Comprehensive Analysis of the SEC’s Proposed Rule on Climate Disclosure Requirements
Overview
On March 21, 2022, the SEC issued a proposed
rule1 that would enhance and standardize the climate-related disclosures
provided by public companies. In his statement expressing support for the proposal, SEC Chair
Gary Gensler emphasized that “if adopted, it would provide investors with
consistent, comparable, and decision-useful information for making their
investment decisions and would provide consistent and clear reporting
obligations for issuers.”
Under the proposed rule, a registrant would be required to
provide disclosures in its registration statements and annual reports (e.g.,
Form 10-K). These would include climate-related financial impact and expenditure
metrics as well as a discussion of climate-related impacts on financial
estimates and assumptions, all of which would be presented in a footnote to the
audited financial statements. Such disclosures would also be subject to
management’s internal control over financial reporting (ICFR) and external
audit.
Outside of the financial statements, a registrant would need to provide
quantitative and qualitative disclosures in a separately captioned
“Climate-Related Disclosure” section that would immediately precede MD&A.
These disclosures would address:
- Scope 1, Scope 2, and Scope 3 greenhouse gas (GHG) emissions.
- Climate-related risks and opportunities.
-
Climate risk management processes.
-
Climate targets and goals.
-
Governance and oversight of climate-related risks.
Such disclosures would be subject to management’s disclosure
controls and procedures and certifications. In addition, the Scope 1 and Scope 2
GHG emission disclosures would be subject to attestation requirements consisting
of limited assurance during a phase-in period, followed by reasonable
assurance2 thereafter.
All disclosure requirements under the proposed rule would be
subject to phase-in over several years, depending on the size of the registrant
and the specific disclosures, as illustrated in the table below (assuming that
the proposed rule’s requirements are finalized by December 2022 and the
registrant has a calendar year-end3):
|
Registrant Type
|
All Disclosures Except Scope 3 GHG
Emission Disclosures
|
Scope 3 GHG Emission Disclosures
|
Attestation on Scope 1 and Scope 2 GHG
Emission Disclosures
|
|---|---|---|---|
|
Large accelerated filer
|
2023
|
2024
|
Limited assurance — 2024
Reasonable assurance — 2026
|
|
Accelerated filer
|
2024
|
2025
|
Limited assurance — 2025
Reasonable assurance — 2027
|
|
Nonaccelerated filer
|
2024
|
2025
|
Not required
|
Smaller reporting companies would be exempt from the Scope 3 GHG emission
disclosure requirements and would have an additional year of transition (i.e.,
all other disclosures would be required in 2025).
Key Components of the Proposed Climate Disclosure Requirements
In the proposing release, the SEC noted that certain aspects of the required
disclosures would be similar to those that some companies already provide under
existing disclosure frameworks and standards, such as the Financial Stability
Board’s Task Force on
Climate-Related Financial Disclosures (TCFD) and the
GHG Protocol.
The proposed rule’s specific disclosure requirements on the following topics are
discussed in the sections below:
Financial Statement Disclosures
The proposed rule would require registrants to disclose, in a footnote to the
financial statements, the financial statement impacts of (1) climate-related
events, including severe weather events and other natural conditions such as
flooding, drought, wildfires, extreme temperatures, and sea level rise, and
(2) transition activities, including “efforts to reduce GHG emissions or
otherwise mitigate exposure to transition risks.” A registrant’s
calculations should take into account, if applicable, the impact of
identified climate-related risks (see the Climate-Related
Risks section below). For both climate-related events and
transition activities, the disclosures would include financial impact
metrics, expenditure metrics, and a discussion of the impact on financial
estimates and assumptions.
Financial Impact Metrics
The proposed rule provides examples of the types of
disclosures registrants would provide to reflect the impact of
climate-related events and transition activities. These include the
following:
|
Examples of Financial Impact
Disclosures
| |
|---|---|
|
Climate-Related Events
|
Transition Activities
|
|
|
Registrants would be required to separately disclose all
negative and all positive impacts of climate-related events as well as
separately disclose all negative and all positive impacts of transition
activities. These disclosures would be required for each affected
financial statement line item if, on an aggregated basis, the absolute
value of all such impacts (i.e., the absolute value of both negative
impacts and positive impacts for both climate-related events and
transition activities) exceeds 1 percent of the related line item.
