SEC Proposes Mandatory Climate Disclosure Rules

Practical Law Legal Update w-034-8988 (Approx. 12 pages)

SEC Proposes Mandatory Climate Disclosure Rules

by Practical Law Corporate & Securities.

Climate-Related Disclosure in Registration Statements and Annual Reports

The SEC proposed to add new subpart 1500 (Climate-Related Disclosure) to Regulation S-K, which would require companies to disclose certain information regarding climate-related risks, governance, and strategy, as well as GHG emissions metrics and methodologies.

Proposed Item 1500 includes a number of defined terms for purposes of the SEC's climate-related disclosure framework. Concepts and vocabulary defined in proposed Item 1500 are similar to those used by the TCFD and GHG Protocol. Items 1501-1506 would require disclosure relating to:

Governance and oversight.
Climate-related risks and impacts on strategy, business model, and outlook.
Risk management.
GHG emissions.
Attestation of emissions disclosure.
Climate-related targets, goals, and transition plans, if any.

The climate-related disclosure rules would apply to companies filing Securities Act or Exchange Act registration statements (such as on Form S-1, Form S-3, or Form 10) and reporting companies filing annual reports on Form 10-K. Reporting companies would also be required to disclose any material change to the climate-related disclosure provided in its registration statement or annual report on Form 10-K in its Form 10-Q.

The required disclosures would have to be provided in a separate section titled "Climate-Related Disclosures." Alternatively, if any required climate-related disclosure is provided in another section, such as risk factors, description of business, or management's discussion and analysis (MD&A), that information can be incorporated by reference in the separate Climate-Related Disclosures section. Companies would also be required to tag the climate-related disclosures in Inline XBRL format.

The SEC is also proposing amendments to forms filed by foreign private issuers (FPIs) (including to Form F-1, Form 20-F, and Form 6-K) to impose substantially the same climate-related disclosure obligations on FPIs as on domestic issuers. The SEC did not propose to amend Form 40-F used by Canadian MJDS-eligible issuers, but did request comment on whether such MJDS-eligible issuers should be required to comply with the proposed climate-related disclosure requirements or whether they should be permitted to comply with Canadian climate-related disclosure requirements if certain conditions are met.

Governance and Oversight

Proposed Item 1501 would require companies to disclose information relating to the oversight of climate-related risks and strategies by the board of directors and management. Such disclosures would generally include:

Who in management and on the board is responsible for assessing, managing, and overseeing climate-related risks, including:
- whether specific members or a board committee is responsible for climate-related risk oversight; and
- whether management has certain positions or committees responsible for assessing and managing climate-related risks and what their level of expertise is.
The process by which such persons and directors are informed on matters relating to climate risks and opportunities.

Climate-Related Risks and Impacts on Strategy, Business Model, and Outlook

Disclosure of Climate-Related Risks

Proposed Item 1502(a) would require companies to disclose any climate-related risk that is reasonably likely to have a material impact on the company, including its business or financial statements, which may manifest over the short-, medium-, and long-term. As with all items in proposed subpart 1500, companies would also be permitted to discuss any climate-related opportunities.

Identified risks would have to be specified as physical or transition risks and a description of the nature of the risk must be provided. For physical risks, this would include whether it is a chronic or acute risk and the location of the company's property, assets, and operations subject to the risk. Additional disclosure would be required if the property, asset, or operations subject to the risk is located in a flood hazard area or water-stressed region.

The SEC's proposed rules do not define short-, medium-, and long-term. Instead, companies would describe how they define their short-, medium-, and long-term time horizons for identified risks, including how they account for, or reassess the expected useful life of, their assets and the time horizons for their climate-related planning processes and goals.

The standard for materiality would be consistent with existing caselaw and SEC guidance addressing materiality in securities laws. A matter would be considered material if there is a substantial likelihood that a reasonable investor would consider it important when making an investment or voting decision. The SEC believes the materiality determination regarding climate-related risks would be similar to what is required when preparing the MD&A section in a registration statement or annual report. For more information on determining materiality, see Practice Note, Determining Materiality in Securities Offerings and Corporate Disclosure.

