On March 21, the SEC released its long-awaited proposed rules on climate disclosure by public companies. Building on years of voluntary reporting prodded by investor engagement, the proposed rules are intended to provide companies “with a more standardized framework to communicate their assessments of climate-related risks as well as the measures they are taking to address those risks.” While the SEC has previously issued climate risk guidance, by standardizing and mandating such information in SEC filings, the SEC intends to “increase the consistency, comparability, and reliability of climate-related information for investors.”
If adopted, the proposed rules would result in companies disclosing extensive, additional information on climate risks and impacts. In fact, commentators have noted that these rules — particularly when considered together with the SEC’s proposed cybersecurity rules and expected rules on human capital management — may be the most significant addition to U.S. public companies’ disclosure obligations in decades.
The Proposal
The new disclosures would be required in both offering and periodic documents filed with the SEC. Different disclosures would be required in both the narrative (Reg S-K) and the financial statements (Reg S-X) in companies’ annual reports, including a new, dedicated climate section in the front-end narrative. At a high level, the proposed rules would require companies to disclose the following information.
Greenhouse Gas Emissions
Scope 1 and 2. Companies would have to disclose their direct GHG emissions (Scope 1) and indirect GHG emissions from purchased electricity and other forms of energy (Scope 2).
Scope 3. If applicable, companies would also have to disclose indirect emissions from upstream and downstream activities in their value chain, if material, or if the company has set a GHG emissions target or goal that includes Scope 3 emissions. There would be an extended phase-in period for Scope 3 emissions disclosures, and smaller reporting companies would be exempt from this requirement entirely.
Assurance. The proposal would also require that larger companies obtain an attestation report from an independent third party on their Scope 1 and 2 emissions. (The report could be from an audit firm or other qualified provider, such as an engineering firm.) Limited assurance, which is commonly used in voluntary engagements of this sort today, would be required to start, and then companies would transition to reasonable assurance, the same level used in a financial statement audit, over time.
Financial Statement Footnotes
Companies’ financial statements would have to include new footnotes detailing the impact of climate-related events (severe weather events as well as physical risks) and transition activities on the line items of their consolidated financial statements. These footnotes would also detail related expenditures, as well as the effect of climate-related events and transition activities on the companies’ financial estimates and assumptions.
Climate Risk Governance
Companies would have to describe the oversight and governance of climate-related risks by their board and management, including identifying board committees responsible for climate-related risk oversight and whether any board member has expertise in climate-related risks. Disclosure would also be required about whether and how the board considers climate-related risks as part of its business strategy and risk management, and whether and how the board sets and oversees climate-related targets or goals.
Climate Risk Disclosure
Companies would have to disclose any climate-related risks that are reasonably likely to have a material impact on the company’s business or consolidated financial statements over the short, medium, and long term. They would also have to describe how any identified climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook, as well as their processes for identifying, assessing, and managing climate-related risks. The proposed rules would also require companies to provide specified details if they have –
- Adopted a transition plan,
- Use scenario analysis, or
- Use an internal carbon price.
Climate Targets and Goals
Finally, if a company has publicly set climate-related targets or goals, it must disclose information about those targets, including the scope of activities or emissions within the target, how it intends to meet the target, whether it is making progress, and its use of carbon offsets or renewable energy credits, if any, to do so.***
Helpfully, a number of the new disclosures incorporate concepts from the Task Force on Climate-Related Financial Disclosure (“TCFD”) Framework and GHG Protocol, which are familiar to many investors and companies given their widespread use today. The SEC’s three-page fact sheet summarizes the entire proposal, including more details on the transition periods.
Takeaways
We believe that, if adopted, the new disclosures will provide useful information for investors. As comments roll in, we expect much of the debate to focus on whether the required information would be useful for investment decisions or is being mandated for other reasons. While we believe there is a clear consensus in the investment community today that such information is material to investment decisions, it also plays a critical role in many investors’ stewardship decisions. As the SEC notes, giving investors “access to more consistent, comparable, and reliable disclosures with respect to [companies’] climate-related risks [] is expected to enable investors to make more informed investment or voting decisions.” (emphasis added). Among other things, this information gives shareholders important insight into companies’ governance and risk management practices on some of the most material risks they face in the near and long-term.
The new climate risk governance disclosures in the SEC’s proposal would do this directly, but many of our investor clients today are also guided in their engagement and voting decisions by other measures of whether and how companies are disclosing and managing climate-related risks. For this reason, Glass Lewis has long included information about sustainability risks and companies’ management of those risks in its proxy voting research. Glass Lewis has now taken that one step further by including the ESG Profile page in its Proxy Papers, which includes information on whether companies are making GHG Scope 1, 2 and 3 emissions disclosures, have GHG emissions or net zero targets, their relevant CDP scores, whether their reporting aligns with TCFD, and numerous other ESG considerations and metrics, with an expanded analysis of companies’ climate risk for those companies with more significant exposure to this matter. Many of the climate-related measures in the ESG Profile overlap with the SEC’s proposed disclosures. We have found that our clients are increasingly looking to this information as helpful context for their stewardship or to directly incorporate into their voting policies. If adopted, the proposal would expand and promote the timeliness, comparability and reliability of the information available for these purposes.
It is also notable that the SEC’s proposal relies heavily on past investor engagement seeking climate reporting. The SEC cites this engagement as evidence of both investors’ need for climate information and the feasibility of companies providing it. As the SEC’s release notes, “many companies have begun to provide some of this information in response to investor demand and in recognition of the potential financial effects of climate-related risks on their businesses.” It is probably fair to say this SEC proposal would not have been launched without years of investor engagement and support for shareholder proposals calling for GHG and TCFD reporting.
Finally, it is important to remember the global context in which most investors today operate. Global investors need reliable, decision-useful climate information in a comparable format for all their investee companies. The European Union is upping E&S disclosure expectations on financial market participants through the Sustainable Finance Disclosure Regulation (“SFDR”) and companies directly through the coming Corporate Sustainability Reporting Directive (“CSRD”). Moreover, the EU and other jurisdictions are not just imposing disclosure requirements, but also substantive requirements for market participants to align their activities with the Paris Accord. There are also encouraging signs of consolidation and convergence among the numerous ESG standard setters. The SEC’s proposal is just disclosure, is less prescriptive, and has a narrower scope than the reporting regimes of the EU and other jurisdictions, but it is nonetheless a massive step forward to closing this gap.
Next Steps
Comments are due May 20, 2022, although this date could be extended if there is a delay in publishing the proposal in the Federal Register. We encourage all interested parties to weigh in with the SEC.