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SECURITIES AND EXCHANGE COMMISSION (SEC) Rules for enhancement and standardization of climate related disclosures Original article: https://www.sidley.com/en/insights/newsupdates/2022/03/sec-proposes-far-reaching-rules-for-enhancement-and-standardization-of-climate-related-disclosures Burgess COMMENTARY Peter Burgess | ||
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SIDLEY UPDATE ... SEC Proposes Far-Reaching Rules for “Enhancement and Standardization” of Climate-Related Disclosures
March 24, 2022 On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) issued proposed rules that would require domestic and foreign registrants to include extensive climate-related information in their registration statements and periodic reports.1 The rules would require disclosure of
The need to produce new disclosures will compel companies to apply added attentiveness to climate-related issues and may necessitate stepped-up engagement with external experts in climate change and climate accounting. While the proposed rules pertain only to disclosures, they will impact operations by indirectly compelling companies to take action, to the extent they are not already doing so, to put monitoring, accounting, planning, and governance practices in place to enable them to satisfy the proposed disclosure requirements. This Update summarizes the principal features of the proposed rules and provides practical guidance for companies considering next steps in light of the proposed rules. Comments on the proposal are due 30 days from official publication or May 20, 2022, whichever is later. Background The proposed rules represent the latest development in a series of events affecting public companies in the U.S. related to the growing attention of investors and the public to climate change and the heightened focus on environmental, social, and governance (ESG) issues in investing and in company operations and disclosures. In 2010, the SEC provided limited guidance to public companies on the SEC’s existing disclosure requirements as they apply to climate change matters.2 As of 2020, in response to intensified interest in ESG in the public markets, roughly 92% of companies in the S&P 500 and 70% of Russell 1000 companies publish sustainability reports addressing environmental issues among other ESG-themed topics.3 With the change of the U.S. presidential administration in 2021, SEC Commissioners signaled an intent to step up SEC efforts to advance mandatory climate-related disclosure requirements for public companies. The new proposed rules are the result of these efforts. Several of the proposed disclosures are similar to those that many companies already provide, although most commonly outside of SEC filings, based on broadly accepted disclosure frameworks, such as the Task Force on Climate-related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol (GHG Protocol). Summary of the Proposed Rules The proposed rules would apply to registrants with reporting obligations under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) and companies filing a registration statement pursuant to the Securities Act of 1933 (the Securities Act) or the Exchange Act. If the rules are adopted as proposed, a registrant would need to include the proposed disclosures in registration statements, such as Securities Act Forms S-1, S-3, S-11, F-1 and F-3, Exchange Act Form 10, and Exchange Act periodic reports, such as Form 10-K, 10-Q and 20-F. Similar to the treatment of other important business and financial information, the proposed rules would also require registrants to disclose any material change to the climate-related disclosure provided in a registration statement or annual report in its Form 10-Q. The following discussion summarizes the principal components of the proposed rules. 1. Climate-Related Risks Under the proposed rules, to be set forth in a new Subpart 1500 to Regulation S-K, a registrant must disclose any “climate-related risks” reasonably likely to have a material impact on the registrant’s business or consolidated financial statements. “Climate-related risks” means the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole. The SEC proposed including a specific reference in this definition to a registrant’s “value chain” — the upstream and downstream activities related to a registrant’s operations4 — to capture the full extent of a registrant’s potential exposure to climate-related risks, which can extend beyond its own operations to those of its suppliers, distributors, and others engaged in upstream or downstream activities. The proposed rules would require a registrant to specify whether an identified climate-related risk is a “physical” or “transition” risk so that investors can better understand the nature of the risk and the registrant’s actions or plan to mitigate or adapt to the risk. The proposing release explains that climate-related conditions and events can present risks related to the physical impacts of the climate — that is, “physical risks” — and to a potential transition to a lower carbon economy — that is, “transition risks.” Defining the key terms is critical for appreciating the scope of these disclosures:
Longstanding Definition of Materiality Applies Registrants would be required to describe climate-related risks that are reasonably likely to have a material impact on the registrant’s business or consolidated financial statements as manifested over the short, medium, and long term. The proposing release notes that, in keeping with existing definitions of the SEC and Supreme Court precedent, a matter is “material” for purposes of the climate rules if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote. According to the proposing release, the materiality determination that registrants would be required to make is functionally similar to what is required in the management discussion and analysis section in a registration statement or annual report. 2. Climate-Related Impacts on Strategy, Business Model, and Outlook The proposed rules would additionally require the registrant to describe the actual and potential impacts of its material climate-related risks on its strategy, business model, and outlook. To this end, the proposed rules would require