Disclosure of Impacts on Strategy, Business Model, and Outlook

After risks are identified, companies would then be required by Item 1502(b) to describe the actual and potential impacts of any climate-related risks identified under Item 1502(a), and proposed Item 1502(c) requires a discussion of how any impacts identified in Item 1502(b) are considered as part of the company's business strategy, financial planning, and capital allocation. For example, a company might set a long-term goal of net-zero GHG emissions by 2050, a medium-term goal of a 30% reduction in GHG emissions by 2030, and a short-term goal of maintaining its emissions at its current rate through 2023. The company would have to disclose any material transition risks due to costs and operational changes implemented to achieve those targets, and the impact of those risks on its strategy, business model, and outlook.

Other disclosure required under proposed Item 1502 includes:

A discussion of how any risks identified in Item 1502(a) have affected or are reasonably likely to affect the company's financial statements, which should include any related climate-related financial metrics referenced in proposed Rule 14-02 of Regulation S-X (see Climate-Related Financial Statement Metrics).
The role that carbon offsets or renewable energy credits or certificates (RECs) play in the company's climate-related business strategy.
Information related to the company's internal carbon price, if one is maintained.
A description of any analytical tools, such as scenario analysis, the company uses to assess the impact of climate-related risks on its business and to support the resilience of its strategy and business model.

Risk Management

In addition to the governance disclosure under Item 1501, proposed Item 1503 would also require companies to describe:

The processes the company has for identifying, assessing, and managing climate-related risks, including how the company:
- determines the relative significance of climate-related risks compared to others;
- determines the materiality of climate-related risks;
- decides whether to mitigate, accept, or adapt to a particular risk; and
- prioritizes addressing climate-related risks.
Whether and how those processes are integrated into the company's overall risk management system or processes.
Any transition plan adopted as part of the company's climate-related risk management strategy, including relevant metrics and targets used to identify and manage physical and transition risks.

GHG Emissions

Proposed Item 1504 would establish the requirements for companies to measure and disclose their GHG emissions data. The SEC is proposing to require companies to disclose their GHG emissions for the most recently completed fiscal year, and for historical fiscal years included in their financial statements in the applicable filing, to the extent such historical GHG emissions data is reasonably available.

Using the scopes concept developed by the GHG Protocol, the SEC is proposing definitions for Scope 1, Scope 2, and Scope 3 emissions similar to those already widely adopted:

Scope 1: direct GHG emissions from operations that are owned or controlled by a company.
Scope 2: indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a company.
Scope 3: all indirect GHG emissions not otherwise included in a company's Scope 2 emissions, which occur in the upstream and downstream activities of a company's value chain.

Disclosure of GHG Emissions Metrics

Under the proposal, all companies must disclose their total Scope 1 and total Scope 2 emissions separately after calculating them from all sources included in the company's organizational and operational boundaries (except for certain investments excludable under Item 1504(b)(2)).

Unlike Scopes 1 and 2 emissions, Scope 3 emissions are only required to be disclosed if either:

The Scope 3 emissions are material.
The company has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.

In addition, smaller reporting companies (SRCs) are excluded from the requirement to disclose Scope 3 emissions (see Accommodations and Safe Harbor Protection).

For each required disclosure of a company's Scopes 1, 2, and 3 emissions, companies would have to:

Disclose both:
- the emissions of each of the seven GHGs specified in Item 1500(g); and
- the aggregate GHG emissions expressed in terms of carbon dioxide equivalent (CO₂e).
Exclude the impact of any purchased or generated offsets.

In addition, companies would also have to disclose the sum of their Scopes 1 and 2 emissions in terms of GHG intensity, a metric intended to help investors compare companies by emission efficiency.

If disclosure of Scope 3 emissions is required, the disclosure should be separate from the company's Scopes 1 and 2 emissions, including separately disclosing the company's Scope 3 emissions in terms of GHG intensity. Scope 3 emissions disclosure must also:

Identify the categories of upstream or downstream activities that have been included in the calculation of Scope 3 emissions.
Identify any categories of Scope 3 emissions that are significant to the company and provide Scope 3 emissions data separately for them, together with the company's total Scope 3 emissions.
Describe the data sources used to calculate the registrant's Scope 3 emissions.