Connecting the Dots
When disclosing financial impact metrics and
expenditure metrics (discussed below), registrants would
use a “bright line” 1 percent threshold for disclosure purposes.
Accordingly, registrants would need to have appropriate
processes, procedures, and internal controls in place for
tracking this information and developing the disclosures when
preparing financial statements.
Example 1
For the year ended December 31,
20X2, Company A records (1) an impairment expense
related to inventory damaged in a significant
wildfire (a climate-related event) and (2) a
reduction in manufacturing expense due to its
energy conservation initiative (a transition
activity). To determine its financial impact
disclosures, A performs the following calculation:
|
Cost-of-Sales Line Item
|
Impact of Wildfire
|
Impact of Energy Conservation
Activities
|
Absolute Value of Positive and
Negative Impacts
|
Approximate Percentage
Impact
|
|---|---|---|---|---|
|
$200 million
|
$1 million of additional
expense
|
$1.5 million of reduced
expense
|
$2.5 million
|
1.25%
|
Because the absolute value of
the aggregated impacts of climate-related events
and transition activities exceed 1 percent of cost
of sales, A would separately disclose the positive
and negative impacts on its cost-of-sales balance
in a footnote to its financial statements. For
example, A may provide the following footnote
disclosure:
Note XX. Climate-related
financial metrics:
|
Financial Statement Line Item
|
Negative Impact From
Climate-Related Events
|
Positive Impact From
Transition Activities
|
|---|---|---|
|
Cost of sales
|
$1 million
|
$1.5 million
|
Expenditure Metrics
The proposed rule provides examples of expenditures that
a registrant may incur, and therefore be required to disclose, to
mitigate exposure to climate-related events and transition activities,
including the following:
|
Examples of Expenditures
| |
|---|---|
|
Climate-Related Events
|
Transition Activities
|
|
Expenditures intended to:
|
|
If the total amount expensed for climate-related events
and transition activities or the total amount capitalized for such
events and activities exceeds 1 percent of the registrant’s total
expenditures or capitalized costs, respectively, separate disclosure of
those amounts would be required, disaggregated by climate-related events
and transition activities. A registrant would perform this calculation
relative to total expenditures and capitalized costs, regardless of the
financial statement line items in which the amounts are included.
Example 2
For the period ended December
31, 20X2, Company B incurred (1) $1.5 million of
expenses related to relocating certain assets that
may be affected by climate-related events and (2)
$1.5 million of training expenses related to new
equipment intended to reduce GHG emissions.
Company B also capitalized $5 million of costs
related to the new equipment. Total expenses were
$250 million, and total capitalized costs were $30
million. To determine its disclosures related to
expenditure metrics, B performs the following
calculations:
Because the expenses and
capitalized costs exceed 1 percent of total
expenses and total capitalized costs,
respectively, B would disclose the expenses
related to both climate-related events and
transition activities and capitalized costs
related to transition activities in a footnote to
its financial statements. For example:
Note XX. Climate-related
financial metrics:
Connecting the Dots
In a manner consistent with the requirements
related to financial impact metrics under the proposed rule,
registrants may need to put additional processes, procedures,
and internal controls in place to track the information needed
to provide expenditure metrics when preparing their financial
statements. However, it may be difficult for registrants to
identify expenditures specifically associated with
climate-related events and transition activities. For example,
the portion of a newly acquired fixed asset or the change in an
insurance premium that is directly attributable to climate may
be difficult to ascertain, particularly when other factors are
at play (e.g., technological advances or other factors that
contribute to insurance cost). During our review of the SEC’s
Division of Corporation Finance (DCF) publicly released
company-specific comment letters (see the Current SEC Guidance
and Activities Related to Climate Change section
below for more information), we observed that information
related to such expenditures was not readily available to some
registrants.
Financial Estimates and Assumptions
Under the proposed rule, registrants would need to
provide disclosures about whether risks, uncertainties, or known factors
associated with climate-related events and transition activities
(including the registrant’s own climate-related targets or goals)
affected the estimates and assumptions reflected in its financial
statements. If applicable, a registrant would be required to
qualitatively disclose how the estimates and assumptions were affected.
For example, a registrant that establishes a specific climate target may
plan to retire certain assets early to reduce GHG emissions. Any change
in the useful life associated with these assets would represent a
financial estimate affected by transition activities.