3. Governance of Climate-Related Risk The proposed rules would require a registrant to disclose, as applicable, certain information concerning a board of directors’ oversight of climate-related risks and management’s role in assessing and managing those risks. As to board oversight, the proposed rules would require disclosure regarding
The proposed rules would require a registrant to describe any processes it has for identifying, assessing, and managing climate-related risks. The registrant would be required to make disclosures on a range of topics, including how it determines or considers
A registrant that has adopted a transition plan as part of its climate-related management strategy would be obligated to update relevant disclosure each fiscal year by describing the actions taken during the year to achieve the plan’s targets or goals. 5. Financial Statement Metrics The SEC is also proposing to add a new Article 14 to Regulation S-X that would require a registrant to disclose in a note to its financial statements certain disaggregated climate-related financial statement metrics that are mainly derived from existing financial statement line items. Particularly, the proposed rules would require, in filings where the registrant is subject to Subpart 1500 of Regulation S-K in a form that also requires audited financial statements, disclosure falling under three categories:
The proposed rules would establish several disclosure requirements related to Scope 1, Scope 2, and Scope 3 emissions. Similar to the GHG Protocol, the proposed rules define Scope 1 emissions as direct GHG emissions from operations that are owned or controlled by a registrant; 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; and Scope 3 emissions as all 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. A registrant would be required to disclose its total Scope 1 emissions separately from its total Scope 2 emissions after calculating them from all sources that are included in the registrant’s organization and operation boundaries. A registrant would disclose its Scope 1 and Scope 2 emissions in gross terms and in terms of GHG intensity. Most registrants would be required to disclose separately its total Scope 3 emissions for the fiscal year if those emissions are material or if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions. The proposed rules would exempt smaller reporting companies (SRCs) from the proposed Scope 3 disclosure requirement. The proposed definitions of Scope 1, Scope 2, and Scope 3 are similar to definitions provided by the GHG Protocol.6 The proposing release suggests that even where a registrant determines that its Scope 3 emissions are not material, and therefore not subject to disclosure, it may be useful for the registrant to explain the basis of its determination to investors. The proposing release also suggests that where a registrant determines that only certain categories of Scope 3 emissions are material, the registrant should consider disclosing why other categories are not material. Further, the proposing release expresses a view that where Scope 3 emissions are deemed material by the registrant, the extent of a registrant’s exposure to Scope 3 emissions, and the choices a registrant makes regarding them, would be important for investors to understand when making investment or voting decisions.7 These suggestions, although not stated as proposed rules, provide additional insight into the level of disclosure the SEC may be expecting, and information it may consider material, related to Scope 3 emissions. The proposed rules would require a registrant to disclose its GHG emissions data from its most recently completed fiscal year and for the historical fiscal years included in the registrant’s financial statements in the applicable filing, to the extent such historical GHG emissions data is reasonably available. However, a registrant would not be required to provide a corresponding GHG emissions metric for a fiscal year preceding its current reporting fiscal year if, for example, it was not required to and has not previously presented such metrics for such fiscal year and the historical information necessary to calculate or estimate such metric is not reasonably available to the registrant without unreasonable effort or expense. A registrant would need to describe the methodology, significant inputs, and significant assumptions used to calculate its GHG emissions metrics. The SEC is also proposing additional rules related to the methodology for calculating GHG emissions. Some of these rules would apply generally to the determination of GHG emissions, while others would apply specifically to the calculation of Scope 3 emissions. Registrants subject to the proposed Scope 3 disclosure requirements would have one additional year to comply with those disclosure requirements. (See “Compliance Dates” below.) Scope 3 Emissions Safe Harbor The proposing release acknowledges that calculation and disclosure of Scope 3 emissions may pose difficulties compared to Scopes 1 and 2 emissions. It may be difficult to obtain activity data from suppliers and other third parties in a registrant’s value chain or to verify the accuracy of that information. It may also be necessary to rely heavily on estimates and assumptions to generate Scope 3 emissions data. In light of these challenges and concerns pertaining to registrants’ taking on liability for information that would be derived largely from third parties, the proposed rules include a safe harbor from certain forms of liability under the federal securities laws. The proposed safe harbor would provide 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. The safe harbor would extend to any statement regarding Scope 3 emissions that is disclosed pursuant to Subpart 1500 of Regulation S-K in an SEC filing. 7. Attestation of Scope 1 and Scope 2 Emissions Disclosures Under the proposed rules, a registrant that is an accelerated filer or large accelerated filer would be required to include in the relevant filing an attestation report covering the disclosure of its Scope 1 and Scope 2 emissions and to provide certain related disclosures about the service provider. The proposed rules set forth minimum standards for experience, expertise, and independence for a GHG emissions attestation provider. At a minimum, the attestation engagement must be at of one the two assurance levels — “limited” or “reasonable” — for the indicated fiscal year for the required GHG emissions disclosures:
