SEC proposes new rules for climate-related disclosures | Skadden, Arps, Slate, Meagher & Flom LLP

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[co-author: Stacy Kray]

On March 21, 2022, the Securities and Exchange Commission (SEC) voted 3-1 to propose long-awaited rules mandating climate-related disclosures in companies’ annual reports and registration statements. The proposed rules would add extensive and mandatory disclosure elements that require companies, including foreign private issuers, to disclose climate-related risks and greenhouse gas (GHG) emissions. In addition, the proposed rules would require the inclusion of certain climate-related financial metrics in a note to companies’ audited financial statements.

The most important findings and proposed disclosure requirements are described below.

The central theses

Extensive and prescriptive disclosure requirements. The proposed rules would require companies to provide climate-related information in a separately labeled section of annual reports and registration statements based on a detailed list of specific disclosure items. Proposed disclosure items include, but are not limited to, climate-related risk oversight and governance, climate-related risks and their impact on business strategy and prospects, and Scope 1 and Scope 2 GHG emissions1 and for certain companies, Scope 3 GHG emissions (ie., indirect emissions from upstream and downstream activities in a company’s value chain). The proposal would also require a new note to the audited financial statements of companies that deal with climate-related impacts on the line items of the financial statements. In addition, large expedited and expedited reporters would need to have independent third-party verification of their greenhouse gas emissions.

phase-in-phases. The proposed rules provide for phase-in periods based on SEC filing status, with extended phase-in periods for Scope 3 disclosures and third-party certification requirements. For example, if the final rules are effective by December 2022, large expedited reporters would begin providing the new disclosures related to fiscal year 2023 in 2024. The proposed implementation periods are summarized in the appendix to this publication.

Prepare for New Disclosures. As proposed, the rules could apply to large expedited applicants once their annual report on Form 10-K or Form 20-F for fiscal year 2023 is available. Companies may not be able to await final rules before considering how to begin collecting 2023 greenhouse gas emissions data and other information needed to meet potential disclosure and financial statement requirements. In this regard, companies should start preparing for the new regulations by assessing the impact on their existing disclosure controls and procedures, as well as internal control over financial reporting related to greenhouse gas emissions and other climate-related disclosures. For additional considerations, see our publication, Enhancing Disclosure Controls and Procedures Relating to Voluntary Environmental and Social Disclosures.

background

As noted in our previous publications, throughout 2021 SEC commissioners and senior officials noted the SEC’s increasing focus (or lack thereof) on climate-related disclosures by publicly traded companies.2 In the proposed release, the SEC expressed concern that while investor demand has increased for more detailed information about climate-related risks companies face, existing disclosures “do not adequately protect investors” by being provided in the first place, they often appear outside of SEC filings and provide “different information, to different degrees of completeness, and in different documents and formats.” The SEC noted in the press release that the proposed rules aim to fill such an information gap by collecting “consistent, comparable, and reliable — and therefore actionable — information” from companies about the impact of climate-related risks.

Key Proposed Climate-Related Disclosure Requirements

Highlights of the proposed disclosure and other requirements include the following:

  • Climate-related disclosure in a separately labeled section of registration statements and annual reports. A proposed new sub-section 1500 of Regulation SK would add extensive and mandatory disclosure requirements for certain climate-related information, including the following:3
    • board and management oversight and management of climate-related risks;
    • climate-related risks that are highly likely to have a material impact on the Company’s operations or consolidated financial statements;
    • whether and how identified climate-related risks have impacted or are expected to impact the Company’s strategy, business model and prospects;
    • the company’s risk management system or process and transition plan related to climate-related risks;
    • Scopes 1 and 2 GHG emissions;
    • Scope 3 GHG emissions and intensity, if material or the company has established a GHG emissions reduction goal or target that includes its Scope 3 emissions;4 and
    • the company’s climate-related targets, if any, and the transition plan to achieve them, and annual progress updates.
  • Climate-related financial risks, metrics and related disclosures in a note to the audited financial statements. The newly proposed Article 14 of Regulation SX would require a note on the audited financial statements in relation to disaggregated climate-related impacts on existing line items of the financial statements, including financial impacts related to severe weather events and other natural conditions and climate-related transition activities. As part of the audited financial statements, this new disclosure would be audited by an independent auditor and would fall within the scope of the Company’s internal control over financial reporting.
  • Independent third-party assurance for Scope 1 and Scope 2 GHG emissions and climate-related financial disclosures (for large accelerated and accelerated reporting only and subject to transition periods). The proposed rules would also impose minimum standards for the required independent third-party verification.

Next Steps

Possible legal challenges. If the new rules are passed, legal challenges are expected, which could delay the implementation of the disclosure requirements. Critics of the proposal include SEC Commissioner Hester Peirce, who voted against the proposal and identified numerous potential “flaws” in a lengthy dissenting statement. Also in a Wall Street Journal In an op-ed piece, former SEC Chairman Jay Clayton and Congressman Patrick McHenry called the proposal excessive and outside the SEC’s authority, jurisdiction and expertise, which “will justifiably draw legal challenges.”

Public Comments. The comment period ends on May 20, 2022 or 30 days after the publication of the proposal in the federal register. The proposal contains specific requests for comments on various aspects of the proposed rules, in addition to requests for comments in general.

Phase-in compliance periods for proposed climate change rules5

ACCESSIBLE TABLE CONTENT

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1 Scope 1 emissions are direct GHG emissions that arise from sources that the company controls or is owned by the company. Scope 2 emissions are indirect GHG emissions related to the company’s purchase of electricity, steam, heating or cooling.

2 See, for example, SEC Primed To Act on ESG Disclosure, SEC Chair Gensler Outlines Roadmap for Climate Risk Disclosure Rulemaking, and SEC Staff Issues Detailed Form 10-K Comments Against Climate-Related Disclosures.

3 In the proposed filing, the SEC noted that the proposed climate-related disclosure framework is based in part on the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and the standards and guidance of the GHG Protocol.

4 Given the difficulties in calculating Scope 3 emissions, companies that disclose Scope 3 emissions would not be held liable for fraudulent disclosures unless such disclosure was made without a reasonable basis or in good faith.

5 Assuming final rules become effective by December 2022 and the company’s fiscal year ends on December 31. A company with a different fiscal year end that results in its fiscal year 2023 beginning before the effective date of the final rules would not have to comply until the following fiscal year. For example, a large expedited applicant with a fiscal year end on March 31 would not have to comply with the new rules until its fiscal year 2024 Form 10-K, which is due 60 days after March 31, 2024.

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