On Monday, March 21, the Securities and Exchange Commission proposed a new rule aimed at requiring public companies to disclose extensive climate-related data to not only the federal government, but also their shareholders. More specifically, the proposed rule, entitled The Enhancements and Standardization of Climate-Related Disclosures for Investors, would amend the SEC’s rules under the Securities Act of 1933 and Securities Exchange Act of 1934. The proposed rule aims to provide investors a better understanding of the risks that climate change poses to companies.
Chair Gary Gensler and Commissioners Allison Herren Lee and Caroline Crenshaw voted in favor of the proposed rule, while Commissioner Hester Peirce—the sole Republican commissioner—dissented. Chair Gensler, in his supporting statement defended the proposed rule as well within the SEC’s mandate, noting that, “[o]ver the generations, the SEC has stepped in when there’s significant need for the disclosure of information relevant to investors’ decisions.”
The new rule would require both foreign and domestic companies in their registration financial statements and annual reports, including 10-Ks, to disclose the following:
- Climate-Related Physical Risks. Registering companies would have to disclose, according to the rule, “any climate-related risks that are reasonably likely to have a material impact on the registrant’s business or consolidated financial statements.” A “climate-related risk” is broadly defined in the rule as “the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole.” Besides identifying the specific physical risks, the registrants need to identity the location (down to the zip code) of any at-risk properties, processes, or operations of the company. There are even more disclosures required for risks categorized as water-related risks.
- Bottom Line Impact. Under the new rule, once companies identify potential risks, they must also outline the actual and conceivable impacts of these material climate-related risks on the company’s strategy, business model, and outlook. Specifically, with respect to physical risks, companies now have to disclose “the impacts of severe weather events and other natural conditions” on line items in their financial statements. Companies must also disclose the impact of any transition-related climate risks on line items in their financial statements, unless those risks amount to less than 1% of the line item.
- Governance of Climate Risks. Under the new rule, companies would now be required to disclose their processes for identifying, assessing, and managing the identified climate-related risks, as well as to disclose how, if at all, those processes have been integrated into the company’s overall risk management program. For example, if a company uses scenario analysis as its analytical tool, then it must disclose as such.
- Transition Plans. Under the new rule, if a company implements a transition plan, which the SEC defines as any “strategy and implementation plan to reduce climate-related risks,” the company would be required to disclose “how it plans to mitigate or adapt to any identified physical risks…[and] transition risks.” Companies would also be required to update this disclosure each fiscal year.
- Greenhouse Gas Emissions. Under the new rule, companies would be required to disclose their Greenhouse Gas Emissions, including both Scope 1 (direct) and Scope 2 (indirect) emissions. This provision would require most companies to further disclose Scope 3 emissions of upstream and downstream activities if (i) these emissions are material or (ii) even if not material, registrants have set Greenhouse Gas Emissions reduction targets or goals that include Scope 3 Greenhouse Gas Emissions. For Scope 3 emissions, the SEC’s new rule does include a “safe harbor” from liability, an exemption for smaller registrants, and a delayed compliance date.
The proposed rule contemplates disclosure compliance dates (as to most of the disclosures) of fiscal year 2023 for large, accelerated filers; fiscal year 2024 for accelerated filers and non-accelerated filers; and fiscal year 2025 for smaller reporting companies.
The SEC has requested comment on the proposed rule by May 20, 2022, or 30 days after publication of the rule in the Federal Register, whichever is later. After the required comment period, the SEC is expected to issue its final rules and its final enforcement date. Although the timeline for a final rulemaking remains uncertain, the SEC’s disclosure timelines assume a December 2022 date for the final rule to take effect.
There’s no doubt, if adopted, this new rule would impose substantial new disclosure responsibilities on public companies in their SEC filings. Many public companies already publish climate-related disclosures voluntarily in reports outside of their required SEC filings. But, the SEC’s proposed rule would now require registrants to disclose such information in SEC filings.
The SEC is hoping that forcing companies to produce these disclosures will compel them to ramp up their attentiveness to climate-related issues. However, opponents believe that the proposed rule will impose significant costs on companies and decrease consistency, comparability, and reliability of climate-related data and disclosures by encouraging subjectivity and assumptions. Opponents also argue that adopting the proposed rule would require the SEC to exceed its statutory limits and possibly even conflict with the First Amendment rights under the U.S. Constitution.
What’s clear, though, is that before this rule gets adopted, companies would be wise to familiarize themselves with the proposed rules, submit a comment to the SEC if they feel it appropriate, and begin to prepare for the potential disclosure requirements and the implementation of the governance and operational systems necessary to satisfy them.