Additional Financial Statement Disclosure Considerations
A registrant would perform these financial impact metric
and expenditure metric calculations in a manner consistent with the
consolidation principles reflected in its financial statements and, if
applicable, would consider the same accounting principles. The
disclosures would be required for all periods presented in the financial
statements (i.e., two years or three years, depending on the
registrant’s requirements). Appropriate context would need to be
provided, including a description of how the metrics were derived, the
significant inputs or assumptions used, and any policy choices related
to the calculation of the metrics. The disclosures would also be subject
to audit in accordance with PCAOB standards.
Connecting the Dots
The proposed rule states that if a registrant
has not previously presented the metrics in historical periods
and the “historical information necessary to calculate or
estimate such metric is not reasonably available to the
registrant without unreasonable effort or expense, the
registrant may be able to rely on Rule 409 or Rule 12b-21 [of
the Securities Exchange Act of 1934] to exclude a corresponding
historical metric.” While those rules allow a registrant to
disclose, in its required SEC filings, information that is
available and include a statement that omitted information could
not be obtained without unreasonable effort or expense, we have
observed historically that registrants rarely avail themselves
of this accomodation.
The proposed rule would allow, but not require, a
registrant to disclose the impact of any opportunities associated with
climate-related events, transition activities, or any other
climate-related opportunities. See further discussion below in the
Climate-Related
Risks section below.
GHG Emissions
Under the proposed rule, GHG emissions are categorized and defined as
follows:
|
Scope 1 GHG emissions
|
“[D]irect GHG emissions from operations that are
owned or controlled by a registrant.”
|
|
Scope 2 GHG emissions
|
“[I]ndirect GHG emissions from the generation of
purchased or acquired electricity, steam, heat, or
cooling that is consumed by operations owned or
controlled by a registrant.”
|
|
Scope 3 GHG emissions
|
“[A]ll indirect GHG emissions not otherwise included
in a registrant’s Scope 2 emissions, which occur in
the upstream and downstream activities of a
registrant’s value chain.”
|
The proposed rule also identifies certain upstream and downstream activities
(Scope 3):
|
Upstream Activities
|
Downstream Activities
|
|---|---|
|
|
Measures
Registrants would be required to disclose Scope 1 and
Scope 2 GHG emissions; Scope 3 GHG emission disclosures would be
required if material or a registrant has established a reduction target
or goal (see the Climate Targets and Goals section below) that includes
such emissions. For each emission scope, a registrant would be required
to disclose gross emissions (before consideration of any purchased or
generated offsets) (1) disaggregated by each GHG (carbon dioxide,
methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons,
perfluorocarbons, and sulfur hexafluoride) and (2) on an aggregated
basis by using carbon dioxide equivalents (“CO2e”). A
registrant would also be required to disclose GHG intensity in terms of
tons of CO2e per unit of revenue and per unit produced for
the total of Scope 1 and Scope 2 GHG emissions and separately for Scope
3 GHG emissions. If a registrant does not have revenue or production,
the registrant would be required to disclose another measure of GHG
intensity. Further, a registrant may disclose additional measures of GHG
intensity if it discloses that such metric was used and why it is useful
to investors.
Boundaries
The proposed rule states that organizational boundaries used “must be
consistent with the scope of entities, operations, assets, and other
holdings within its business organization as those included in, and
based upon the same set of accounting principles applicable to, the
registrant’s consolidated financial statements.” That is, GHG emissions
disclosed under the proposed rule would reflect all emissions for
consolidated subsidiaries and the registrant’s share of GHG emissions
for investments for which the registrant applies either proportional
consolidation or the equity method of accounting. Any entities not
consolidated, proportionally consolidated, or accounted for under the
equity method would be reflected in the Scope 3 GHG emission
disclosures.
Connecting the Dots
While many aspects of the proposed rule are consistent with the
GHG Protocol, the treatment of subsidiaries and affiliates is
not. The GHG Protocol permits a company to apply either an
equity share approach (reflecting its economic interest in each
subsidiary) or a control approach (reflecting the emissions for
any controlled subsidiary). A company can choose to define
“control” either in financial or operational terms. Under the
proposed rule, registrants already reporting under the GHG
Protocol would need to revise their reporting boundary and
inventory management plan to align with the consolidated
financial statements.