Assuming the proposed rules will be adopted with an effective date in December 2022 and that the hypothetical accelerated or large accelerated filer has a December 31 fiscal year-end, the following transition periods would apply: Filer Type Scopes 1 and 2 GHG Disclosure Compliance Date Limited Assurance Reasonable Assurance Large Accelerated Filer Fiscal year 2023 (filed in 2024) Fiscal year 2024 (filed in 2025) Fiscal year 2026 (filed in 2027) Accelerated Filer Fiscal year 2024 (filed in 2025) Fiscal year 2025 (filed in 2026) Fiscal year 2027 (filed in 2028) During the transition period when limited assurance is required, the proposed rules would permit an accelerated filer or a large accelerated filer, at its option, to obtain reasonable assurance of its Scope 1 and 2 emissions disclosure. The proposed rules would require the attestation report for accelerated filers and large accelerated filers to be included in a new separately captioned “Climate-Related Disclosure” section in the relevant filing and provided pursuant to standards that are publicly available at no cost and are established by a body or group that has followed due process procedures, including the broad distribution of the framework for public comment. The proposing release observes that attestation standards of the Public Company Accounting Oversight Board (PCAOB), the American Institute of Certified Public Accounts (AICPA), and the International Auditing and Assurance Standards Board (IAASB) would meet this due process requirement. The proposed rules would not include any requirement for a registrant to obtain an attestation report covering the effectiveness of internal control over GHG emissions disclosure, and therefore such a report would not be required even when the GHG emissions attestation engagement is performed at a reasonable assurance level. The proposed rules otherwise set forth minimum attestation engagement and report requirements that are primarily derived from the AICPA’s attestation standards and are largely similar to the report requirements under PCAOB AT-101 and IAASB ISAE (International Standard on Assurance Engagements) 3410. The SEC has also proposed minimal attestation report requirements in addition to prevailing attestation standards to assist investors in evaluating the qualifications of the GHG emissions attestation provider selected by the registrant. 8. Emissions Targets and Goals If a registrant has previously set climate-related targets or goals, the proposed rules would require it to disclose them, including, as applicable, a description of
If the registrant has used carbon offsets or renewable energy certificates (RECs) in its plan to achieve climate-related targets or goals, it would be required to disclose the amount of carbon reduction represented by the offsets or the amount of generated renewable energy represented by the RECs, the source of the offsets or RECs, and the cost of the offsets or RECs. Furthermore, the proposed rules make clear that a registrant’s disclosure of its climate-related targets or goals should not be construed to be promises or guarantees. To the extent that information regarding a registrant’s climate-related targets or goals would constitute forward-looking statements, for example, with respect to how a registrant intends to achieve its climate-related targets or goals and expected progress regarding those targets and goals, under the proposed rules such statements would fall under the Private Securities Litigation Reform Act safe harbors, assuming all other statutory requirements for those safe harbors are satisfied. Treatment for Purposes of the Securities Act and Exchange Act The proposing release proposes to treat the required climate-related disclosures as “filed” and therefore subject to potential liability under Section 18 of the Exchange Act, except for disclosures furnished on Form 6-K. Such climate-related disclosures would also be subject to potential Section 11 liability if included in or incorporated by reference into a Securities Act registration statement. This treatment would apply both to the disclosures in response to proposed Subpart 1500 of Regulation S-K and Article 14 of Regulation S-X. Consequently, the rules, if adopted as proposed, could lead to companies’ being more circumspect and careful in disclosing carbon targets and goals given the potential for SEC enforcement actions and federal securities law claims arising out of such disclosures. Compliance Dates The table below summarizes the proposed phase-ins for the compliance dates of the proposed rules. The table assumes, for illustrative purposes, that the proposed rules will be adopted with an effective date in December 2022 and that the registrant has a December 31 fiscal year-end. Registrant Type Disclosure Compliance Date Financial Statement Metrics Audit Compliance Date All proposed disclosures, including GHG emissions metrics: Scope 1, Scope 2, and associated intensity metric, but excluding Scope 3 GHG emissions metrics: Scope 3 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 Filer and Non-Accelerated Filer Fiscal year 2024 (filed in 2025) Fiscal year 2025 (filed in 2026) SRC Fiscal year 2025 (filed in 2026) Exempted If the proposed rules are adopted in 2022, large accelerated filers would not be subject to the rules until filings made in 2024 that include 2023 financial statements. Comment Period The proposed rules will be open for public comment until the later of May 20, 2022 or the date that is 30 days after their publication in the Federal Register. Next Steps for Public Companies Given that the proposed rules are not yet finalized, the following practical guidance is provided for consideration by public companies.
----- Heather M. Palmer Partner HPALMER@SIDLEY.COM +1 713 495 4525 Houston ----- Sonia Gupta Barros Partner SBARROS@SIDLEY.COM +1 202 736 8387 Washington, D.C. ----- John P. Kelsh Partner JKELSH@SIDLEY.COM +1 312 853 7097 Chicago ----- Samir A. Gandhi Partner SGANDHI@SIDLEY.COM +1 212 839 5684 New York ----- Samuel B. Boxerman Partner SBOXERMAN@SIDLEY.COM +1 202 736 8547 Washington, D.C. ----- Leonard Wood Senior Managing Associate LWOOD@SIDLEY.COM +1 713 495 4679 Houston ----- Evan Grosch Associate EGROSCH@SIDLEY.COM +1 713 495 4554 Houston
| The text being discussed is available at | https://www.sidley.com/en/insights/newsupdates/2022/03/sec-proposes-far-reaching-rules-for-enhancement-and-standardization-of-climate-related-disclosures and |