The SEC proposed new rules mandating climate disclosure by public companies in March 2022. The announcement has drawn mixed reactions from public companies and the investor community.
While many public companies publish sustainability reports, they report on a voluntary basis and the metrics they use vary widely. The intention of the proposed climate disclosure rule is to create a standardized reporting regime for climate-related data. In theory, the standardization of disclosure requirements would enable investors to make more informed comparisons between public companies.
Global Trends on Climate Change Disclosure
Outside of the United States, regulators are getting tougher on environmental, social and governance (ESG) initiatives. There has been a shift from voluntary disclosure of ESG-related initiatives to mandatory disclosure requirements for public companies.
The Task Force on Climate-Related Financial Disclosures (TCFD) is an organization created by the Financial Stability Board. TCFD has been influential in developing recommendations on climate-related disclosure. The TCFD consists of 32 members from countries in the G20. Michael Bloomberg serves as chair of the TCFD.
Like the United States, regulators in the European Union announced measures to standardize climate-related disclosure requirements. Regulators in Hong Kong have also introduced disclosure requirements on climate-related risks.
Key Aspects of the Proposed Rule
If the proposed climate disclosure rules go into effect, public companies would be subject to mandatory climate-related disclosure in periodic reports filed with the SEC. These reports include Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q. Companies that file registration statements using a Form S-1 or Form S-3 would also be required to provide climate-related disclosure.
The proposed rule includes qualitative and quantitative disclosure requirements. On the qualitative side, public companies would be required to provide disclosure covering:
Board oversight of climate risk
Climate risk analysis and processes
Impact of climate risks on business strategy and outlook
Impact of climate-related events on financial statements
Details on the company’s climate goals
The quantitative component of the climate disclosure requirements would entail providing information on Scope 1 and 2 greenhouse gas (GHG) emissions, as defined by the Greenhouse Gas Protocol (GHG Protocol). Scope 1 emissions are direct emissions from the company and operations under its control. Scope 2 emissions are indirect emissions from the generation of purchased energy from a utility provider.
While Scope 1 and 2 emissions would be mandatory to report under the newly proposed SEC rule, Scope 3 emissions would have to be disclosed by companies on a case-by-case basis. Scope 3 emissions are indirect emissions in the company’s value chain. Some Scope 3 examples include emissions by suppliers, distributors, and transportation providers.
The SEC indicated that it has “not proposed a bright-line quantitative threshold for the materiality determination” for Scope 3 emissions. Instead, the SEC will evaluate the facts and circumstances facing a particular company on a case-by-case basis to determine the appropriate Scope 3 emissions threshold.
Timing of the Climate Disclosure Rule
The SEC has set an aggressive timeline for implementing the proposed rule. Its goal is to finalize the rule in December 2022. That means the rule would begin to apply to public filings in 2024.
Reactions to the Proposed Rule
SEC Commissioner Allison Herren Lee referred to climate risk as “one of the most momentous risks to face capital markets since the inception of this agency.”
Others have had a more negative reaction to the proposed climate disclosure rules, calling them government overreach. If adopted, public companies would have to devote more resources to compliance measures. The collection of data and preparation of the disclosure will likely entail a time-consuming and costly process.
Apart from increased compliance costs, companies could see their legal bills increase. Lawyers are preparing for an uptick in litigation activity stemming from the implementation of the rules.
“The plaintiffs lawyers are waiting in the wings,” commented Craig Marcus, a partner at the international law firm Ropes & Gray LLP.
In-house lawyers at large companies are studying the rules to prevent costly securities litigation in the future. The strict climate reporting rules could target companies for material misstatements on omissions. Even half-truths disclosed to public investors could subject companies to litigation risk.
Darren Robbins, who runs a plaintiffs law firm specializing in securities litigation, is cautiously optimistic. “What the SEC is doing is encouraging much more accurate and complete disclosures, and you may see litigation if there are material omissions or misstatements made to investors with regard to those climate disclosures,” stated Mr. Robbins.