The SEC’s Climate-Disclosures Proposed Rule – Eight Key Takeaways

1) Proposed Amendments to Regulation S-K with Qualitative Disclosures Largely Modeled on the TCFD Framework

The proposed rule would add a new subpart to Regulation S-K requiring the disclosure of certain climate-related information modeled on the Task Force on Climate-Related Financial Disclosures (“TCFD”) framework. A registrant would be required to disclose:

• Governance of climate-related risks (board and management oversight);
• Material climate-related impacts on its strategy, outlook, and business model;
• Management of climate-related risks, to include identification and assessment and, where applicable, adoption of a transition plan;
• Scope 1 and Scope 2 GHG emissions metrics and Scope 3 emissions metrics where material or where the issuer has set a GHG emissions reduction target inclusive of Scope 3 emissions; and
• Climate-related targets (e.g., reduction of GHG emissions, conservation, energy usage, water usage, etc.) if the issuer has set any such targets.

According to the SEC, the use of the TCFD framework, given its widespread adoption, should help to produce “consistent, comparable, and reliable” climate-related disclosures. The proposed rule states that investors have experience using TCFD disclosures and that its use may reduce the burden on issuers of such disclosures. However, this may not entirely be the case. In the proposed rule, with regard to the disclosure of governance of climate-related risks, the SEC refers to a recent 2021 TCFD report which found only 25 percent of surveyed companies provided TCFD-recommended board disclosures and 18 percent provided TCFD-recommended management disclosures in 2020. Given that companies are utilizing the TCFD framework but not actually fully implementing all the recommendations, the proposed rule’s requirements may prove more burdensome on issuers than the Commission projects.

Under the proposed rule, a company would be required to disclose climate-related risks over the short-, medium-, and long-term. The SEC does not propose specific time frames that would define short-, medium-, and long-term and instead proposes to leave it to each issuer to develop relevant time horizons for disclosure.

2) Disclosure of Scope 1 and Scope 2 Emissions and Potential Disclosure of Scope 3 Emissions

a) Scope 1 and Scope 2 Emissions

The proposed rule would require a registrant to disclose its Scope 1 and Scope 2 GHG emissions for each fiscal year included in its consolidated financial statements. In line with the GHG Protocol, the proposed rule defines Scope 1 emissions “as direct GHG emissions from operations that are owned or controlled by a registrant” and Scope 2 emissions “as 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 registrant.” Importantly, the proposed rule requires a registrant to separately disclose its total Scope 1 emissions from its total Scope 2 emissions and disclose both in the disaggregate (i.e., by each constituent greenhouse gas¹) and the aggregate (as CO₂ equivalent). The SEC posits access to “decision-useful information” as the rationale behind this form of disclosure; specifically, that investors can understand the risks posed by each constituent GHG as well as the risk posed by total GHG emissions by scope.

The disclosure of Scope 1 and Scope 2 emissions would be required in gross terms, excluding the use of purchased or generated offsets.

b) Scope 3 Emissions

Following much debate, the proposed rule would also require disclosure of Scope 3 emissions if material or if a company has included Scope 3 emissions within its GHG emissions reduction goal. Again in line with the GHG Protocol, the proposed rule defines Scope 3 emissions as:

[A]ll indirect GHG emissions not otherwise included in a registrant’s Scope 2 emissions, which occur in the upstream and downstream activities of a registrant’s value chain. Upstream emissions include emissions attributable to goods and services that the registrant acquires, the transportation of goods (for example, to the registrant), and employee business travel and commuting. Downstream emissions include the use of the registrant’s products, transportation of products (for example, to the registrant’s customers), end of life treatment of sold products, and investments made by the registrant.

When compared to Scope 1 and Scope 2, it may be significantly more challenging for companies to identify and calculate their Scope 3 emissions and determine whether such emissions are material. The proposed rule considers Scope 3 GHG emissions “material” if there is “a substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision,” a definition consistent with SEC and U.S. Supreme Court precedent. The proposed rule discusses several situations in which Scope 3 emissions disclosure might constitute material information. For example, Scope 3 emissions disclosure might be necessary to provide investors a complete picture of the transition risks associated with the transition to a low-carbon economy. Additionally, such disclosure may be material in helping investors assess a company’s strategy to reduce its carbon footprint in light of regulatory, market, and political constraints.

The SEC’s proposed rule also provides that, in determining materiality, companies should consider whether Scope 3 emissions constitute a “relatively significant portion” of its overall GHG emissions. However, even when Scope 3 emissions only make up a small portion of a company’s overall GHG emissions, they may still be material where they “represent[] a significant risk, [are] subject to significant regulatory focus, or ‘if there is a substantial likelihood that a reasonable [investor] would consider [them] important.’”