Methods and Assumptions
Regardless of the scope of GHG emissions it discloses, a registrant would
need to include its significant inputs and assumptions as well as the
method it used to perform the corresponding calculations. While the
proposed rule does not prescribe a specific method for GHG emission
calculations, a registrant would have to disclose the approach it used
(including the use of any material, third-party data), calculation
tools, and organizational and operational boundaries. It would also need
to disclose any data gaps and whether proxy data or another method has
been used to address them. If a registrant changed the method or
assumptions it used to measure GHG emissions between the current and
prior year, it would be required to disclose such change.
Connecting the Dots
The proposed rule does not outline the specific
disclosures that a registrant must provide when a change occurs.
However, ASC 250,4 which requires a company to disclose, among other
information, the nature and reason for a change as well as a
description of the impacts on the affected financial statement
line items, may be applied analogously.
Estimates
The proposed rule would permit a “reasonable estimate” for fourth quarter
GHG emission disclosures in the absence of current available data as
long as the registrant discloses any material differences between the
actual versus estimated GHG emission data in its next filing. Within its
annual report, a registrant would be required to disclose any material
changes between the method or significant assumptions used in the
calculations in the current period and those used in historical periods.
Information about GHG emissions would be required for the most recently
completed fiscal year and, if reasonably available, would need to be
provided for the historical periods presented within a registrant’s
financial statements.
Connecting the Dots
As noted in the Financial Statement
Disclosures section above, the proposed rule
indicates that registrants may be able to omit certain required
information under Rule 409 or Rule 12b-21 of the Securities
Exchange Act of 1934; however, we have rarely observed instances
in which registrants have done so for other required
disclosures.
Additional Scope 3 Disclosures
If a registrant discloses Scope 3 GHG emissions, it would be required to
describe the categories of upstream and downstream activities included
in the calculation and provide separate Scope 3 GHG emission disclosures
for each significant category. Further, the proposed rule explicitly
states that a registrant would be required to consider “outsourced
activities that it previously conducted as part of its own operations”
when measuring Scope 3 GHG emissions. A registrant can also provide a
range for its Scope 3 GHG emissions “as long as it discloses its reasons
for using the range and the underlying assumptions.”
In addition, a registrant would be required to disclose the data it used
to calculate its Scope 3 GHG emissions, including any of the following:
-
“Emissions reported by parties in the registrant’s value chain, and whether such reports were verified by the registrant or a third party, or unverified.”
-
“Data concerning specific activities, as reported by parties in the registrant’s value chain.”
-
“Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a registrant’s value chain, including industry averages of emissions, activities, or economic data.”
Scope 3 GHG emission disclosures would be subject to securities law safe
harbor provisions, and they would not be considered fraudulent under
such law unless there was no reasonable basis to make or reaffirm them
or they were provided other than in good faith.
Governance
The proposed rule would require a registrant to disclose the following
information about how its board of directors oversees climate-related risks:
-
The specific board member(s) or board committee(s) responsible for overseeing climate-related risks.
-
Whether any board member has expertise in climate-related risks and, if so, the nature of such expertise.
-
The processes undertaken by the board of directors or board committee(s) to discuss climate-related risks, how those groups are informed of such risks, and how frequently such discussions occur.
-
How climate-related risks are considered by the board of directors or board committee(s) “as part of its business strategy, risk management, and financial oversight.”
-
How the board of directors establishes climate-related targets or goals or oversees the registrant’s progress toward such targets or goals.
Connecting the Dots
The proposed rule’s requirements related to
identifying a climate-related risk expert may be viewed similarly to
those associated with identifying an audit committee financial
expert under the Sarbanes-Oxley Act5 since both require the expert to be named. However, the
proposed rule would require a registrant to describe the
individual’s expertise in “detail as necessary to fully describe the
nature of the expertise.” Such disclosure is generally not required
for an audit committee financial expert.
In addition, the proposed rule would require a registrant to provide the
following disclosures regarding how its management assesses and manages
climate-related risks:
-
The specific executives or management committee(s) responsible for assessing and managing climate-related risks.
-
The relevant expertise of management.
-
The processes that management undertakes to obtain information about and monitor climate-related risks.
