In March 2022, the Securities and Exchange Commission (SEC) put forth a draft rule concerning climate risk disclosures, signaling a significant shift toward mandating corporate transparency regarding the financial and operational challenges posed by climate change. This resulted in a huge inflow of public comments and rigorous debate over the scope of such a rule, the SEC’s ability to mandate and regulate in this area, and the potential shift in status quo that was being required.
A final rule was expected by fall of 2023, but these comments and challenges have been a primary driver in repeatedly pushing back the announcement. It’s now expected to be released in the second quarter of 2024.
What’s included in the proposed SEC Climate Disclosure Rule
The proposed rule would require domestic and foreign registrants to include climate-related information in its registration statements and annual reports.
A summary of proposed points includes: (from the SEC FACT SHEET on Enhancement and Standardization of Climate-Related Disclosures)
- Climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook;
- The registrant’s governance of climate-related risks and relevant risk management processes;
- The registrant’s greenhouse gas (“GHG”) emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance;
- Certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements; and
- Information about climate-related targets and goals, and transition plans, if any.
SEC Objective for the Proposed Climate Disclosure Rule
The escalating threat of climate change introduces significant risks to the financial landscape of the United States. From the impact of intensifying weather patterns on infrastructure and transportation, to fluctuations in investment valuation in response to policy and consumer preferences, these climate-driven risks translate into financial vulnerabilities.
The SEC’s objective for this proposed rule is to establish a framework for disclosures that’s not only consistent and comparable across the board, but also carries sufficient reliability to effectively inform investment decisions. This provision of information pertaining to climate-related risks aligns with the SEC’s foundational purpose of ensuring that investors have accurate information on which to base decisions. It also echoes a growing call for insightful and actionable data on how climate change is reshaping the financial landscape and influencing corporate viability.
Gaps in Voluntary Climate-Related Risk Reporting
While an increasing number of public companies are committing to net-zero targets and establishing benchmarks to reduce greenhouse gas (GHG) emissions, the current state of reporting is disparate and lacks uniformity. This lack of standardization has made it unreliable as data for driving decisions by investors.
Recognizing the potential for climate-related risks to influence the stability of companies, investment decisions, and the broader financial markets, financial overseers are actively engaging in measures to gauge and address these risks.
In light of this, the SEC has identified a gap in voluntary climate risk disclosures, concluding that they fall short in safeguarding investor interests. Proponents of the SEC proposal have advocated for these enhanced disclosure mandates to ensure the delivery of reliable, comparable data on climate-related risks within the financial sphere. Arguably, such measures fall within the purview of the SEC’s regulatory framework, which is designed to fortify investor protection and uphold the integrity of the markets, as delineated under various sections of the United States Code (15 USC 77g, 15 USC 78l, 78m, and 78o). The Commission’s authority enables the creation of disclosure obligations that align with the public interest and reinforce investor security.
Scope 3 Emissions Discussion Delays Final Announcement
Among the reasons causing the current delay in the final announcement is the reporting of Scope 3 emissions.
Although the pending climate disclosure rules will apply only to public companies, if Scope 3 reporting is included as a requirement, it would mean that private suppliers would have to report their emissions as part of the process. The SEC does not regulate private companies and therefore must decide how to obtain useful emissions information from the public companies without indirectly mandating disclosures from private firms.
Because of this, there was speculation that Scope 3 reporting would not be included in the final rule. Nevertheless, there is large scale support among proponents of ESG reporting to keep such requirements in.
Additional Impact: California Climate Laws and the SEC Rule
Drawing further public comment and concern is the related impact of California’s newly enacted climate legislation. The California laws compel larger companies operating within the state, those with revenues exceeding $1 billion, to comprehensively report their Scope 1 and 2 emissions starting in 2026, and Scope 3 beginning in 2027.
This requirement is more stringent than those being finalized by the SEC, which allows for more leeway in reporting certain emissions. The California law includes the obligation to disclose Scope 3 emissions, the indirect emissions from a company’s value chain, including both suppliers and customers. In contrast, the SEC’s draft rules require the disclosure of Scope 3 emissions only if they are considered material by the company.
The implementation of California’s laws could compel companies to disclose more detailed emission information than they otherwise would have, if the SEC decides to not require Scope 3 reporting. This increased level of disclosure could lead to intensified examination and accountability by stakeholders, especially if the Scope 3 emissions are considerable compared to the company’s direct emissions.
While companies are provided a legal cushion against inaccuracies in Scope 3 emissions reporting until 2030 under California’s rules, the SEC’s safe harbor provisions offer limited protection, extending only to companies that demonstrate good faith. The SEC has formidable regulatory clout, with the ability to impose penalties and escalate severe cases of non compliance for criminal prosecution. Company officials also risk litigation from shareholders if disclosures are found to be misleading.
