Climate-related impacts like rising sea levels, massive fires and increasing emissions stand to put many companies at risk. However, the growing tide of regulations has the potential to lift all boats (or at least the baseline level of companies’ climate-related disclosures).

At the beginning of this month, the SEC issued long-awaited rules governing companies’ climate-related disclosures. These rules represent a significant enhancement to the reporting requirements previously promulgated by the agency, and also serve to place the U.S. more on par with the disclosure requirements seen in other Western markets (and some U.S. states).

In this post, we provide a brief overview of the new rules, highlight several areas of disclosure that could become more relevant as a result of their implementation, and discuss the potential impact on companies and their stakeholders.

Overview

Following a nearly two-year process, the rules that were ultimately adopted are far less stringent than those originally proposed. Nonetheless, the new requirements will force many companies to increase the quality and quantity of their climate-related disclosures, and provide more detailed reporting on a wider range of topics. Previous SEC guidance on climate disclosures, a 29-page document issued in 2010, essentially articulated that climate change can be a material risk for companies, and, when it is, companies should provide disclosure of these risks in their official filings. Now, that guidance has effectively been superseded by detailed rules explained in an 886 page document that very specifically outlines what climate-related information companies must disclose to shareholders.

Key Requirements

Under these new rules, large companies will be required to begin reporting on their climate-related risks for fiscal year 2025, while smaller companies will begin reporting in fiscal years 2026 and 2027. In the following years, large companies will also be required to provide an accounting of their Scope 1 and 2 emissions and, eventually, assurance for these emissions.

In addition, the SEC also highlights the following disclosure requirements:

  • Plans taken, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis or internal carbon prices;
  • Any oversight by the board of climate-related risks and any role by management in assessing and managing material climate-related risks;
  • The capitalized costs, expenditures expensed, charges and losses incurred as a result of severe weather events and other natural conditions;
  • The capitalized costs, expenditures expensed and losses related to the use of carbon offsets and renewable energy credits or certificates;
  • Whether the estimates and assumptions used to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans.

Unsurprisingly, the rulemaking has been controversial from the start. The SEC received more than 24,000 comment letters on its proposal, including more than 4,500 unique letters, and the final rules are already facing legal challenges from multiple sides. Oil and gas industry groups announced that they are suing in the Fifth Circuit to stop their implementation. In addition, a number of Republican-led states have challenged the rules in the 11th Circuit Court of Appeals. Not to be outdone, two environmental NGOs, the Sierra Club and Earthjustice, have  taken legal action in the D.C. Circuit Court of Appeals on the basis that the rules do not go far enough, specifically referencing the removal of a requirement that companies disclose their Scope 3 emissions.

Scope 3 Emissions & Other Notable Omissions

The potential inclusion of Scope 3 emissions was, by far, one of the more controversial areas of the proposed rules. Broadly classified as emissions that are not under companies’ direct control, Scope 3 emissions often represent the most significant proportion of companies’ overall emissions. However, since they are, by definition, not under a company’s control, estimating and managing such emissions can be extremely challenging. While many have criticized the rules for omitting these emissions, others have argued that removal of the Scope 3 provisions will help the rule withstand legal challenges.

In addition to removing the Scope 3 disclosure requirement, the rules were also amended to apply to approximately 60% fewer companies than originally proposed. The rules now only require certain emissions disclosures if a company considers them to be material, potentially allowing issuers to report such information at their own discretion. In addition, companies will no longer have to describe board members’ climate expertise and the assurance level required for certain companies’ Scope 1 and 2 emissions was reduced, among other provisions.

Notable Provisions: Physical Risks of Climate Change and Severe Weather Events

The final rules have left plenty of room for critique from both companies and environmental activists, which arguably could be seen as a sign of effective compromise. However, even in their more limited form, the rules will provide investors with more disclosure to consider and incorporate in their investment decisions. For example, the physical risks of climate change and the impact of severe weather events represent an important, but potentially underappreciated, area where the rules represent an enhancement to previous requirements.

Obviously, curbing global emissions is a critical aspect in mitigating some of the worst impacts of climate change. However, in many cases, a focus on a company’s own emissions (or even their Scope 3 emissions) has overshadowed the conversation about the potential, more immediate, physical risks of climate change, which in many instances may be far more disruptive and impactful to a company’s operations.

To illustrate this focus on emissions reductions, most climate-related shareholder proposals have focused on companies’ emission reduction strategies. However, only a handful of proposals have meaningfully addressed enhanced disclosure of companies’ physical exposure to intensifying weather brought about by climate or other climate-related impacts. While a focus on the physical risks of climate change may not do much to solve the collective problem of climate change, it is an issue that is incredibly salient for businesses of all sizes, in all industries. Accordingly, it is an issue that is likely also material to investors, and the new requirements may spur additional shareholder engagement on the topic.

Arguably, disclosure on the physical risk to companies as a result of climate change was already required by the 2010 SEC climate guidance. However, over time, this disclosure has, in the vast majority of cases, become increasingly meaningless, with companies often providing boilerplate language without many specifics. Going forward, shareholders can expect to receive a more concrete understanding of how their investee companies are exposed to financially material climate-related risks.

Under the final rules, companies will be required to disclose a discrete set of actual expenses that they incur and can attribute to severe weather events and other natural conditions. Specifically:

  • (i) the aggregate amount of expenditures expensed as incurred and losses, excluding recoveries, incurred during the fiscal year as a result of severe weather events and other natural conditions; and
  • (ii) the aggregate amount of capitalized costs and charges, excluding recoveries, recognized during the fiscal year as a result of severe weather events and other natural conditions.

This marks another area of compromise, as the SEC removed a provision of the proposed rules that would have required the disclosure of the impact of severe weather events and other natural conditions and transition activities on each line item of a company’s consolidated financial statements.

Impact of the New Rules

Accounting for severe weather events represents just one small (albeit important) aspect of the broader climate reporting that will be required under the new SEC rules. For investors working to integrate climate and other non-financial considerations into their stewardship and investment processes, getting regular access to standardized reporting and data could be extremely beneficial.

However, it is important that shareholders understand that just because these rules have been promulgated does not necessarily mean all companies will be reporting robust, decision-useful information concerning their climate risks, particularly at the onset. There are still hurdles to this outcome in the form of legal changes, the potential for boilerplate disclosure under some provisions, and companies’ ability to apply these rules at their discretion based on their definition of materiality.

As such, we likely won’t know the impact of these new rules until companies begin providing this enhanced climate disclosure in the coming years. However, there is reason to believe that, should these rules withstand legal challenges, shareholders will be much better able to gauge and quantify the impact of climate change on their portfolio companies. While many companies have already provided disclosure that far surpasses these requirements, it sets a new baseline for those that haven’t.