Methodology Disclosure

The proposed rules would also require companies to disclose their methodology, significant inputs, and significant assumptions used to calculate their GHG emissions metrics, including:

The company's organizational and operational boundaries.
Calculation approach.
Any tools used by the company to calculate its GHG emissions.

To promote consistency, the proposed rules require a company's organizational boundary and determination of whether it owns or controls a particular source of GHG emissions to be consistent with the scope of entities, operations, assets, and other holdings within its business organization as those included in, and based upon the same set of accounting principles applicable to, the company's financial statements. Thus, for domestic issuers, US generally accepted accounting principles (GAAP) will apply.

Other methodology-related disclosure required under the proposal includes:

The use of reasonable estimates when disclosing GHG emissions, including a description of any underlying assumptions and the reason for using the estimates.
Any use of third-party data when calculating GHG emissions, regardless of scope.
Gaps in the data required to calculate GHG emissions.
Any material change to the methodology or assumptions underlying GHG emissions disclosure from the previous fiscal year.
Specifically pertaining to Scope 3 emissions:
- companies must include GHG emissions from outsourced activities that used to be conducted as part of their own operations;
- any significant overlap in the categories of activities producing Scope 3 emissions, and how the company accounted for the overlap, must be disclosed; and
- companies may present their estimated Scope 3 emissions in terms of a range, provided they disclose the underlying assumptions and reasons for using the range.

Emissions Attestation Report

In addition to disclosure of its GHG emissions, the SEC is proposing under Item 1505 to require large accelerated filers and accelerated filers to:

Obtain an attestation report from an independent attestation service provider covering, at a minimum, their Scopes 1 and 2 emissions.
Disclose certain information about the service provider and the engagement.

The SEC is also proposing minimum qualification and independence requirements for attestation service providers and minimum requirements for the attestation report.

To ease the initial burden, the SEC is proposing a phase-in period for the attestation requirement and transition period where only limited assurance is required before the requirement is scaled up to reasonable assurance (see Phase-In Periods). However, large accelerated filers and accelerated filers would be permitted to voluntarily obtain reasonable assurance earlier than required.

Further, while not required to obtain a GHG emissions attestation report, proposed Item 1505(e) would require filers other than large accelerated filers or accelerated filers to disclose whether any of their GHG emissions disclosures were subject to voluntary third-party attestation or verification and certain information regarding the third-party attestation, if applicable.

Climate-Related Targets, Goals, and Transition Plans

Proposed Item 1506 would require companies to disclose certain information about climate-related targets or goals that have been set (such as GHG emissions reductions or increased revenues from low-carbon products driven by transitional risks). Companies with climate-related targets or goals would be required to disclose, among other things:

The scope of activities and emissions included in the target.
The unit of measurement, including whether the target is absolute or intensity based.
The defined time horizon, including whether the time horizon is consistent with one or more goals established by a climate-related treaty, law, regulation, policy, or organization.
The defined baseline time period and baseline emissions against which progress will be tracked with a consistent base year set for multiple targets.
Any interim targets.
How the company intends to meet its climate-related targets or goals.

Companies would be able to provide the disclosure required by Item 1506 as part of their disclosures in response to proposed Items 1502 or 1503.

Climate-Related Financial Statement Metrics

In addition to the amendments to Regulation S-K, the SEC is also proposing to add new Article 14 (Climate-related disclosure) to Regulation S-X. Proposed Rule 14-02 of Regulation S-X would require companies providing the disclosures under new subpart 1500 of Regulation S-K in a form that also requires audited financial statements to disclose certain climate-related financial metrics in a note to their financial statements. The climate-related financial metrics disclosures, which would only be required if certain minimum thresholds are met, would fall within three categories:

Financial impact metrics, specifically impacts from:
- severe weather events and other natural conditions (such as flooding, drought, wildfires, extreme temperatures, and sea level rise);
- transition activities; and
- any climate-related risks identified under proposed Item 1502(a) of Regulation S-K.
Expenditure metrics, which refer to the positive and negative impacts associated with the financial impact metrics.
Financial estimates and assumptions impacted by severe weather events and other natural conditions.

