On January 4, 2023, the U.S. SEC announced its Fall 2023 SEC regulatory agenda. While there were more than 24 rules set to be finalized in the spring and fall, one rule, in particular, has garnered a significant amount of attention: the SEC climate disclosure rule.
If adopted, this amendment to a 2010 Guidance on ESG Disclosures rule would require publicly traded companies to enhance and standardize the disclosure of the company’s exposure to climate change risks and the potential impacts such exposure may have on the business and its future plans.
But what exactly does the SEC climate disclosure rule cover and entail?
Read this overview to learn more about its background, scope, corporate sustainability reporting requirements, consequences of noncompliance, as well as implications for companies and investors.
Background and scope of the SEC climate disclosures
In 2010, the SEC issued release 33-9106, Guidance on Climate Change Disclosures, which encouraged companies to inform investors about material risks, uncertainties, impacts, and opportunities as they relate to climate change. The SEC wanted registrants to:
- Disclose internal governance and oversight of climate-related issues.
- Provide analysis of controls around climate reporting in management’s annual report.
- Update, improve, augment, or change sustainability reporting as needed.
The purpose of this was to provide investors with clear and comprehensive ESG data and metrics about how climate risks affected investment strategy and financial performance.
While this rule paved the way for future disclosure rules, it was largely toothless, lacking specificity, broad-scale applicability, and enforcement mechanisms. For most companies, disclosure was done voluntarily. And, as Sara Dewey notes in Harvard’s Environmental & Energy Law Program, this information was often inconsistent and fragmented:
“70 percent of companies in the Russell 1000 published sustainability reports in 2020, yet 86 percent of institutional investors surveyed in 2021 were skeptical about companies’ ability to deliver on their sustainability goals. Investors are calling for standardized integrated reporting requirements to enhance the comparability, reliability, and transparency of this information.”
To address such flaws, the SEC’s new climate risk disclosure rule sought to enhance the original rule by making disclosures “consistent, comparable, and reliable.” It enhanced the existing rules by pulling from both the Task Force on Climate-Related Financial Disclosure (TCFD) as well as the GHG protocol, which introduced the concepts of “scopes of emissions.”
Overview of the SEC’s climate assessment and reporting requirements
The proposed SEC climate disclosure is lengthy, spanning more than 500 pages. Needless to say, there’s a lot to unpack.
Generally speaking, it contains guidance recommendations that would compel companies to report on their climate risks and opportunities annually. Within that report, they must detail their industry-specific climate-related risks and opportunities, including the methods used to assess and manage them.
The new rule can be broken down into three categories of disclosure:
1. Material climate impacts – Companies are expected to disclose:
- Location and proportion of assets exposed to physical climate-related hazards.
- Transition risks that may arise over time due to changes in regulation, reputation, technology, or the market.
- Strategic, final, and operational impacts of climate change.
- Governance and risk management procedures to manage these risks.
2. Greenhouse gas emissions – Companies are required to report audited scope 1 and scope 2 emissions, which are directly generated by the company through its operations or through the energy it buys. In some cases, filers must also include scope 3 disclosures if they’re material or if they’re relevant to the filer’s targeted goals.
3. Targets and transition plans – Companies are expected to disclose any existing targets regarding energy usage, emissions reductions, conservation, etc., as well as plans for achieving those targets.
SEC climate risk disclosure rule’s scope, applicability, and timeframe
Publicly traded companies have been put on notice. As of now, April 2023 is the release date for this final climate-related disclosure rule. If approved, the phase-in period would likely become effective in April 2024. However, it’s important to note that smaller—read: non-public—reporting companies would likely be exempt from scope 3 GHG emissions disclosures and have an additional year to transition.
That said, it remains to be seen what impact the Supreme Court’s recent ruling in W. Virginia v. EPA—which determined that the EPA has no constitutional authority to regulate carbon emissions—will have on SECs’ ability to regulate climate-related risk disclosures. In all likelihood, a new spate of legal challenges will soon call into question the SEC’s rule-making authority.
Even so, the writing is on the wall—stronger climate-related regulations are coming to the States soon. Knowing this, proactive companies—including private entities—are making necessary changes to address sustainability and disclosures sooner rather than later by:
- Measuring emissions to create benchmarks
- Collecting operational data to refine estimates with real figures
- Creating a reduction strategy
- Involving all levels of their organization
Naturally, many companies are currently scratching their heads, wondering whether the disclosure rule will apply to them and, if so, when they’ll need to act.
Who does the rule apply to?
This proposed rule would apply to U.S. 10-K filers as well as foreign private issuers who file 20-F forms with the SEC.
What Is the reporting timeframe?
As mentioned, this depends on if and when the law is passed and whether there is a legal challenge to the SEC’s authority to regulate such activities.
