Environmental, social, and governance risks and opportunities

SEC Climate Risk Rule is Transformative At a Cost

For the first time disclosure of a business’ greenhouse gas (GHG) emissions is mandated
ESG law

Last Monday, the U.S. Securities and Exchange Commission voted 3 to 1 to issue a long awaited proposed new rule to mandate climate risk disclosures by public companies and other businesses in their supply chains.

The 510 page proposed rule will require public companies to include climate related disclosures in their registration statements and periodic reports such as 10-K annual reports, including information about climate related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate related financial statement metrics in a note to their audited financial statements. Most significant in this rule is that for the first time SEC mandated information about climate related risks will expressly include disclosure of a business’ greenhouse gas (GHG) emissions.

There are of course existing SEC rules that require companies to disclose material risks regardless of the source or cause of the risk, including climate risks. In 2010, the SEC issued guidance to companies advising how to apply existing disclosure rules in the context of climate change and last year supplemented that with additional climate change disclosure guidance. SEC staff, in reviewing nearly 7,000 annual reports submitted in 2019 and 2020, found that a third included some disclosure related to climate change risk (where presumably after consideration the other two-thirds concluded there was no material climate change risk requiring disclosure).

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In point of fact, for more than 10 years we have been advising companies and their consultants about SEC climate change disclosures, and last year wrote a blog post describing how in anticipation of this now published rule there had been, A Sea Change in SEC Climate Change Disclosure.”

Stuart Kaplow

But a sea change is too modest a characterization of this new rule. This is profound and transformative potentially dwarfing all other existing SEC required disclosures. SEC Commissioner Hester M. Peirce, the sole Republican and dissenter having voted against this rule, said, “We are here laying the cornerstone of a new disclosure framework that will eventually rival our existing securities disclosure framework in magnitude and cost and probably outpace it in complexity.”

And while there will no doubt be debate over the efficacy of this SEC rule in protecting investors, in particular in light of how expensive it will be to comply with and that it addresses GHG only and not the larger ESG space, the mandate is likely palatable to many because it only requires disclosure and sets no climate change limits or other restrictions on business.

And while there will no doubt be debate over the efficacy of this SEC rule in protecting investors, in particular in light of how expensive it will be to comply with and that it addresses GHG only and not the larger ESG space, the mandate is likely palatable to many because it only requires disclosure and sets no climate change limits or other restrictions on business.

The rule, which SEC Chair Gary Gensler acknowledges is based on the U.K. Net Zero Strategy, will require companies to disclose information about (1) the company’s governance of climate related risks and relevant risk management processes; (2) how any climate related risks identified by the company have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short, medium, or long term; (3) how any identified climate related risks have affected or are likely to affect the company’s strategy, business model, and outlook; and (4) the impact of climate related events (severe weather events and other natural conditions) and transition activities on the line items of a company’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.

But the reason this rule is consequential for business is that it will also require a company to disclose information about its direct GHG emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a company will be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3, and not defined in this rule), if material or if the company has set a GHG emissions target or goal that includes Scope 3 emissions (e.g., including if a company has committed to be carbon neutral by 2030, or the like [something that is today de rigueur]). The rule proposes a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. 

Under the rule accelerated filers and large accelerated filers would be required to include an attestation report from an independent attestation service provider covering Scopes 1 and 2 emissions disclosures, with a phase-in over time, “to promote the reliability of GHG emissions disclosures.” We have provided those services reliably for more than a decade and will be providing them under this mandatory rule.

The proposed rules would include a phase-in period for all companies, with the compliance date dependent on the company’s filer status, and an additional phase-in period for Scope 3 emissions disclosure, starting for fiscal year 2023 filed in 2024.

Nearly all, if not every company, including non public companies that are in the supply chain of a public company, will incur new and significantly greater time, effort and costs in complying with this new rule, including at a minimum in calculating GHG emissions.

Addressing ESG governance factors, this rule specifically requires disclosure of, among other matters, processes for how boards and management are informed of and make determinations about climate risks; all in a similar structure as the recent cybersecurity rule.

Comments on this proposed rule are due 30 days after publication in the Federal Register or May 20 (which is 60 days after issuance), whichever is later.

This rule is maybe best described as a big hairy audacious goal toward mandatory ESG disclosure. There are very real questions about what will ultimately be implemented after judicial challenges, complimentary actions by other nations, not to mention what the SEC will do after what is expected to be robust public comment. 

What is clear, is that nearly all, if not every business will incur new and significantly greater costs in complying with this new rule, including at a minimum calculating GHG emissions that will dwarf the cumulative existing SEC disclosure requirement for public companies. Climate change will no longer be reduced to a footnote in a third of annual reports, but rather will require yearlong work efforts that will result in more robust annual reporting by all businesses.

All of which makes this new climate rule an overarching environmental disclosure mandate all embracing of ESG, the biggest business opportunity in history, waiting to be unlocked.

If there is a takeaway, today, businesses across America should begin to read the more than 500 page rule, or better yet immediately begin to quantify their GHG emissions or in the alternative engage a consultant to develop a plan for GHG disclosures. Give us a call.

About the Author

Nancy Hudes and Stuart Kaplow, two Maryland attorneys who are among the principals at ESG Legal Solutions have combined forces, joining together to publish this blog leveraging their focused experience and legal knowledge for business interests in the ESG space.

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