On March 21 this year, the Securities and Exchange Commission (SEC) proposed rule changes requiring registrants to include material climate-related disclosures in their registration documents and periodic filings. The comment period for the proposed rules ends May 20, 2022, after which it will likely take the rest of the year before the SEC finalizes the rules. If finalized by Dec 31, 2022, the rules are expected to apply to filings for FY 2023 beginning in 2024 according to a schedule determined by the registrant’s category.

The rules apply to all SEC registrants except registered investment companies, asset-based issuers and Canadian issuers filing under the Multi-Jurisdictional Disclosure System (MJDS).

This will have a profound impact on large emitters, as oil and gas, energy, industrial, construction, transportation and even agriculture may be categorized; it may be noted that these presently constitute the heart of global economic growth engines.

Context and Background:

The disclosures are intended to allow investors to make informed decisions regarding investment in companies with an account of their climate risk, the material business impact therein, and their Greenhouse Gas (GHG) emissions. Following the Environmental Protection Agency (EPA)’s regulation of emissions under the Clean Air Act in 2009, the SEC had issued guidance in 2010 requiring large emitters (25,000 tons or more) of GHG emissions to collect and report data regarding their emissions annually. The proposed rules in 2022 raise the requirements several notches up from previous guidance to detailed mandatory requirements broadening the scope of reporting.

Broad Disclosure Requirements:

Registrants would provide detailed information about their management of climate change issues, including climate-related governance, strategy, risk management and metrics, and goals. These respective areas conform to the familiar four pillars outlined by the Task Force for Climate-related Financial Disclosure (TCFD) convened by the Financial Stability Board, upon which, along with measurement and reporting of GHG emissions in accordance with the Greenhouse Gas Protocol, the proposed requirements are mostly based.

Whereas TCFD addresses climate-related opportunities also, the SEC rules address climate risk only. Although its eleven recommended disclosure topics organized into the four reporting pillars present a voluntary framework, several international jurisdictions are codifying aspects of it.

Following GHG Protocol, emissions of seven gases covered by the Kyoto Agreement will be reported upon: Carbon Dioxide, Methane, Nitrous Oxide, Hydrofluorocarbons, Perfluorocarbons, Nitrogen Trifluoride, and Sulphur Hexafluoride.

Paralleling International Sustainability Reporting Standards:

The European Union has maintained a more forward stance on sustainability and climate-related disclosures preceding the recent SEC rules proposal. In April 2021 the European Commission issued the Corporate Sustainability Reporting Directive (CSRD) introducing mandated EU sustainability standards, to be prepared by the European Financial Reporting Advisory Group (EFRAG) and adopted through secondary legislation. The first set of standards is due for adoption by 31 October, 2022 for applicability in FY 2023; the second set of standards will apply in FY 2024.

The directive will apply to all listed companies, and to all large companies meeting at least 2 out of 3 criteria: 250 employees, and/or over €40M turnover, and/or over €20M in total assets.

The International Financial Reporting Standards (IFRS) Foundation had announced at the COP26 in November 2021 the formation of the International Sustainability Standards Board (ISSB), unifying and consolidating multiple reporting frameworks  for global standardization of sustainability reporting. A working group of the ISSB floated draft reporting requirements compatible with the Paris Agreement on March 31, 2022, that international institutional investors will be seeking compliance with.

Among the countries incorporating TCFD recommendations into legislation or regulation are Canada, New Zealand, Switzerland, Singapore, Hong Kong, and the UK, discussed below.

Regulation Precedent Set by the UK

The proposed regulations are preceded in action by the United Kingdom, the first country in the G-20 following TCFD recommendations to regulate its requirements into law. As of April 6, 2022, over 1,300 of the largest UK-registered companies and financial institutions will need to disclose climate-related financial information.

This will include many of the UK’s largest traded companies, banks and insurers, as well as private companies with over 500 employees and £500 million in turnover.

SEC Reporting Thresholds – Registrant Categories:

The SEC categorizes registrants by size, which determines rules applicability, as follows:

New Rules Implementation Timelines:

If the rules get implemented by December 31, 2022, as planned, reporting requirements will take effect in a phased manner by category, as listed in the table below:

For Scope 3 emissions specifically, there will be an additional year for each category, except in the case of smaller reporting entities, which shall remain exempt from this reporting requirement:

Reporting Requirements:

The SEC will require emissions and climate-related management reporting on the behalf of registrants in initial registration (forms 10, S-1, S-11, S-4, and for foreign registrants, forms F-1 and F-4) as well as the annual 10-K (and 20-F for foreign issuers), and quarterly/periodic 10-Q (6-K for foreign issuers) interim reports.

All disclosures would be filed rather than furnished. These would hence be subject to disclosure controls and procedures, including liability, except for certain safe harbors.

Both narrative and quantitative disclosures will be tagged in Inline Extensible Business Reporting Language (IXBRL).

Financial Statements

Per proposed changes to regulation S-X, quantitative factors, the reporting will cover with specified metrics and disclosures the impact of climate-related events on the line items of a registrant’s consolidated financial statements.

The proposed disclosures would address three categories:

• Financial impact metrics
• Expenditure metrics (separately aggregated for capitalized costs)
• Financial estimates and assumptions

Current and potential material impacts of identified climate events on business and consolidated financial statements over the short, medium and long terms will all be presented.

All disclosures would be subject to audit as part of the financial statement assurance process and within scope of the registrant’s internal control of financial reporting.