The proposed rules would require disclosure to be provided for the company's most recently completed fiscal year and for the historical fiscal years included in the financial statements in the applicable filing. For example, if the company is an emerging growth company (EGC) or SRC, only two years would be required. However, if the historical information is not reasonably available to the company, the company may be able to exclude the information in reliance on Securities Act Rule 409 or Exchange Act Rule 12b-21.

For more information on Regulation S-X, see Practice Note, Regulation S-X: What Lawyers Need to Know. For a collection of resources on the principles governing financial statements and financial reporting, see Financial Statements, Financial Reporting and Auditing Toolkit.

Accommodations and Safe Harbor Protection

To account for concerns relating to liability or burdensome disclosure obligations, particularly for Scope 3 emissions disclosure requirements, the SEC included certain accommodations as part of its proposed rules:

A safe harbor for Scope 3 emissions disclosure from certain forms of liability under the federal securities laws.
An exemption for SRCs from the Scope 3 disclosure provisions.
A longer phase-in period for Scope 3 emissions disclosure (see Phase-In Periods).

The SEC did not create a new safe harbor for all proposed climate-related disclosures. To the extent the proposed disclosures constitute forward-looking statements and all conditions are met, the statutory safe harbors under the Private Securities Litigation Reform Act (PSLRA) would apply. However, as noted by the SEC in its proposing release, the PSLRA safe harbors do not apply to disclosures made in connection with an initial public offering (IPO).

For more information on the forward-looking statements safe harbor, see Practice Note, Forward-Looking Statements: Securing the Safe Harbor.

Furnished Versus Filed

While public comments supported both positions, the SEC has decided to treat the proposed climate-related disclosures as filed rather than furnished, which subjects the proposed disclosures to liability under Section 18 of the Exchange Act and Section 11 of the Securities Act. However, by the terms of the form, climate-related disclosures provided in a Form 6-K would be treated as furnished.

For more information on the distinction between furnished and filed, see Practice Note, Furnished Versus Filed: What's the Difference?.

Phase-In Periods

In order to provide companies with time to prepare for the proposed climate-related disclosures, the SEC proposed to phase-in the disclosure requirements of subpart 1500 of Regulation S-K and Article 14 of Regulation S-X. The phase-in period is based on filer status and registrant type in order to provide additional time to smaller companies.

Assuming the proposed rules will be adopted and become effective in December 2022 and that the company has a calendar year-end fiscal year, the table below illustrates the proposed compliance dates:

Registrant Type	Disclosure Compliance Date		Financial Statement Metrics Audit Compliance Date
	All proposed disclosures, including Scopes 1 and 2 GHG emissions metrics and associated intensity metric.	Scope 3 GHG emissions metrics and associated intensity metric.
Large Accelerated Filer	Fiscal year 2023 (filed in 2024)	Fiscal year 2024 (filed in 2025)	Same as disclosure compliance date.
Accelerated and Non-Accelerated Filers	Fiscal year 2024 (filed in 2025)	Fiscal year 2025 (filed in 2026)
SRCs	Fiscal year 2025 (filed in 2026)	Exempted

For large accelerated filers and accelerated filers required to provide attestation reports for Scopes 1 and 2 emissions metrics, the following table illustrates the attestation phase-in periods and transition periods from limited assurance to reasonable assurance (with the same effective date and fiscal year-end assumptions):

Filer Type

Scopes 1 and 2 GHG Disclosure Compliance Date

Limited Assurance

Reasonable Assurance

Accelerated Filer

Fiscal year 2024

(filed in 2025)

Fiscal year 2025

(filed in 2026)

Fiscal year 2027

(filed in 2028)

Large Accelerated Filer

Fiscal year 2023

(filed in 2024)

Fiscal year 2024

(filed in 2025)

Fiscal year 2026

(filed in 2027)

Related Reporting and SEC Rulemaking Tracker

For more information on the current voluntary ESG and sustainability reporting landscape, see Practice Note, ESG Disclosure & Sustainability Reporting Frameworks.

For more on recent developments related to ESG and climate disclosure, see Practice Note, Key Developments in ESG and Climate Disclosure Tracker.

To view the up-to-date status of all significant SEC rulemaking, including information on actions taken, comment period deadlines, and final rule effective and compliance dates, see Practice Note, SEC Rulemaking Tracker.

SEC Proposes Mandatory Climate Disclosure Rules | Practical Law