Scope 3 emissions should also be disclosed if they are a part of a company’s GHG emissions reduction target. The SEC asserts that this requirement enables investors to understand not just the potential financial impact of such a commitment but also the scale and scope of the actions a company may need to take in order to fulfill its commitment. This could include assessing the progress made toward the GHG emissions reduction goal, further understanding the company’s overarching strategy, and the “efficiency and efficacy” of the actions taken to achieve the goal.

3) Attestation Requirements

Under the proposed rule, large accelerated filers and accelerated filers would be required to include an attestation report from, and provide certain information about, a GHG emissions attestation provider with respect to its Scope 1 and Scope 2 emissions data. The proposed rule contemplates an initial transition period for a limited assurance attestation report and a subsequent transition period for a reasonable assurance attestation report. The proposed rule notes that “a reasonable assurance opinion provides positive assurance that the subject matter is free from material misstatement” and that reasonable assurance is equivalent to the level of assurance provided in an audit of a registrant’s consolidated financial statements included in a Form 10-K. In contrast, in a limited assurance engagement, a conclusion is expressed as to whether the assurance provider is aware of “any material modifications that should be made to the subject matter . . . in order for it to be fairly stated or in accordance with the relevant criteria.” The proposed rule describes limited assurance as equivalent to the level of assurance provided with respect to a registrant’s interim financial statements included in a Form 10-Q.

The SEC rationalizes its attestation requirements on the basis that it should improve both the accuracy and consistency in the reporting of such information and provide investors an “enhanced level of reliability” by which they can evaluate the registrant’s disclosures.

4) Disclosure of Acute and Chronic Physical Climate Risks

Physical climate risks are present throughout the proposed rule and are defined to include both “acute” and “chronic” risks to a registrant’s operations or the operations of those with whom a registrant does business. “Acute” risks are those that are event-driven and are often related to short-term extreme weather events (e.g., floods, hurricanes). “Chronic” risks concern longer-term weather patterns and their effects (e.g., sea level rise, drought, increased wildfires). Under the proposed rule, a company would be required to specify an identified risk as physical or transition, and, in the case of the former, categorize the risk as acute or chronic. Additionally, the registrant would need to describe the nature of the physical risk and include details pertaining to location, thereby identifying processes, properties, or operations that may be subject to the physical risk. This locational disclosure would, however, only be required if the registrant determined it would have a material impact on its business or financial statements. Examples included in the proposed rule are flooding, water scarcity/stress, and increased temperatures.

5) Disclosure of Scenario Analysis and Maintained Internal Carbon Price

Registrants often use analytical tools, such as scenario analysis, to assess the impact of climate-related risks on operations and consider the resiliency of their business model and strategy. If a registrant uses such tools, the proposed rule would require disclosure of certain information; namely, “parameters, assumptions, and analytical choices, and the projected principal financial impacts on the registrant’s business strategy under each scenario” (i.e., those scenarios considered such as 1.5 °C and/or 2 °C above pre-industrial levels). The disclosures would also need to include quantitative and qualitative information. The SEC notes that much of these disclosures would include predictions or other forward-looking statements, and, therefore, the PSLRA forward-looking safe harbors would be applicable. The Commission notes that disclosure of the scenario analyses performed by a registrant will help investors better understand the scenarios considered and help evaluation of the registrant’s plan to manage climate-related risks.

Additionally, some registrants may use an internal carbon price — “an estimated cost of carbon emissions used internally within an organization” — to assess climate-related risks and opportunities. The proposed rule would require disclosure of an internal carbon price, if used, to include: (i) “the price in units of the registrant’s reporting currency per metric ton of carbon dioxide equivalent (“CO₂e”)”; (ii) the total price and how this is estimated to change over time; (iii) the boundaries for measurement providing the basis of the total price (if different from the organizational boundary used to measure GHG emissions); and (iv) the reasoning behind the selection of the internal carbon price applied by the registrant. Like scenario analysis, the SEC notes the applicability of the PSLRA safe harbors for forward-looking statements regarding any assumptions about future events. The Commission explains that these items of disclosure would help investors understand both the rationale and assumptions for the internal carbon price and allow them to assess the reasonableness and effectiveness of the internal carbon price as a planning tool.

However, it is worth considering that these disclosures could disincentivize registrants from using such analytical tools and an internal carbon price. The level of information the SEC is seeking in the proposed rule for scenario analysis is far more granular than what companies have typically reported under the TCFD framework and could prove more burdensome and, ultimately, more difficult. Moreover, registrants may be reluctant to disclose this information on the basis that it could result in significant competitive impacts.

