On March 21, the SEC published its long-expected proposed disclosure requirements to enhance and standardize public company climate-related disclosures. The proposals would create an extensive and detailed body of new disclosures, affecting both the text of SEC filings and the financial statements. In particular, as explained below, all companies would be required to disclose Scope 1 and Scope 2 greenhouse gas (GHG) emissions, and many larger companies – accelerated filers – would be required to disclose Scope 3 GHG emissions. Scope 1 and 2 GHG emission disclosures would be subject to independent third-party attestation requirements. Further, the financial statements of all companies, regardless of size, would be required to include footnote disclosure regarding impacts exceeding one percent of any line item of climate-related events and transition activities; these new financial statement disclosures would of course be subject to the audit. In addition, all public companies would be required to make detailed disclosure in their SEC filings concerning a variety of climate-related matters, including climate risk strategy, climate risk management, and climate risk governance.
The SEC’s proposals draw on the disclosure recommendations of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) and on the Greenhouse Gas Protocol (GHG Protocol) created by the World Resources Institute and the World Business Council for Sustainable Development. Companies that are already making voluntary disclosures based on the TCFD recommendations and the GHG Protocol will have a head start in complying with the SEC proposals. However, the SEC’s proposal is more detailed and contains many elements that are not features of the TCFD and GHG regimes. All companies, especially those not currently making TCFD disclosures, will need to create new information systems, controls, and disclosure procedures to comply with the SEC requirements, assuming they are adopted. For many companies, this will require a considerable investment of time, talent, and financial resources.
One consequence of the proposals is that audit committees will need to prepare for a major change in the nature and scope of their responsibilities. Most audit committees are not directly responsible for ESG oversight. However, financial statement preparation, the content of SEC filings, internal control over financial reporting, disclosure controls and procedures, and the work of the external and internal auditors are all core financial audit committee oversight responsibilities. The proposed climate disclosures would significantly affect these areas. Management and audit committees should begin to prepare now by analyzing the proposals and considering how compliance would affect their disclosure processes.
Proposed Disclosure Requirements
The SEC’s proposals have six major aspects:
1. New Financial Statement Footnotes
The proposals would require financial statements filed with the SEC to include footnote disclosure of the impact on the financial statements of “climate-related conditions and events” (such as to droughts, floods, and other weather events and natural conditions) and of climate change transition activities (such as changes in asset salvage values or useful lives). The impact of such events and activities on financial statement estimates and assumptions would also have to be disclosed. Specifically:
Financial impact metrics. A company would be required to make footnote disclosure of disaggregated information about the impact of climate-related conditions and events and transition activities on the consolidated financial statements unless the impact is less than one percent of any financial statement line item. Within each category (i.e., climate-related events or transition activities), impacts would be required to be disclosed on a line-by-line basis for all negative impacts and on a line-by-line basis for all positive impacts.
Expenditure metrics. The expenditure metrics would require footnote disclosure of the aggregate amounts of annual expenditures and capitalized costs associated with climate-related events, transition activities, and climate-related risks. For each category, the notes would be required to disclose separately the amount incurred during the year for positive and negative impacts of climate-related events and of transition activities (including GHG emissions reductions and other steps to mitigate exposure to transition risks). The expenditure metrics would be subject to the same one-percent-of-a-line-item disclosure threshold as the financial impact metrics.
Financial estimates and assumptions. Footnote disclosure would be required of the impact of risks and uncertainties associated with climate-related events and transition activities on estimates and assumptions reflected in the consolidated financial statements. The company would be required to provide a narrative description of how the development of estimates and assumptions was affected by climate events and activities, including separate disclosure of the impact of climate-related events and transition activities, including identified transition risks.
Since these disclosures would part of the financial statements, they would, like any other financial statement disclosures, be subject to the requirements of internal control over financial reporting and to the external audit. The auditors would, in turn, be subject to PCAOB auditing standards with respect to their examination of these disclosures.
