On March 6 – almost two years after publishing its initial proposal – the SEC adopted final rules requiring public companies to make extensive disclosures concerning climate change. The Commission did, however, step back in some respects from the most controversial aspects of its 2022 proposals. According to the Commission’s press announcement, “The final rules reflect the Commission’s efforts to respond to investors’ demand for more consistent, comparable, and reliable information about the financial effects of climate-related risks on a registrant’s operations and how it manages those risks while balancing concerns about mitigating the associated costs of the rules.” For a discussion of the Commission’s 2022 climate-related disclosure proposals, see SEC Unveils its Climate Disclosure Proposals, March 2022 Update.
The SEC Commissioners approved the climate rules by a 3-2 vote. In her dissenting statement, Commissioner Peirce predicted that the rules would result in a “flood of climate-related disclosures [that] will overwhelm investors, not inform them.” Legal challenges to the new rules have already been filed, and the courts will have to determine whether these landmark requirements exceed the Commission’s authority.
For most companies, implementing the SEC’s climate disclosure rules will require significant changes to information-gathering processes, internal controls, and disclosure review. Because of new financial statement disclosures and greenhouse gas (GHG) emission attestation requirements, the work of the company’s auditor or other external assurance providers will also be affected. Audit committees should begin to prepare now for the impact these changes will have on the committee’s work and to oversee management’s compliance plans. As explained below, the climate disclosure rules will be phased in over time, beginning for the largest public companies in 2026 with their annual reports for fiscal years ending on or after December 31, 2025.
Key Requirements of the Climate-Related Disclosure Rules
The new rules require quantitative disclosure regarding the financial statement effects of severe weather and other natural events and material Scope 1 and Scope 2 GHG emissions. In addition, the rules require companies to make qualitative – narrative – disclosures regarding a range of climate-related issues, including climate risks and risk management strategies, governance practices, and targets and goals. Below is an overview of the main features of the rules.
1. Financial Statement Effects Disclosure
The final rules require financial statements filed with the SEC to include footnote disclosure of the impact on the statements of severe weather events and other natural conditions (such as to hurricanes, tornados, flooding, drought, wildfires, extreme temperatures, and sea level rise). The financial statements will also need to disclose the impact of such events, and of the company’s climate-related goals and plans, on accounting estimates and assumptions. Specifically:
Financial statement impacts. The financial statements must disclose aggregate expenditures incurred and losses recognized in the income statement as a result of severe weather events and other natural conditions, subject to a threshold of the greater of 1 percent of pretax income (or loss) or $100,000. In addition, the financial statements must disclose aggregate capitalized costs and charges reflected on the balance sheet because of severe weather events and other natural conditions, subject to a threshold of the greater of 1 percent of the absolute value of stockholders’ equity (or deficit) or $500,000. Disclosure is required when the weather event or natural condition is a “significant contributing factor” to the cost, expenditure, charge, loss, or recovery.
Carbon offsets and renewal energy credits. If carbon offsets and renewable energy credits (RECs) are material to the company’s plans to achieve climate-related targets or goals, the financial statements must disclose information concerning the beginning and ending balances of these offsets and RECs, including the amounts expensed and capitalized during the period. The financial statements must also disclose which line items are affected by offsets and RECs and the applicable accounting policy.
Financial statement estimates and assumptions. Footnote disclosure is required of whether and, if so, how, severe weather events and other natural conditions, or any climate-related targets, goals, or transition plans, materially impacted estimates and assumptions used to produce the financial statements.
These disclosures, like other financial statement disclosures, will be within the scope of the company’s external audit. In addition, the company’s internal control over financial reporting (ICFR) will need to encompass these new disclosures, and both the management assessment of ICFR effectiveness and the auditor’s opinion on ICFR (when required) will include these controls.
2. GHG Emissions Disclosure
a. Disclosure
The climate rules require disclosure of Scope 1 GHG emissions (those from the company’s owned or controlled operations) and Scope 2 GHG emissions (those from power, such as electricity or steam, purchased by the company), if such emissions are material. This requirement will only apply to larger companies – accelerated filers and large accelerated filers, generally, companies with market capitalizations of at least $75 million or $700 million, respectively. GHG emissions disclosure will not apply to companies that meet the SEC’s definitions of an emerging growth company or a smaller reporting company.
The Commission offers guidance as to the meaning of materiality in this context. It states that companies should “apply traditional notions of materiality under the Federal securities laws” and that the materiality of GHG emissions “is not determined merely by the amount of these emissions.”
