California Governor Newsom has signed legislature that will require many U.S. companies to disclose their scope 1, 2, and 3 greenhouse gas (GHG) emissions and to prepare an annual climate-related financial risk report. The Climate Corporate Data Accountability Act (CCDAA) and the Climate-Related Financial Risk Act (CRFRA) are estimated to apply to as many as 10,000 companies that do business in California, including a significant share of SEC reporting companies. The SEC has also proposed extensive climate disclosure requirements, although it is uncertain when the Commission will take final action on its proposals. See SEC Unveils its Climate Disclosure Proposals, March 2022 Update. In recent Congressional testimony, SEC Chair Gensler suggested that the California law may make it easier for the SEC to act on its proposal: “That may change the baseline. If those companies were reporting to California, then it would be in essence less costly [to comply with an SEC GHG reporting requirement] because they’d already be producing that information.” SEC chief says new California law could 'change baseline' for coming SEC climate rule, Reuters, September 27, 2023
The California legislation is a major milestone in mandatory in U.S. public company climate disclosure and may have national ramifications. However, it is difficult to fully assess the likely effects at this early stage. In his statement on the signing of the CCDAA, Governor Newsom noted that the implementation deadlines “are likely infeasible” and that the GHG reporting protocol specified in the new law could result in inconsistent reporting. He directed his staff to work with the California Legislature to address these issues next year. He also expressed concern about “the overall financial impact of this bill on businesses” and instructed the administrative agency that will oversee the law “to make recommendations to stream-line the program.” Governor Newsom issued a similar statement with respect to CRFRA. Accordingly, although the bills have been signed into law, their final scope and timing appears to still be in flux.
The Climate Corporate Data Accountability Act
CCDAA requires the California State Air Resources Board (CARB) to adopt regulations by January 1, 2025, requiring “reporting entities” to annually report their scope 1, scope 2, and scope 3 GHG emissions. A reporting entity for CCDAA purposes is any U.S. public or private entity with annual global revenue exceeding $1 billion that does business in California. The concept of doing business in California is not defined in either CCDAA or CRFRA.
CARB is directed to structure the GHG reporting regulations “in a way that minimizes duplication of effort” and to permit reporting entities to submit reports prepared to meet other national and international reporting requirements, “as long as those reports satisfy all of the requirements” of CCDAA. Reporting will be made publicly to a nonprofit emissions reporting organization under contract with CARB.
The legislation defines scope 1, 2, and 3 emissions as follows:
“Scope 1 emissions” means all direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities.
“Scope 2 emissions” means indirect greenhouse gas emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a reporting entity, regardless of location.
“Scope 3 emissions” means indirect upstream and downstream greenhouse gas emissions, other than scope 2 emissions, from sources that the reporting entity does not own or directly control and may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.
Scope 3 disclosure requirements are controversial because they require estimation and reliance on information from third parties. Significantly, the California law is broader than the SEC’s proposed GHG reporting regime in that the SEC proposal would only require Scope 3 emissions disclosure if material or if the company has disclosed a Scope 3 emissions target.
CCDAA disclosure will begin in 2026 with respect to FY 2025 scope 1 and scope 2 emissions and in 2027 with respect to FY 2026 scope 3 emissions. As noted above, however, Governor Newsom apparently intends to ask the Legislature to extend these deadlines.
The CCDAA also requires an independent audit of GHG disclosures. It provides that reporting entities must “obtain an assurance engagement performed by an independent third-party assurance provider on all of the reporting entity’s scope 1 emissions, scope 2 emissions, and scope 3 emissions.” These assurance engagements “shall be performed at a limited assurance level beginning in 2026 and at a reasonable assurance level beginning in 2030.”
The Climate-Related Financial Risk Act (CRFRA)
CRFRA requires covered entities to prepare a biennial climate-related financial risk report. The CRFRA is broader in scope than the CCDAA: A covered entity for CRFRA purposes would be any U.S. public or private entity with annual global revenue exceeding $500 million that does business in California.
CRFRA reports must disclose (1) the company’s climate-related financial risks, in accordance with the 2017 recommendations of the Task Force on Climate-Related Financial Disclosures, and (2) measures the company has adopted to reduce and adapt to such climate-related financial risks. The reporting requirement may be satisfied by preparing a publicly accessible report that includes climate-related financial risk disclosure information in compliance with an exchange listing standard, a requirement of federal law, or the standards of the International Sustainability Standards Board.
Companies subject to CRFRA are required to submit their climate-related financial risk report to the state and to make the report available to the public on a website. The first biennial report is due on or before January 1, 2026, although, as noted above, this date may be extended.
Comment: These new California laws are likely to be subject to legal challenges and possibly to legislative revisions before they take effect. However, whatever their ultimate fate, the legislation serves as a warning that mandatory climate reporting is likely to become a reality for most, if not all, public companies (and many private companies as well) in the near future. Audit committees should be discussing with management its plans to generate the information to comply with likely disclosure requirements. For example, GHG emissions disclosure is a feature of virtually all climate change reporting frameworks, including both the CCDAA and the SEC proposal. Companies that are not currently collecting this information should consider how they will do so and what new controls and procedures will be needed to assure reliability, particularly as to scope 3 emissions. Climate disclosures, voluntary or mandatory, will almost certainly be a fertile source for litigation and regulatory challenge, and audit committees should be making sure that management is preparing to meet these new responsibilities.