2. GHG Emissions
a. Disclosure
All public companies would be required to disclose their Scope 1 and Scope 2 GHG emissions. (Scope 1 emissions are those directly from facilities or operations owned or controlled by the company. Scope 2 emissions are those that result from the production of purchased electricity or other forms of energy.) Scope 1 and Scope 2 emissions would need to be disclosed separately, both in the aggregate (in absolute terms, not including offsets) and disaggregated by each constituent greenhouse gas (carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride). In addition, disclosure would be required in terms of intensity. The proposed rules would define “GHG intensity” to mean a ratio that expresses the impact of GHG emissions per unit of economic value (e.g., metric tons of CO2e per unit of total revenues) or per unit of production (e.g., metric tons of CO2e per unit of product produced).
Accelerated filers (generally, companies with market capitalization in excess of $75 million) would also be required to disclose Scope 3 emissions. (Scope 3 GHG emissions are those in the company’s value change that are upstream and downstream from the company’s own activities, such as emissions that result from the activities of suppliers or from customer use of the company’s products.) However, Scope 3 disclosure would only be required if the company has set a GHG emissions target or goal that includes Scope 3 emissions or if Scope 3 emissions are material. Where required, Scope 3 emission disclosures would be in absolute terms, not including offsets, and in terms of intensity.
b. Safe Harbor
Determining Scope 3 emissions may require companies to rely heavily on estimates and assumptions. Accordingly, the proposal includes a safe harbor from liability under the securities laws for Scope 3 emissions disclosures an SEC filing. This safe harbor would provide that a Scope 3 emissions disclosure would not be deemed to constitute a fraudulent statement unless it were shown that the statement was made without a reasonable basis or was disclosed other than in good faith.
c. Attestation
Accelerated filers would be required to include in their SEC filings an attestation report from an independent third party on their Scope 1 and Scope 2 emissions. Non-accelerated filers would not be subject to the GHG emissions attestation requirement. The GHG emissions attestation provider could be – but would not be required to be – the company’s financial statement auditor. The attestation provider would however have to be an expert in GHG emissions and independent of the company and its affiliates. The attestation report would have to 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 PCAOB, AICPA, or IAASB. While attestation would not be required as to Scope 3 emissions disclosures, if a company elected to voluntarily obtain and disclose such an attestation, it would have to meet the same requirements, and make the same disclosures, as apply to Scope 1 and 2 disclosure attestations.
Under the SEC’s proposed phase in of the climate rules, the assurance provider would initially only have to provide limited or negative assurance regarding GHG emission disclosures; the assurance opinion could simply state that, based on performing described procedures, the assurance provider had no reason to believe that the disclosures were materially misleading. After a phase-in period (which depends on company size), reasonable assurance, the same level of assurance that must be provided with respect to the financial statements, would be required. For larger accelerated filers (generally companies with market capitalization in excess of $700 million), Scope 1 and 2 GHG disclosure would begin in fiscal 2023, limited assurance would be required for fiscal 2024, and reasonable assurance for fiscal 2026.
3. Climate Risk Governance
All companies would be required to describe the board’s oversight of climate-related risks, including board committees responsible for climate-related risk oversight and whether any board member has expertise in climate-related risks (and the nature of such expertise). Disclosure would also be required about, among other things, 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 would also be required to describe management’s role in assessing and managing climate-related risks. This would include disclosure of management positions or committees responsible for climate-related risks, disclosure of the processes by which the managers or management committees are informed about and monitor climate-related risks, and disclosure about whether and how often the responsible managers or committees report to the board or a board committee on climate risks.
4. Climate Risk Strategy, Business Model, and Outlook
Companies would be required to describe any climate-related risks that are reasonably likely to have a material impact on the company’s business or consolidated financial statements over the short, medium, and long term. This would include:
Whether and how such impacts are considered as part of the registrant’s business strategy, financial planning, and capital allocation and any material climate-related risks that have or are reasonably likely to affect the financial statements.
The company’s internal carbon price, if any, and how that price is determined.
A description of the scenarios, assumptions, and projected financial impacts, if the company uses scenario analysis in the context of climate-related risks.
5. Climate Risk Management
All companies would be required to describe any processes for identifying, assessing, and managing climate-related risks. This disclosure would need to include, for example, how the company determines the relative significance of climate-related risks and considers existing or likely regulatory requirements. If the company has a climate transition plan, it would have to disclose and discuss the plan.