6) Proposed Amendments to Regulation S-X

The proposed rule would also add a new subpart to Regulation S-X requiring certain climate-related financial statement metrics consisting of “disaggregated climate-related impacts on existing financial statement line items” that are mainly derived from existing financial statement line items. These disclosures would be included in a note to a registrant’s audited financial statements, and such metrics would be subject to audit by an independent registered public accounting firm and come within the scope of a registrant’s internal control over financial reporting. Specifically, disclosures would fall under three categories:

1) Financial impact metrics, which include disclosing the financial impact of (a) severe weather events and other natural conditions, such as the impact of flooding, drought, wildfires, extreme temperatures and sea-level rise (“physical risks”) and (b) transition activities, including efforts to reduce GHG emissions or otherwise mitigate exposure to climate-related risks prompted by regulatory, technological, market (including changing consumer, business counterparty, and investor preferences), liability, reputational or other transition-related factors (“transition risks”) and (c) climate-related risks, each on any relevant line items in the financial statements;

2) Expenditure metrics, which include disclosing expenditures related to the same climate-related events, transition activities and identified climate-related risks, with (i) expenditure expenses and (ii) capitalized costs related to same separately aggregated; and

3) Financial estimates and assumptions, which include disclosures regarding whether the estimates and assumptions used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with, or known impacts from, climate-related events (including identified physical risks) or transition activities (including identified transition risks).

The SEC is proposing that these items be included in financial statements unless the aggregate impact of such items is less than 1 percent of the total line item for a relevant year, which is a significant departure from the typical quantitative benchmark of 5 percent detailed in SAB 99, and would also require disaggregation of positive and negative impacts.

7) Disclosures are Required to be Filed Rather than Furnished

Under the proposed rule, all of the proposed required climate-related disclosures would be treated as “filed” and therefore subject to potential liability under Exchange Act Section 18 and under Securities Act Section 11 if included in or incorporated by reference into a Securities Act registration statement. The proposed rule notes the SEC’s belief that it is beneficial to investors to require climate-related information in SEC filings, as opposed to sustainability reports or other related publications, as information filed with the Commission is subject to disclosure controls and procedures and a heightened liability standard. This typically causes registrants to prepare and review information filed in the Form 10-K more carefully than information presented outside of SEC filings.

The SEC also noted several times that existing safe harbors for forward-looking statements under the Securities Act and Exchange Act would be available for aspects of the proposed disclosures. In addition, the proposed rule includes a new safe harbor that provides that disclosure of Scope 3 emissions by or on behalf of the registrant would be deemed not to be a fraudulent statement unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith. According to the proposed rule, safe harbor is intended to mitigate potential liability concerns associated with providing emissions disclosure based on third-party information by making clear that registrants would only be liable for such disclosure if it was made without a reasonable basis or was disclosed other than in good faith.

8) Phased-In Compliance Approach

The SEC is proposing a phased in compliance approach as set out in the table below. We have added detail regarding when the proposed rule would take effect under an assumption that the final rule goes into effect by the end of the year.

	Required Disclosures other than Scope 3 Emissions	Scope 3 Emissions (if required)
Large Accelerated Filer	Begins with first full fiscal year following rule effective date (earliest 2023 annual report filed in 2024)	Begins with second full fiscal year following rule effective date (earliest 2024 annual report filed in 2025)
Accelerated and Non-Accelerated Filer	Begins with second full fiscal year following rule effective date (earliest 2024 annual report filed in 2025)	Begins with third full fiscal year following rule effective date (earliest 2025 annual report filed in 2026)
Smaller Reporting Company	Begins with third full fiscal year following rule effective date (earliest 2025 annual report filed in 2026)	N/A

Next Steps for Commenting on the Proposed Rule

It is difficult to overstate the sweeping nature of the SEC’s proposed rule and the amount of resources and effort that will be necessary for issuers to develop the required information and include it in their Exchange Act reports. Issuers are advised to carefully review the proposed rule in its entirety and submit comments to the SEC in response to the over two hundred (200) requests for comments. Such comments may cover parts of the proposed rule or the whole of the proposed rule.

The comment period on the proposed rule is now open and will either close on May 20, 2022 (sixty (60) days after issuance) or thirty (30) days after publication in the Federal Register, whichever is later. The SEC has indicated that it hopes to finalize the rule by the end of 2022, but it is likely that several interested parties will request to extend the comment period. Following public comment, the Commission must consider all “relevant matter[s] presented” during the comment period and respond in some form. The final rule will include analysis of the “relevant” materials.

¹ The proposed rule defines greenhouse gases as: carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride.