On March 21, 2022, the Securities and Exchange Commission (the “SEC” or “Commission”) proposed rules for climate change disclosure requirements for both U.S. public companies and foreign private issuers. The SEC posted a 500+ page Proposing Release (the “Proposing Release”) and issued a Press Release and a Fact Sheet summarizing notable provisions. These disclosure requirements are mostly prescriptive rather than principles-based, and in many respects are derived from the Taskforce on Climate-related Financial Disclosures (“TCFD”) reporting framework and the Greenhouse Gas Protocol.
This bulletin provides an overview of, and our current perspectives on, the SEC’s recently proposed rules that would establish a new climate change reporting framework for U.S. public companies and foreign private issuers as well as practical recommendations on what companies should be doing now. Below is a summary of takeaways for public companies on these new proposed rules.
Key Takeaways and Actions
- Absence of materiality. The proposed disclosure standards largely eschew the use of a materiality standard; other than in the context of Form 10-Q updating, only the climate change risk disclosures, one of the two standards for requiring Scope 3 emissions disclosure, and certain details regarding emissions disclosures are predicated on materiality (and in the case of risk disclosures, the standard is “reasonably likely” to have a material impact). Notably, Chair Gensler stated that the definition of “materiality” applicable to the proposed rules is the one used under the U.S. securities laws, notwithstanding other “materiality” definitions used by various environmental, social, and governance reporting frameworks, suggesting that company disclosures in sustainability reports may encompass topics not required to be addressed under the proposed rules.
- Inner workings disclosure. The proposed rules would require companies to disclose detailed underlying methodologies regarding climate-change issues to a degree that has few precedents in the SEC’s rules. For example, a company would not only have to disclose its GHG emissions, but would also have to provide a detailed description of its methodology, including significant inputs, calculation approach, and calculation tools. Thus, the rules would provide insights into key internal aspects of this one facet of a company’s business and operations to a greater degree than most other aspects of the company’s operations, potentially resulting in the disclosure of proprietary business strategies and competitively sensitive information.
- Vague disclosure triggers based on company actions. In many cases, company actions can trigger disclosure under the proposed rules. For example, a company would have to provide Scope 3 emissions disclosure if the company “has set” a Scope 3 target or goal. Similarly, detailed disclosures would be required if a company “uses” a scenario analysis, “maintains” an internal carbon price, “has set” any climate-related target or goal, “has adopted” a transition plan. Moreover, once these disclosures are triggered, the proposed rules would prescribe detailed information that would have to be disclosed and would impose conditions on the disclosure that may differ from the company action that triggered the disclosure. For example, Scope 3 emissions disclosure would be required to be provided by constituent GHG, even if the target or goal that triggered the disclosure was not developed in that manner. Given the detailed reporting requirements that would be triggered by various company actions, the rules could disincentivize companies from taking such actions or from modifying or updating their planning around these types of actions and could lead to widely disparate disclosures among companies, largely without regard to the materiality of such actions or disclosures.
Although the rules have only been proposed and are subject to comment (which we believe will be significant) and any final rules could be challenged in court, it is not too early to start thinking about the potential implications of the proposed rules, if they are adopted as proposed, and assess what additional steps may be necessary to take in order to be well-positioned to comply. The following planning suggestions should be tailored, as appropriate, to your company’s particular industry and size.
- Participate in the rulemaking. Under the Administrative Procedure Act, the SEC is required to consider and reasonably respond to public comments. Accordingly, companies concerned about aspects of the proposed rules should consider participating in the rulemaking proceedings, either by submitting their own comments or by working in conjunction with a trade association. Among other things, comments may address the expected costs of compliance with the proposed rules (including quantitative data, where available); requirements in the proposed rules that are unclear, impractical or unduly burdensome; and possible alternatives to provisions of potential concern.
- Conduct a gap analysis against any existing disclosures. Companies should start by taking stock of their existing climate-related disclosures—including in their SEC filings and on their websites (e.g., on an ESG webpage or stand-alone ESG report), as applicable—and assessing what additional disclosures would be needed to comply with the proposed climate-related risk disclosure framework. That will help focus and inform compliance and readiness efforts once final rules are issued.
- Assess the sufficiency of internal and external climate change resources. Given their breadth and complexity, compliance with the proposed rules, if adopted, likely would require substantial internal and external resources. As a result, companies should begin to assess their internal resources’ expertise and external service providers. In assessing resource sufficiency, consideration should also be given to the timing for preparing these disclosures, since most will need to be finalized early the following year in time for the annual report on Form 10-K. This is an already busy time for internal legal and financial reporting teams and, for those companies that voluntarily publish an ESG report, this timing likely represents an acceleration of when similar disclosures otherwise would have been prepared as ESG reports are often published later in the year. Companies should start gathering information necessary for budgeting and organizational planning purposes.
- Evaluate disclosure controls and internal controls. Given that the proposed new disclosures would be included in SEC filings, companies should assess their existing disclosure controls and procedures, as well as internal control over financial reporting as it relates to the proposed Regulation S-X rules, to identify any necessary enhancements to cover the new climate-related disclosures. As a general matter, in light of the potential disclosure liability that attaches to these disclosures generally (even those included on company websites), it is important to have robust processes in place to collect and verify the underlying data and assumptions.
- Revisit climate-related risk oversight and management practices. As the proposed rules would require significant disclosure about climate-related risk oversight and management practices, companies should begin assessing their existing practices and considering whether any enhancements are warranted to how the board oversees climate-related risks (e.g., whether at the full board level or a committee, frequency for monitoring, etc.) and how these risks are managed internally before such practices are subject to disclosure.
- Reassess board composition, focusing on climate change expertise. As the proposed rules would require disclosure about any climate change expertise on the board of directors, companies should start assessing the relevant qualifications of existing board members to consider what the potential disclosure would look like and evaluate whether it is appropriate (or not) to make climate change expertise a recruitment focus area for future board refreshment opportunities.
- Conduct a detailed materiality assessment of climate-related risks to the business. As a significant portion of the new Regulation S-K, qualitative disclosure requirements would include a materiality qualifier, companies, would be well served by conducting a more detailed materiality assessment of climate change risks and opportunities in their business than they have done in the past.
- Begin considering the potential significance of Scope 3 emissions for your company. As a threshold question for whether Scope 3 emissions disclosure would be required is whether they are material, companies should start to consider the potential significance of their Scope 3 emissions, including taking into account a company’s value chain. As this likely will require reliance on third-party data to some extent, companies should begin identifying potential data sources, including both industry resources and partners in their value chains.
- Discuss implications with your outside auditor. Companies should start discussing with their outside auditors the implications of both (1) the proposed financial statement disclosure requirements on the firm’s audit, and (2) the proposed disclosure requirements outside of the financial statements on the comfort letter process. Companies also should consider whether their outside auditors could be engaged to conduct the required GHG emissions attestation.