6. Climate-Related Targets and Goals
If a company publicly discloses climate-related targets or goals, it would be required to include in SEC filings information concerning such targets and goals, including the activities and emissions in the target, the period within which the target is to be achieved, and how the company intends to meet the targets or goals. Companies would also be required to provide annual progress updates.
Effective Dates
If adopted, the climate disclosure requirements would be phased in over time, beginning in fiscal year 2023, depending on the size of the company. The release proposing the climate change disclosures contains two tables that summarize the schedule under which companies would be required to comply with the new requirements. Assuming adoption of the proposed rules with an effective date in December 2022, the disclosures would take effect under the following schedule:
Source: SEC Release No. 33-11042 (SRC means smaller reporting company).
The compliance dates for the GHG emissions disclosure attestation requirements would be:
Source: SEC Release No. 33-11042 (footnote omitted).
Comments: As noted above, the SEC’s proposals would create an extensive and detailed body of new disclosures. Indeed, the climate risk proposals arguably represent the most far-reaching changes to the SEC disclosure requirements in many decades – perhaps the most far-reaching changes that have ever been proposed in a single release. In most cases, compliance would require major changes in data obtained from suppliers and customers, information systems, internal control over financial reporting, disclosure controls and procedures, relationships with the company’s auditor (and possibly with other attestation providers), and other aspects of the company’s disclosure infrastructure. Since the audit committee has oversight responsibility for these activities, the nature and scope of the committee’s responsibilities would change substantially.
It is of course not certain that the proposals will be adopted in their current form, although some form of enhanced SEC climate change disclosure requirements seems inevitable. Comments on the proposed rules are due 30 days after its publication in the Federal Register or May 20, 2022, whichever is later, and the SEC’s phase in schedule assumes adoption of the rules before the end of 2022. This is an exceedingly tight timeframe for consideration of what is likely to be a large volume of comments and seems to suggest that the Commission does not intend to make significant changes to the proposals prior to adoption.
It is also possible that, regardless of the Commission’s schedule, implementation of the rules will be delayed by legal challenges. At minimum, the proposals test the limits of the Commission’s authority to require disclosure. Commission Peirce voted against the proposals and issued a strong dissenting statement which will likely provide a blueprint for legal challenges. She asserts that the proposal “steps outside our statutory limits by using the disclosure framework to achieve objectives that are not ours to pursue and by pursuing those objectives by means of disclosure mandates that may not comport with First Amendment limitations on compelled speech.”
Against this background, audit committees should consider taking two steps. First, committees or their individual members may want to comment on the proposals. As noted, the proposals raise important legal and policy questions about the role of the SEC and the scope of its investor protection mandate. The SEC is required to consider whether its rules promote efficiency, competition, and capital formation and, in that context, the costs and benefits of its actions. Audit committees are well-positioned to provide input on these questions, particularly the potential costs of compliance.
Second, managements should be considering the steps that would be necessary to comply with the new disclosure requirements, if adopted, and audit committees should be active in overseeing that process. Some questions that audit committees might ask as part of that oversight 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 proposals?
What is the quality of the climate-risk information currently available? Are the procedures and controls applicable to this information comparable to those applicable to existing SEC-required disclosures?
When would Scope 1 and 2 GHG emissions disclosure phase in for the company? Is this information currently available? Would attestation be required? If so, when would limited assurance and reasonable assurance phase in?
Would the company be required to disclose Scope 3 GHG emissions? If so, is this information currently available? How would the company obtain the necessary information to make such disclosures? What inputs are available from third parties, such as suppliers and customers?
Is the company currently making voluntary disclosures (e.g., climate-related goals or targets) or using any internal tools (e.g., an internal carbon price, a climate transition plan, or scenario analysis) that would trigger mandatory SEC disclosures?
What internal parties (e.g., finance, legal, investor relations, internal audit, the board and board committees) would be involved in compliance with the new rules? Are they aware of and prepared for the demands that would be placed on them? Would their position descriptions, functional responsibilities, charters, and policies and procedures need to be revised?
What external parties (e.g., outside counsel, the independent auditor, independent assurance providers, consultants) would be involved in compliance with the new requirements? Are they aware of and prepared for the demands that would be placed on them?
What changes would be necessary in the company’s disclosure controls and procedures and internal control over financial reporting to comply with the new disclosure requirements?