If it does pass, large companies would have to disclose the information for fiscal year 2024, so filing year 2025. Smaller companies would have an additional year-long grace period until fiscal year 2025.
All filers would also be granted an additional year beyond those deadlines to report scope 3 emissions.
What types of information must be disclosed?
There are dozens of potential disclosures that a company may be required to reveal. That said, some of the more broad disclosures include:
- Oversight and governance of climate-related risk.
- How climate-related risk may impact the business value creation over the short, medium, and long term.
- How climate-related risks have (or will) shape the company’s strategy, outlook, and business model.
- How the company identifies, assesses, and manages climate risk, and how such processes fit into the broader risk management policy.
- The impact of climate-related events and transaction activities on line items.
Additionally, companies are required to report GHG emissions, including:
- Scope 1 and 2 emissions in aggregate and disaggregated, in terms of both absolute and intensity-based emissions.
- Scope 3 emissions (if material or relevant to emissions targets).
Consequences of noncompliance
As of now, the SEC rules have not yet proposed penalties for noncompliance, though it’s reasonable to assume that failure to comply could result in significant consequences, including reputational harm, legal liability, and financial penalties.
Last year, California’s Climate Disclosure legislation adopted amendments that set administrative and civil penalties if a reporting entity failed to comply with requirements:
- An administrative penalty of $25,000 per day for the first 30 days, and $50,000 per day thereafter, for late or incomplete reports to be imposed by the Secretary of State.
- A civil penalty of $1,000,000 per violation, to be assessed by the Attorney General in a civil action for a reporting entity that repeatedly or intentionally violates the reporting regulations adopted by the Secretary of State
Benefits of the rule for companies and investors
Both companies and investors stand to benefit from these climate-related disclosure rule changes.
By complying with these rules, a company will be better positioned to meet customer and stakeholder expectations thanks to:
- Better risk management, especially regarding climate-related risks
- Reduced legal and reputational risk
- Increased access to capital
- A competitive advantage
These disclosures create transparency and visibility for investors that enable them to:
- Have a deeper understanding of their investment opportunities
- Align themselves with companies that share their sustainability priorities
- Have greater confidence in the market as a whole
Challenges and costs associated with compliance
Naturally, complying with these new regulations can present operational challenges for publicly traded companies.
This is a large and complex regulatory bill. Simply understanding what is expected of a company will be a significant challenge in and of itself, let alone making the necessary changes to comply with the rules.
The largest operational challenge and cost will likely involve locating and collating all of the relevant emissions data. For that, having robust sustainability software makes it much easier to measure your environmental data, build a plan that reduces your carbon emissions, and then report your actions in a manner that’s compliant with the SEC’s standards.
Implications For companies and investors
While publicly traded companies may be the focus of this rule, chances are, it will have significant downstream effects.
For example, to report scope 3 emissions, public companies will very likely need to request their suppliers’ emissions data. As a result, both companies large and small, will need to take the necessary steps to create visibility and control over their organizational emissions data.
Complying with the SEC’s climate risk disclosure rule
While the SEC’s newest climate risk disclosure rule hasn’t yet been set in stone, all signs indicate that either this specific rule or a rule like it will soon become the national standard.
By taking proactive steps now to measure and manage your greenhouse gas emissions data, you’ll be better prepared for any future disclosure laws.
Wondering where to start?
Sustain. Life’s sustainability management software provides advanced carbon emissions measurement and decarbonization capabilities for leading companies that need to take meaningful climate action.
1. SEC, “Release No. 33-9106 75 Fr 6290 Climate Change Disclosures,” https://www.sec.gov/comments/climate-disclosure/cll12-8804071-237954.pdf Accessed March 21, 2023
2. Harvard Law, “What to know about the SEC’s Proposed Climate Risk Disclosure Rule,” https://eelp.law.harvard.edu/2022/04/what-to-know-about-the-sec-proposed-climate-risk-disclosure-rule/ Accessed March 21, 2023
3. HK Law, “SEC ESG-Rulemaking Wave Continues with Proposed Rule for Advisers and Funds,” https://www.hklaw.com/en/insights/publications/2022/06/sec-esg-rulemaking-wave-continues-with-proposed-rule Accessed March 21, 2023
4. Supreme Court, “West Virginia v. EPA,” https://www.supremecourt.gov/opinions/21pdf/20-1530_n758.pdf Accessed March 21, 2023
5. Akin Gump, “California Climate Disclosure Legislation Clears Critical Hurdles,” https://www.akingump.com/en/experience/practices/climate-change/speaking-sustainability/california-climate-disclosure-legislation-clears-critical-hurdles.html Accessed March 21, 2023