A registrant may also elect to disclose management’s role in assessing
climate-related opportunities and the board of director’s oversight of such
opportunities.
Connecting the Dots
The disclosures described above, particularly with
respect to risk management and governance, are consistent with those
in the SEC’s recent proposed rule6 on cybersecurity risk. Historically, matters related to
governance have been described primarily in a registrant’s proxy
statement. Under the proposed rule, expanded governance disclosures
would be required in annual reports, and the timeline for providing
such governance information would be accelerated.
Climate-Related Risks
A registrant would be required to disclose how climate-related risks have (1)
had or are likely to have a material impact on its business or financial
statements and (2) affected or are likely to affect the registrant’s
“strategy, business model, and outlook.” The proposed rule defines
climate-related risks 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.”
These risks may include physical risks that are acute (e.g., hurricanes,
floods) or chronic (e.g., longer-term weather patterns such as sustained
higher temperatures) as well as transition risks. The table below outlines
the disclosure requirements.
|
Required Disclosures by Type of
Climate Risk
| |
|---|---|
|
Physical Risks
|
Transition Risks
|
|
Nature of the risk and whether it is related to
regulatory, technological, market, liability,
reputational, or other transition risks.
|
For all climate-related risks, a registrant would be
required to disclose the actual or potential impacts of the risk, including
on its operations, products, services, suppliers, transition activities
(e.g., new technologies or processes), research and development
expenditures, or “any other significant changes or impacts.” The disclosures
would also address how the risks affect or are reasonably likely to affect
the financial statements, including those related to the metrics associated
with financial impacts and expenditures described in the Financial Statement
Disclosures section above. A registrant would also have to
disclose how the risks affect business strategy, financial planning, and
capital allocation and whether the impacts are expected to occur in the
short, medium, or long term. The proposed rule does not prescribe such time
frames but would require registrants to develop their own definitions and
disclose them.
Connecting the Dots
Many public companies currently address climate-related risks as part
of their risk factor disclosures in their annual reports. For
example, more than three-quarters of companies in the S&P 500
index disclosed matters related to climate change or emissions in
the risk factor section of their most recent annual report. However,
the proposed rule would require significantly more granular
disclosure than the information companies currently provide.
If a registrant uses an internal carbon price (e.g., a
monetary cost assigned to carbon emissions for budgeting, forecasting, or
performance management), it would be required to disclose (1) the current
price per metric ton of CO2e, (2) the registrant’s total price,
(3) whether and, if so, how the total price is expected to change over time,
(4) how such price is determined and the rationale for selecting it, and (5)
how the price is used to assess and manage climate-related risks.
If a registrant uses a scenario analysis or another analytical tool to assess
the resilience of its business, it would need to describe the scenario
(e.g., 2 degree increase), the assumptions made, and the scenario’s
projected financial impacts.
The proposed rule would permit (but not require) disclosure of
climate-related opportunities, which are defined as “actual or potential
positive impacts of climate-related conditions and events on a registrant’s
consolidated financial statements, business operations, or value chains, as
a whole.”
Climate Risk Management
A registrant would be required to disclose its processes for “identifying,
assessing, and managing” climate-related risks. Such disclosure would
include how the registrant (1) assesses the significance and materiality of
climate-related risks; (2) considers actual or potential regulations (e.g.,
GHG emission limits) as well as shifts in customer demand, technology, or
market prices in assessing transition risks; and (3) prioritizes and
mitigates climate-related risks. Further, a registrant would disclose
whether those processes are integrated into its broader risk management
program.
If a registrant has adopted a climate transition plan, the proposed rule
would require a description of such plan, including how the registrant
intends to mitigate or adapt to climate-related risks as well as the
relevant targets and metrics used in identifying and managing physical and
transition risks. A registrant would be required to update its disclosure
annually to specify its progress toward completing the transition plan.
The proposed rule would also permit, but not require, a registrant to
disclose its process of identifying, assessing, and managing climate-related
opportunities.
Climate Targets and Goals
If a registrant has set any climate-related targets or goals related to, for
example, a reduction in GHG emissions, energy usage, or water usage, it
would be required to disclose information such as:
-
The scope of activities encompassed in the target (e.g., Scope 1 and Scope 2 only, domestic operations only).
-
The time horizon envisioned for achieving the target (e.g., a 50 percent reduction in GHG emission by 2030).
-
Any interim targets established.
-
How the target is measured (e.g., reduction of CO2e emitted, reduction of CO2e emitted per unit of revenue).
-
How the registrant plans to achieve its targets or goals.
-
An update each year of the registrant’s progress relative to its targets or goals and how (or whether) such progress has been achieved.
-
If carbon offsets or renewable energy certificates (RECs) have been used as part of the plan to achieve climate-related targets or goals, information about the carbon offsets or RECs, including how much of the progress made is attributable to offsets or RECs.
Connecting the Dots
In recent comment letters from the DCF (see the Current SEC
Guidance and Activities Related to Climate Change
section below), registrants were asked to describe the impact of
climate-related commitments on their costs and capital expenditures
in the context of MD&A. The proposed rule would expand on these
comments and add specific disclosure requirements related to climate
targets and goals.
Attestation Requirements
A registrant’s financial statement footnote disclosures
would be subject to existing audit requirements for financial statements and
ICFR. The Scope 1 and Scope 2 GHG emission disclosures would be subject to
limited assurance during a phase-in period, followed by reasonable
assurance. Any voluntary assurance obtained (e.g., Scope 3) would be subject
to the same requirements and the same attestation standards as Scope 1 and
Scope 2 GHG emission disclosures. While the proposed rule does not prescribe
specific attestation standards, it imposes certain minimum requirements for
those standards, including that they be publicly available, established with
appropriate due process, and subject to public comment.
Under the proposed rule, a GHG emissions attestation provider would have to
be (1) an expert in GHG emissions that performs engagements in accordance
with professional standards and (2) independent from the registrant. The GHG
attestation report would include specific information such as the specific
attestation standard used, management’s responsibility for the information,
and the attestation provider’s responsibility. The registrant would also be
required to provide additional disclosures, including those related to the
attestation provider’s (1) licensing or accrediting information and (2)
record-keeping obligations, as well as whether the attestation engagement is
subject to an “oversight inspection program.”
Connecting the Dots
While the proposed rule does not establish specific attestation
standards, its requirements are consistent with the standards issued
by the AICPA, PCAOB, and IAASB. Further, the independence
requirements required under the proposed rule are similar to those
already established for independent registered public accounting
firms.
Internal Controls and Disclosure Controls and Procedures
The disclosures outlined in the Financial Statement Disclosures
section above would be subject to a registrant’s ICFR because they would be
included in the audited financial statements. Accordingly, both management’s
assessment and the auditor’s attestation regarding the effectiveness of
ICFR, which must be provided by accelerated and large accelerated filers
that are not EGCs, would need to address the proposed rule’s additional
disclosure requirements.
Disclosure controls and procedures (DCPs) are a broad set of
controls that largely encompass ICFR and are designed to ensure that
information that must be disclosed by the registrant in its filings or
submissions under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within specified periods. Management
must disclose its evaluation of DCPs and provide certifications related to
the information disclosed in quarterly and annual reports. The disclosures,
including GHG emissions, that would be required outside of the financial
statements would be subject to a registrant’s DCPs and management
certifications.
Location and Timing of Required Disclosures
Under the proposed rule, a registrant would provide the disclosures in its
registration statements (e.g., Forms S-1, S-3, S-4, F-1, F-3, F-4) as well
as its annual reports (e.g., Forms 10-K and 20-F). The disclosures outlined
in the Financial Statement Disclosures section above
would be required in the financial statements, whereas the remaining
disclosures, including GHG emissions and related attestation report, would
be required in a newly created “Climate-Related Disclosure” section that
would be presented immediately before MD&A. If disclosure requirements
outlined in the proposed rule are addressed in other sections of the
document (e.g., MD&A, risk factors), a registrant would be permitted to
incorporate them by reference in the Climate-Related Disclosure section. The
disclosures in the financial statements and the Climate-Related Disclosure
section would be due at the same time as a registrant’s registration
statement or annual report. The proposed rule would require a registrant to
electronically tag the required narrative and quantitative disclosures by
using Inline XBRL.
The financial statement disclosures discussed above would only be required in
audited financial statements and thus would not be included in interim
financial statements filed on Form 10-Q. However, the proposed rule would
require a registrant to disclose, in its quarterly reports on Form 10-Q (for
domestic registrants) or Form 6-K (for foreign registrants), any material
changes to the information disclosed in its last annual report. This may
include, for example, material changes in fourth quarter emissions if a
registrant used estimates for disclosures in its annual report.
Affected Companies
The proposed rule’s disclosures would be required for all domestic and
foreign registrants, except for asset-backed issuers. Further, the
disclosures would be required for companies completing an initial public
offering (IPO) and private operating companies (target) merging with a
registrant (including special-purpose acquisition companies). The
information for target companies would be required in the proxy statement or
Form S-4 filed in advance of the transaction.
Connecting the Dots
An EGC is a category of issuer that was established in 2012 under the
Jumpstart Our Business Startups Act to encourage certain companies
to undertake IPOs by permitting them to apply less stringent
reporting and regulatory requirements for a certain period. Notably,
the proposed rule does not provide any exemption for EGCs
undertaking an IPO; therefore, such entities would be subject to the
same disclosure requirements as non-EGCs.
Materiality
The proposed rule states that the definition of materiality
used by a registrant should be consistent with the Supreme Court’s
definition; that is, “a matter is material if there is a substantial
likelihood that a reasonable investor would consider it important when
determining whether to buy or sell securities or how to vote.” The proposed
rule emphasizes that materiality is based on facts and circumstances and
takes into account qualitative and quantitative factors as well as the
probability and magnitude of future events.
Questions to Consider
The proposed rule would significantly change the climate-related disclosure
requirements for public companies. For most companies the effort needed to
comply with the disclosure requirements will be substantial, and the time to
begin preparing is now.
In a recent Deloitte survey of 300 finance, accounting, sustainability,
and legal executives at public companies with over $500 million in revenue, more
than half (57 percent) indicated that data availability (access) and data
quality (accuracy or completeness) remain their greatest challenges with respect
to environmental, social, and governance (ESG) data for disclosure. Less than a
quarter (21 percent) of respondents currently have an ESG council or working
group focused on ESG topics; however, more than half (57 percent) are actively
working to establish one. A strong majority (82 percent) also believe that they
will need additional resources to generate ESG disclosures that meet the
information needs of critical stakeholders.
Given the challenges expressed by survey respondents and in
anticipation of the final rule, companies may wish to begin preparing ahead of
time by using the proposed rule as a guide and by considering the following
questions:
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With whom does the oversight responsibility for climate-related or other ESG risks and opportunities reside? What involvement does finance, internal audit, the audit committee, or the board of directors have? What policies and procedures are in place to govern such involvement?
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What climate-related information is currently gathered and available? What level of assurance is currently obtained over this information? What additional information (if any) would need to be developed or gathered (including for disclosure in the audited financial statements)?
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How does the company evaluate the materiality of climate-related disclosures? Are there systems and processes in place for gathering the necessary information for determining whether such disclosures are material?
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What DCPs are in place to address the proposed rule’s disclosure requirements, and what ICFR is in place to address the disclosure that would be required in the audited financial statements?
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When is climate-related information currently prepared and reviewed? How does that timing compare with the reporting deadlines proposed by the SEC? What resources (e.g., people, processes, technologies) would the company need to meet the proposed reporting deadlines?
As noted above, the SEC has indicated that the proposed rule is consistent with
existing frameworks or standards, such as those recommended by the TCFD and the
GHG Protocol. Therefore, registrants that already provide such disclosures may
be better positioned to implement the proposed rule’s requirements.
Current SEC Guidance and Activities Related to Climate Change
The proposed rule arrives approximately one year after then SEC Acting Chair
Allison Herren Lee issued a request for input on climate-change disclosures as a
prelude to rulemaking. Chair Gensler has similarly focused on climate risks and
climate-related disclosures during his tenure. For example, in his
testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, he noted that “[c]ompanies and investors alike would
benefit from clear rules of the road” and that he had directed the SEC staff to
consider economic analysis and public comment in developing the requirements
related to such disclosures.
Currently, the SEC’s guidance on climate-related disclosures is
primarily contained in its 2010 interpretive
release,7 which provides considerations within the context of existing SEC
requirements. Further, in September 2021, the DCF issued comment letters to more
than 30 registrants about their climate-change disclosures on the basis of the
themes in the 2010 interpretive release. On September 22, 2021, the DCF publicly
released a “Dear Issuer” letter that included samples of the types of
comments the DCF may issue to public companies about such disclosures. The
sample comments, which the DCF published before publicly releasing any
company-specific letters about climate disclosures, served as an early warning
to registrants that had not received comments from the DCF about such
disclosures. For more information about the “Dear Issuer” letter, see Deloitte’s
September 27, 2021, Heads
Up.
Beginning in February 2022, the DCF began to publicly release company-specific
comment letters and responses related to climate disclosures. The DCF’s comments
in those letters, which were largely consistent with its sample comments,
demonstrated that the staff had considered public disclosures in corporate
social responsibility (CSR) reports and other corporate disclosures. They also
contained inquiries about whether registrants would need to make material
capital or operating expenditures to honor climate-change mitigation
commitments, such as reducing greenhouse gases. We observed that if registrants
received a company-specific comment letter, such letter contained, on average,
around six comments. In addition, substantially all registrants that received an
initial letter received a follow-up comment letter that included, on average,
about five comments. In certain cases, registrants received a third round of
comments from the DCF.
In their responses to the comment letters, many registrants stated that (1)
specific climate-related disclosures mentioned in the comments would not be
material to their business; (2) climate-related disclosures and risk factors
were already incorporated into their existing disclosures; or (3) the
information in their CSR report was intended for a broader audience than users
of the SEC filings. In other words, they generally believed that while
employees, customers, suppliers, nongovernmental organizations, and governments
may use CSR reports, not all the information contained within them is material
for disclosure purposes in SEC filings. The DCF’s follow-up comment letters
principally requested a more detailed materiality analysis as support for the
initial responses, which registrants provided. In some cases, registrants agreed
to modify or expand language in future filings, particularly that related to
risk factors and, to a lesser extent, MD&A. We did not observe follow-up
comments from the DCF regarding information that registrants included in the CSR
reports but excluded from SEC filings.
In addition to the proposed rule, the SEC’s regulatory agenda includes potential
amendments to SEC regulations related to investment fund names. Such amendments
may address certain requirements associated with the characterization of
investment funds as “sustainable” or “ESG” funds.
Providing Feedback to the SEC
The SEC is interested in feedback on the proposed rule from market participants
and does not require a specific format for the submission of comments. Some
commenters may choose to present their views in a narrative format without any
reference to specific questions posed by the SEC, and others may choose to
answer all, or only some, of the specific requests for comment. Any format is
acceptable, and the SEC encourages all types of feedback. Comments on the
proposed rule are due 30 days after its publication in the Federal Register or
May 20, 2022, whichever is later.
Other Resources
In addition to the resources discussed above, Deloitte resources such as the
following may help companies assess their approach to climate-related
disclosures:
See also:
Footnotes
1
SEC Proposed Rule Release No. 33-11042, The
Enhancement and Standardization of Climate-Related Disclosures for
Investors.
2
The objective of a limited assurance engagement is for
the service provider to express a conclusion about whether it is aware
of any material modifications that a registrant should make to ensure
that the subject matter (e.g., the Scope 1 and Scope 2 GHG emission
disclosure) is fairly stated or in accordance with the relevant
criteria. By contrast, the objective of a reasonable assurance
engagement, which provides the same level of assurance as an audit of a
registrant’s financial statements, is to express an opinion on whether
the subject matter is, in all material respects, in accordance with the
relevant criteria.
3
If a large accelerated filer or accelerated filer does
not have a calendar year-end and its 2023 or 2024 fiscal year would
begin before the mandatory compliance dates described above, the
registrant would not have to comply with the GHG emissions disclosure
requirements until the following fiscal year. That is, calendar-year-end
companies would be the first to be required to adopt the proposed
rule.
4
FASB Accounting Standards Codification
(ASC) Topic No. 250, Accounting Changes and Error
Corrections.
5
See SEC Final Rule Release No.
33-8177, Disclosure Required by
Sections 406 and 407 of the Sarbanes-Oxley Act of
2002.
6
SEC Proposed Rule Release No. 33-11038,
Cybersecurity Risk Management, Strategy, Governance,
and Incident Disclosure.
7
SEC Interpretation Release No. 33-9106, Commission
Guidance Regarding Disclosure Related to Climate Change.