Separate Section Disclosures

The reporting will cover GHG emissions and other disclosures in a separate and appropriately captioned section, per regulation S-K mandating qualitative disclosures:

• Description of Business – Item 101.
• Legal proceedings – Item 103.
• Risk Factors – Item 105.
• Management’s Discussion – Item 303.

The information set for disclosures would include:

• Processes for identifying climate-related physical and transition risks.
• Governance of the climate-related risk management function.
• Integration of climate risk into the registrant’s overall risk management function.
• Current and potential effects of identified climate events on strategy, business model and outlook.
• If scenario analysis used, description of scenarios including parameters, assumptions, analysis and projections.
• Metrics and targets used to identify and manage risks in transition plan, if adopted.
• Internal carbon price used, how it is set.
• Climate-related targets, goals and transition plan, if publicly set:
  • Scope of activities and emissions, timelines
  • How targets are intended to be met
  • Relevant data on progress against goals, how achieved – updates each year
  • Amount of Carbon reduction by any offsets used; amount of renewable energy generated for any Renewable Energy Certificates used.

Materiality Standards:

The standard for materiality of information remains a substantial likelihood that an investor will deem the information important in making an investment decision. There is a negative standard also to be considered, in that if disclosures are omitted, it would significantly change the mix of reporting relevant to the investment decision.

Whereas the standard in Europe has enveloped company-induced impacts occurring external to the company, the SEC has rejected the European double-materiality standard and stayed with impacts upon the registrant itself.

There are bright-line materiality thresholds for metrics. For the financial impacts and expenditure disclosures around financial statements, a 1% threshold is established for materiality. If the aggregate impact of the disclosures relating to any line item exceeds 1% of the total for that line item, disclosure will be deemed material and required.

The SEC has emphasized the dynamic nature of materiality assessments. Because circumstances will shift and vary, a requirement is placed for disclosures for the short, medium and long term.

Emissions Reporting Requirements by Scope:

Whereas the SEC’s previous guidance of 2010 required larger emitters – 25,000 metric tons or more of CO 2 equivalent emitted annually – to report facility-specific emissions as mandated by the EPA, the proposed rules will require emissions information, disaggregated as well as in the aggregate at registrant entity level.

• Scope 1 (direct) and 2 (indirect) GHG emissions metrics separately disclosed, in absolute and intensity terms, aggregated as well as disaggregated by constituent GHG.

• Scope 3 GHG emissions (scope 2 emissions occurring upstream or downstream of the registrant’s value chain), if material or if target or goal set, in absolute and intensity terms without offsets.

Assurance Requirements:

Attestation by a third-party that meets standards of experience, expertise and independence will be required for certain larger registrants. The attestation level will increase over time from that of Limited Assurance, as currently required for 10-Q financial reports, to Reasonable Assurance as required for 10-K financial report filings.

Assuming rules implementation by December 31, 2022:

Liability Safe Harbor:

Disclosure of Scope 3 emissions through the registrant’s value chain will require reliance on information provided by third parties. While there is no broad liability safe harbor, a proposed targeted safe harbor would deem such disclosures not fraudulent unless made or affirmed without a reasonable basis or disclosed in other than good faith.

Influences over Final Rules Determination:

The SEC has floated the rules as a draft, establishing a baseline and soliciting comments. The rules are impactful and have proponents as well as detractors.

Challenges

Even the SEC did not have unanimous consent among its commissioners regarding the rules proposed, and there may be changes of commissioners within the SEC before the final rules are issued.

Several members of congress have expressed their opposition to the rules already.

There is the potential for court challenges also, possibly on the basis of:

• The SEC’s authority,
• a potential violation of first amendment restrictions against compelled speech,
• economic cost-benefit considerations.

There may accordingly be expected a softening from aspects of the draft rules in the final set of rules.

Support

But with stakeholder activism regarding climate change and corporate disclosures, there is strong investor pressure towards structured and mandatory corporate sustainability disclosures, particularly climate change. Investors may go beyond even the proposed SEC reporting  requirements, in both the content and the timelines of information disclosure. That does appear to be an accelerating trend as alarm regarding deviation from Paris Agreement goals rises. Large institutional investors have been adjusting their investment portfolios in conformance with Environmental Social and Governance considerations for years already, beyond regulatory requirements.

Multiple regulatory authorities and legislative entities may also establish their own requirements regarding aspects of climate impact disclosure that businesses will have to adhere to outside of the SEC’s requirements.

• In November 2021 the New York State Department of Financial Services (DFS) issued guidance for insurers regarding climate change risk management.
• A bill passed by the California senate in January 2022 and now with the house would require all businesses with over $1 billion in revenue operating in the state to disclose all emissions data, including scope 3, to the California Secretary of State’s office beginning January 2024.
• The Federal Deposit Insurance Corporation (FDIC) floated draft principles for climate-related financial disclosures for large financial institutions in March 2022.

Next for Registrants:

The comment period for the proposed rules will close on May 20, 2022. Registrants may compare the proposed disclosure requirements with their current disclosures, identify gaps, and analyze operational requirements for compliance. 

Comments may then be provided to the SEC by registrants until the close date.

Whatever the shape of the final SEC rules, it is clear that there will be a requirement for more robust and structured reporting on climate change influenced by multiple stakeholder and governance groups on all business entities. Organizations need to dedicate appropriate resources accordingly.

© Haseeb Ahmed, The Stanwork Group