SEC Proposes Far-Reaching Rules for “Enhancement and Standardization” of Climate-Related Disclosures

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: 

• “Physical risks” include both acute and chronic risks to a registrant’s business operations or the operations of those with whom it does business. 
• “Transition risks” are actual or potential negative impacts on a registrant’s consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks. 
• “Acute risks” are event-driven risks related to shorter-term extreme weather events, such as hurricanes, floods, and tornadoes. 
• “Chronic risks” are risks that the business may face as a result of longer-term weather patterns and related effects, such as sustained higher temperatures, sea level rise, drought, and increased wildfires.

The proposed rules would require a registrant to describe the nature of any transition risks, including whether they relate to regulatory, technological, liability, reputational, or other transition-related factors, and how those factors impact the registrant, and any physical risk, including whether the risk may be categorized as an acute or chronic risk.

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

• discussion of how a registrant has considered the identified impacts as part of its business strategy, financial planning, and capital allocation 
• current and forward-looking disclosures to facilitate understanding of whether the implications of the identified climate-related risks have been integrated into the registrant’s business model or strategy, including how resources are being used to mitigate climate-related risks 
• information regarding the material impacts of transition risks and physical risks on a registrant’s strategy, business model, and outlook
• discussion of whether and how any of a registrant’s identified climate-related risks affected or are reasonably likely to affect the registrant’s consolidated financial statements

If a registrant uses an internal carbon price — that is, an estimated cost of carbon emissions — when assessing climate-related factors, it would be required to disclose information about this price and the methodology for establishing and updating the price. A registrant would also need to describe how it uses its disclosed internal carbon price to evaluate and manage climate-related risks.

A registrant also would be required to describe any analytical tools, such as scenario analysis, that it uses to assess the impact of climate-related risks on its business and consolidated financial statements, or to support the resilience of its strategy and business model in light of foreseeable climate-related risks. If a registrant uses scenario analysis, the proposed amendments would require disclosure of the scenarios considered (e.g., an increase of no greater than 2º or 1.5ºC above preindustrial levels), including parameters, assumptions, and analytical choices, and the projected principal financial impacts on the registrant’s business strategy under each scenario. The disclosure is expected to include both quantitative and qualitative information.

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 identity of board members or board committees responsible for the oversight of climate-related risks, including whether any board member has expertise in climate-related risks
• the processes and frequency by which the board or board committee(s) discuss(es) climate-related risks
• how the board is informed about climate-related risks, and how frequently the board considers such risks 
• whether and how the board or board committee considers climate-related risks as part of its business strategy, risk management, and financial oversight
• whether and how the board sets climate-related targets or goals and how it oversees progress against those targets or goals

As to management oversight, the proposed rules would require disclosure regarding, as applicable,

• whether certain management positions or committees are responsible for assessing and managing climate-related risks and, if so, identifying such positions or committees and disclosing the relevant expertise of the position holders or members
• the processes by which the responsible managers or management committees are informed about and monitor climate-related risks
• whether the responsible positions or committees report to the board or board committee on climate-related risks and how frequently this occurs

4. Risk Management and Transition Plans

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 

• the relative significance of climate-related risks compared to other risks 
• existing or likely regulatory requirements or policies, such as GHG emissions limits, when identifying climate-related risks 
• shifts in customer or counterparty preferences, technological changes, or changes in market prices in assessing potential transition risks
• the materiality of climate-related risks, including how it assesses the potential size and scope of any identified climate-related risk

If a registrant has adopted a transition plan as part of its climate-related risk management strategy, the proposed rules would require the registrant to discuss the plan, including how it plans to mitigate or adapt to any physical and transition risks identified. A “transition plan” means a registrant’s strategy and implementation plan to reduce climate-related risks. The rules would also require a registrant that has adopted a transition plan as part of its climate-related risk management strategy to discuss, as applicable, how it plans to mitigate or adapt to any identified transition risks, including laws, regulations, and policies that restrict GHG emissions or products with high GHG footprints or that require the protection of high conservation value land or natural assets; imposition of a carbon price; and changing demands or preferences of consumers, investors, employees, and business counterparties. 

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: 

• Financial Impact Metrics. The registrant would disclose the financial impacts of severe weather events, other natural conditions, transition activities, and identified climate-related risks on line items in the consolidated financial statements included in the relevant filing unless their aggregated impact is less than 1% of the total line item for the relevant fiscal year. 
• Expenditure Metrics. Proposed expenditure metrics refer to the positive and negative impacts associated with the same climate-related events, transition activities, and identified climate-related risks as the proposed financial impact metrics. A registrant would separately aggregate amounts of expenditure expensed and capitalized costs incurred during the fiscal years presented.⁵
• Financial Estimates and Assumptions. A registrant would disclose 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, such as flooding, drought, wildfires, extreme temperatures, and sea level rise.

The proposed financial statement metrics would be required in the financial statements, and therefore would be included in the scope of any required audit of the financial statements in the relevant disclosure filing, subject to audit by an independent registered public accounting firm, and within the scope of the registrant’s internal control over financial reporting.

6. GHG Emissions Metrics Disclosure: Scopes 1, 2, and 3

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:

The objective of a limited assurance engagement is for the service provider to express a conclusion about whether it is aware of any material modifications that should be made to the Scopes 1 and 2 emissions disclosure for it to be fairly stated or in accordance with the relevant criteria. In such engagements, the conclusion is expressed in the form of negative assurance regarding whether any material misstatements have been identified. In contrast, the objective of a reasonable assurance engagement, which is the same level of assurance provided in an audit of a registrant’s consolidated financial statements, is to express an opinion on whether the subject matter is in accordance with the relevant criteria in all material respects. A reasonable assurance opinion provides positive assurance that the subject matter is free from material misstatement.

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:

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

• 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 by which the target is intended to be achieved and 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 set by the registrant 
• how the registrant intends to meet its climate-related targets or goals

A registrant would be required to update this disclosure each fiscal year by describing the actions taken during the year to achieve its targets or goals.

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.

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.

• Evaluate how the proposed rules would impact your future disclosures in SEC filings. Public companies should begin assessing the gaps between climate-related information they currently disclose, inside and outside of SEC filings, and what would be required under the proposed rules, if adopted. These gaps could be significant for many companies. In addition, many companies that have to date been partially compliant with TCFD in climate-related disclosures may need to rework their approach or disclose more information to satisfy the proposed disclosure requirements that are derived from the TCFD reporting framework. 
• Evaluate how the proposed rules would impact your operations. While the proposed rules pertain only to disclosure, if adopted they may impact operations, as companies would be compelled to take actions, to the extent they are not doing so already, to have monitoring, accounting, planning, and governance practices in place so that required disclosures could be made. The likelihood of the adoption of the proposed rules in some form suggests that companies should begin considering the processes, personnel, policies and technologies that would be needed to satisfy the new disclosure requirements.
• Identify the disclosure obligations that would be challenging for your enterprise to meet. Many of the proposed disclosure requirements would create new challenges for public companies that have not made these disclosures in the past, including the new attestation requirements applicable to disclosures of Scope 1 and Scope 2 emissions. The proposed Scope 3 emissions disclosures would also inevitably pose challenges. On the one hand, a company choosing to disclose Scope 3 emissions will face hurdles of estimating emissions of third parties. On the other hand, as the proposing release notes, a company choosing not to disclose all or certain Scope 3 emissions on the basis that they are not material may feel a need — or may be expected — to explain the basis of its determination to investors.⁸
• Line up attestation firms, auditors, and advisers as needed. As the proposed rules would require attestation of and auditing of climate-related information, companies may need to evaluate the capabilities of their current service providers to supply these services and, if necessary, line up providers to fill gaps and needs. Changes in operations and disclosures may necessitate the engagement of new expertise, both inside and outside of the company, related to management, operations, and legal ramifications related to the new disclosures and any new operational initiatives designed to support them. Companies may additionally wish to assess the expected costs of increased engagement with outside advisers.
• Review existing climate-related goals. Public companies should begin to carefully review their climate-related goals, such as net-zero emissions pledges, including a comprehensive understanding and review of all internal processes and assumptions that go into these goals. If your company is anticipating releasing new climate-related goals, it may be advisable to delay the release of such goals until after the final rules have been released and engage counsel with the necessary expertise to review such goals. If your company has not yet identified climate-related goals, it may be time to begin exploring options.
• Participate in the comment period. The SEC takes into account feedback from registrants when drafting final rules. In light of the significant new burdens the proposed rules would impose on companies directly and indirectly, we encourage public companies to reach out to counsel and other advisers as necessary to discuss giving input to the SEC on the proposed rules, either individually or through their trade associations. 
• Keep an eye on the potential for litigation. In the sole dissenting statement objecting to the proposed rules, Commissioner Hester Peirce argued that the proposed rules are beyond the scope of the SEC’s legal mandate.⁹ The “major questions” doctrine, which provides that agency rules of major significance be the subject of a clear delegation of congressional authority, may provide support to such arguments. Threats of litigation along these and other lines against final rules may soon be in the pipeline and could contribute to delays in the finalization of the proposed rules in their current or amended form. 

