 43.
[11] Propose Rule, supra note 1 at 44–45. The Task Force on Climate-Related Financial Disclosure (“TFCD”)was established by the Financial Security Board at the direction of G20 finance Ministers. Id. at 37. The SEC noted that the framework from the TFCD has wide support from organizations and financial institutions, and that the framework has been proposed as the basis for disclosure requirements in a number of countries and the EU. Id. at 38–39. Furthermore, as the SEC noted, “[t]he GHG Protocol’s Corporate Accounting and Reporting Standard provides uniform methods to measure and report the seven greenhouse gasses covered by the Kyoto Protocol – carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride, and nitrogen trifluoride.” Id. at 40–41; see also World Business Council for Sustainable Development and World Resources Institute, The Greenhouse Gas Protocol, A Corporate Accounting and Reporting Standard REVISED EDITION (2015) https://ghgprotocol.org/corporate-standard.
[12] Fact Sheet, supra note 9 at 3.
[13] Propose Rule, supra note 1 at 41.
[14] Fact Sheet, supra note 9 at 3; see also 17 C.F.R. § 240.12b-2 (2022) (definition of small reporting company).
[15] Propose Rule, supra note 1 at 41.
[16] Propose Rule, supra note 1 at 43.
[17] Propose Rule, supra note 1 at 43–44. This climate-related information would also “come within the scope of the registrant’s internal control over financial reporting” that subject to review by the accountants. Id. at 43–44; see also 17 C.F.R. § 210.1-02(a)(2).
[18] Proposed Rule, supra note 1 at 1.
[19] See Proposed Rule, supra note 1 at 21 (citing to letters from the American Enterprise Institute, Cato Institute, Heritage Foundation, and Texas Public Policy Foundation).
[20] Proposed Rule, supra note 1 at 47–48; see also Fact Sheet, supra note 9 at 3 (table outlining a hypothetical phase-in calendar).
