In an article published in December 2021, we noted that Securities and Exchange Commission (SEC) Chair Gary Gensler had asked SEC staff back in July 2021 to develop a “mandatory climate risk disclosure rule proposal” that would require public companies to report certain ESG metrics and risks to investors. On March 21, 2022, the SEC released its nearly 500 page rule proposal that would require reporting companies to include climate-related information in their registration statements and periodic reports (such as Form 10-K). In a fact sheet issued by the SEC, the Commission describes the following disclosures companies would be obliged to make if the rule is officially adopted:
Additionally, below are some noteworthy takeaways and implications of the rule proposal:
Included in the above disclosures is the volume of Scope 1 and Scope 2 greenhouse gas (GHG) emissions generated by the company. Scope 1 refers to direct emissions from sources owned or controlled by the company (e.g., company-owned vehicles, furnaces, boilers, etc.) while Scope 2 refers to indirect emissions from purchased electricity. For larger companies, the SEC will require an attestation report from an independent provider covering the disclosure of these emissions. In cases where Scope 3 emissions (i.e., indirect emissions from activities in a company’s value chain) are material to the company’s operations or where companies have made public GHG reduction pledges, these emissions would need to be disclosed as well.
Climate-related events refer to severe weather events or natural conditions that can adversely affect a company’s business or financials. Rising sea levels, flooding, tropical storms, droughts, wildfires, earthquakes, and extreme cold/heat can disrupt operations, damage supply chains, raise insurance costs, and cause a scarcity of resources or raw materials. Examples of companies that may be vulnerable to climate-related events could be:
If the company has publicly set climate-related targets or goals, it will need to give details regarding the goals, outline the time horizon and methods for meeting these goals, issue periodical progress updates, and disclose any risks that may come with the transition to more sustainable strategies (e.g., investment in new technology, increased costs related to reporting, etc.)
The SEC approved the new rule proposal in a 3-1 vote, citing greater disclosure framework standardization and enhanced investor protection as benefits of the proposed rule change. By giving investors insight into the environmental risks facing public companies—as well as the ways in which companies are anticipating and managing these risks—the SEC aims to help investors make more informed financial decisions.
However, the rule proposal has also met with criticism from several corners. Some business leaders and general counsel fear that the extensiveness of the required disclosures will prove costly for their companies, especially if they are required to disclose Scope 3 emissions. Scope 3 emissions are generated by both upstream and downstream activities in a company’s value chain and therefore involve gathering data from outside parties such as vendors, contractors, and customers. The emissions from these sources are almost always the most difficult and most costly to measure (although it should be noted that the rule proposal does include a “safe harbor” for liability for Scope 3 disclosures).
The one dissenting SEC vote, cast by Commissioner Hester Peirce, was followed by a statement opposing the rule change. In this statement, Peirce argues that the new framework is overly prescriptive, overreaching, and will place an undue burden on reporting companies. She posits that existing SEC disclosure requirements for material risks already naturally encompass any climate-related material risks. She further argues that the SEC’s materiality nexus for climate disclosures is either non-existent or too vague, saying, “Some of the proposed disclosure requirements apply to all companies without a materiality qualifier, and others are governed by an expansive recasting of the materiality standard.”
Peirce also argues that the SEC’s emphasis on quantitative data in the new disclosure rule may give investors a false sense of security: “…the release mistakenly assumes that quantification can generate clarity even when the required data are, in large part, highly unreliable. Requiring companies to put these faulty quantitative analyses in an official filing will further enhance their apparent reliability, while in fact leaving investors worse off, as Commission-mandated disclosures will lull them into thinking that they understand companies’ emissions better than they actually do.”
The SEC is accepting public comments on the rule proposal for the 60 days following its issuance.
If you have any further questions regarding SEC regulation or climate/ESG-related disclosures, please contact Roger E. Barton.