For additional information on the topics covered in this update and current issues around rulemaking of the SEC and other federal agencies, see recent publications of Sidley Austin LLP on our practice pages for Public Companies, ESG, Capital Markets, and Corporate Governance and Executive Compensation, including Sonia Barros, Preparing Your 2021 Form 10-K: A Summary of Recent Key Disclosures Developments, Priorities, and Trends, Sidley Corporate Governance and Executive Compensation Update (Feb. 4, 2022); Sonia Barros, SEC Climate Change Comment Letters Signal Early Action on Environmental, Social, and Governmental Disclosures, Sidley Environmental Update (Oct. 7, 2021); Sonia Barros, Lindsay Smith, and Rebecka E. Manis, Environmental, Social, and Governance Disclosures in Proxy Statements: Benchmarking the Fortune 50, Sidley Corporate Governance Update (Aug. 31, 2021); Heather Palmer, Managing ESG Risks through the Energy Downturn, The Texas Lawbook (Nov. 18, 2020); Holly Gregory, Heather Palmer, and Leonard Wood, Emerging ESG Disclosure Trends Highlighted in GAO Report, Sidley Environmental, Social and Governance Update (Jul. 16, 2020). 

¹ SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors (2022), Release Nos. 33-11042; 34-94478, https://www.sec.gov/rules/proposed/2022/33-11042.pdf. 
² SEC, Commission Guidance Regarding Disclosure Related to Climate Change (2010), Release Nos. 33-9106, 34-61469, FR-82, http://www.sec.gov./rules/interp/2010/33-9106.pdf. 
³ Governance & Accountability Institute, Inc., 2021 Sustainability Reporting in Focus (Nov. 2021).
⁴ “Upstream activities” include activities by a party other than the registrant that relate to the initial stages of a registrant’s production of a good or service. “Downstream activities” include activities by a party other than the registrant that relate to processing materials into a finished product and delivering it or providing a service to the end user.
⁵ For each of these categories, a registrant would be required to disclose separately the amount incurred during the fiscal years presented (i) toward positive and negative impacts associated with the climate-related events and (ii) toward transition activities, specifically, to reduce GHG emissions or otherwise mitigate exposure to transition risks.
⁶ “Upstream emissions” include emissions attributable to goods and services that the registrant acquires, the transportation of goods, and employee business travel and commuting. “Downstream emissions” include the use of the registrant’s products, transportation of products, end of life treatment of sold products, and investments made by the registrant.
⁷ See Release No. 33-11042 at 174. 
⁸ See “6. GHG Emissions Metrics Disclosure: Scopes 1, 2 and 3” above. 
⁹ See Commissioner Hester M. Peirce (SEC), “We Are Not the Securities and Environment Commission – At Least Not Yet,” Mar. 21 2022, https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321.