“A registrant’s Scopes 1 and/or 2 emissions may be material because their calculation and disclosure are necessary to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations, or financial condition in the short- or long-term. For example, where a registrant faces a material transition risk that has manifested as a result of a requirement to report its GHG emissions metrics under foreign or state law because such emissions are currently or are reasonably likely to be subject to additional regulatory burdens through increased taxes or financial penalties, the registrant should consider whether such emissions metrics are material under the final rules.” (footnote omitted)
b. Attestation
Companies that must disclose material Scope 1 and Scope 2 GHG emissions will also be required to obtain attestation -- the opinion of an independent third-party regarding those disclosures. The attestation provider could be the financial statement auditor or another professional, although the provider will have to be an expert in GHG emissions that is independent of the company and its affiliates. The attestation report must be provided pursuant to standards that are publicly available and that are established by a body that has followed due process procedures – such as the Public Company Accounting Oversight Board, American Institute of Certified Public Accountants, or International Auditing and Assurance Standards Board.
Under the SEC’s phase-in schedule for the climate rules, the attestation will initially only have to provide limited or negative assurance regarding GHG emission disclosures. A limited assurance report would typically state that, based on performing described procedures, the provider has no reason to believe that the GHG disclosures are materially misleading. However, the largest companies – large accelerated filers – will eventually have to obtain reports that provide reasonable assurance, the same level of assurance that must be provided with respect to the financial statements. In a reasonable assurance opinion, the provider states that, based on the procedures performed, it has reasonable grounds to believe the disclosures are materially correct. The rules require large accelerated filers to obtain reasonable assurance over their Scope 1 and 2 GHG disclosures beginning in 2033.
3. Climate-Related Risks Disclosure
The climate rules require companies to disclose any climate-related risks that have materially impacted, or are reasonably likely to materially impact, the company, including impacts on its business strategy, results of operations, or financial condition. The company should describe separately risks that are reasonably likely to have a short-term (the next 12 months) and a long-term (beyond the next 12 months) impact.
4. Disclosure of Impacts of Climate-Related Risks on Strategy, Business Model, and Outlook
With respect to its climate-related risks, the rules require a company to disclose –
The actual and potential material impacts of such risks on the company’s strategy, business model, and outlook.
Any transition plan to manage a material transition risk. A “transition plan” means a strategy and implementation plan to reduce climate-related risks, including a plan to reduce GHG emissions. However, if the company does not have a plan, no disclosure is required.
Use of scenario analysis, if the company uses scenario analysis to assess the impact of climate-related risks that are reasonably likely to have a material impact.
Information about its internal carbon price, if the company’s use of an internal carbon price is material to how it evaluates and manages a climate-related risk.
5. Risk Management Disclosure
Companies will be required to describe any processes for identifying, assessing, and managing climate-related risks. This disclosure should include how the company identifies whether it has incurred or is reasonably likely to incur a material physical or transition risk; how it decides whether to mitigate, accept, or adapt to the particular risk; and how it prioritizes whether to address the climate-related risk. In addition, disclosure must include whether and how climate risk management has been integrated into the company’s overall risk management system.
6. Governance Disclosure
The rules require companies to describe the board’s oversight of climate-related risks, including board committees responsible for such risks. This disclosure includes whether and how the board considers climate-related risks as part of its business strategy, risk management, and financial oversight and whether and how the board sets and oversees climate-related targets or goals.
Companies will also be required to describe management’s role in assessing and managing climate-related risks. This disclosure includes which management positions or committees are responsible for climate-related risks; the expertise of the individuals occupying these positions; the processes by which they assess and manage climate-related risks; and whether these managers or committees report to the board about climate risks.
7. Targets and Goals Disclosure
The climate rules require companies to disclose any climate-related target or goal that has materially affected, or is reasonably likely to materially affect, the company’s business, results of operations, or financial condition. Among other things, this disclosure includes the activities subject to the target or goal, the time horizon over which the target or goal will be achieved, and the baseline against which the company will measure progress. The rules also require disclosure of how the company intends to meet its climate-related targets or goals. Disclosure concerning progress must be updated annually.
Significant Changes from the 2022 Proposals
While the rules the Commission has adopted are far-reaching, they are not as extensive as those originally proposed in 2022. Significant changes from the proposals include:
The proposed requirement that all SEC registered companies disclose Scope 1 and Scope 2 GHG emissions has been narrowed. The final rules only require large accelerated filers and accelerated filers that are not emerging growth companies or smaller reporting companies to disclose Scope 1 and Scope 2 emissions. Further, disclosure is only required of material GHG emissions.
The final rules do not require any SEC reporting of Scope 3 GHG emissions (emissions in the company’s supply change or from customer use of its products). The proposed Scope 3 emissions disclosure requirement was the most controversial aspect of the proposal, particularly because of its potential indirect impact on non-SEC registrants that are suppliers to public companies (e.g., farmers).
Unlike the proposal, the final rules do not require line-by-line analysis of the financial statement impact of severe weather events and climate transition activities. The requirement to discuss the impact of severe weather and natural conditions is on an aggregate basis and subject to a higher threshold (one percent of net income or stockholders’ equity). The impact of transition activities is no longer part of the financial statement disclosure requirements.
The final rules do not include the proposed requirement to disclose board members’ climate expertise.
Many of the climate-related disclosures are qualified by materiality (e.g., Scope 1 and Scope 2 GHG emissions, impacts of climate-related risks, and use of scenario analysis).
The final rules include more lengthy phase-in periods. For example, smaller reporting companies will not need to beginning making any disclosure under the climate rules until 2027, and large accelerated filers will not be required to obtain reasonable assurance reports on their material Scope 1 and Scope 2 GHG emissions until 2033.
Implementation Schedule
The climate rules will be phased, with the compliance date for a particular company dependent on its status as a large accelerated filer (LAF), accelerated filer (AF), emerging growth company (EGC), smaller reporting company (SRC), or non-accelerated filer (NAF). In addition, qualitative disclosures and financial statement effect disclosures, financial expenditure disclosures, GHG emissions disclosures, and attestation requirements have separate phase-in schedules. (Financial expenditure disclosures include material expenditures that result from mitigation of or adaptation to climate-related risks, of transition plans, or of actions to achieve targets or goals.)
LAFs with must comply (1) with the qualitative disclosures and financial statement effect disclosure for fiscal years beginning in 2025, (2) with the GHG emissions disclosure and financial expenditure disclosures for fiscal years beginning in 2026, (3) with the GHG emissions limited assurance attestation requirement for fiscal years beginning in 2029, and (4) with the GHG emissions reasonable assurance attestation requirement for fiscal years beginning in 2033.
AFs (other than SRCs and EGCs) with must comply (1) with the qualitative disclosures and financial statement effect disclosure for fiscal years beginning in 2026, (2) with the financial expenditure disclosures for fiscal years beginning in 2027, (3) with the GHG disclosures for fiscal years beginning in 2028, and (4) with the GHG emissions limited assurance attestation requirement for fiscal years beginning in 2031.
NAFs, SRCs and EGCs with must comply (1) with the qualitative disclosures and financial statement effect disclosure for fiscal years beginning in 2027 and (2) with the financial expenditure disclosures for fiscal years beginning in 2028.
Below is an SEC-prepared table which summaries the phase-in schedule.
Source: SEC Fact Sheet, The Enhancement and Standardization of Climate-Related Disclosures: Final Rules
Comments: While pared back from the SEC’s 2022 proposals, the final climate rules create an extensive and detailed body of new disclosures -- arguably the most far-reaching changes to the SEC disclosure requirements in many decades. The audit committee’s oversight of the company’s information gathering, controls, disclosure, and reporting processes will be significantly affected by these new requirements. While the implementation schedule is not as tight as in the original proposals, and delays arising from the legal challenges to the rules are possible, management, the audit committee, and the full board should begin considering now what steps the company will need to take to comply.
Questions that audit committees might ask as part of their oversight of the implementation of the SEC’s climate-related disclosure regime include:
What climate-risk related information does the company currently collect? What information does it disclose? What gaps are there between the information currently available and the disclosures required under the new rules? How do the requirements of the SEC’s new rules compare to any other climate-related reporting requirements to which the company is subject (e.g., California or EU requirements)?
How will the company’s information-gathering processes, internal control over financial reporting, and disclosure controls and procedures need to change in order to implement the new rules?
Are the company’s Scope 1 and 2 GHG emissions material under the test outlined in the SEC’s release? If so, when would GHG disclosure phase in for the company? Is Scope 1 and Scope 2 GHG emissions information currently available to the company?
If the company will be required to disclosure GHG emissions, when will attestation be required? How will the company determine who should provide the required attestation?
Which company personnel.(e.g., finance, legal, investor relations, internal audit) will be involved in compliance with the new rules? Are they aware of and prepared for the demands that will be placed on them? Would their position descriptions, functional responsibilities, charters, and policies and procedures need to be revised? Does management responsible for SEC reporting currently possess the necessary skills and expertise regarding climate-related disclosure? How will any gaps in these skills be addressed?
Does the audit committee currently possess expertise regarding climate-related disclosure? Would the committee benefit from education (or a membership change) to enhance its understanding of this field?