Streamlining ESG for Investors: SEC Proposes New Rules for Climate-Related Disclosures

Today’s investors seek to better understand the market implications of the transition to a low-carbon economy and how companies manage environmental impacts. Public companies must provide comprehensive information to enable well-informed decisions and voting by investors, including climate-related disclosures, for which regulatory guidance has existed since 2010. As investors desire more thorough, consistent, and comparable information, the Securities and Exchange Commission (SEC) is taking an all-encompassing approach to improve environmental, social, and governance (ESG) disclosures.

In March, the SEC approved a set of proposed rules requiring registrants to disclose certain climate-related information in their financial statements and reports. Under the proposed rules, registrants will be subject to several new disclosure requirements.

Disclosing climate risks, carbon pricing and offsets, and greenhouse gas emissions

Climate-related risks: Climate events can pose financial risks to companies across industries. The proposed rules will require issuers to assess the impacts of climate-related risks on their strategy, business model, outlook, products and services, other parties in their value chain, activities to mitigate climate risks, and R&D expenditures. Disclosures in the registration statements and annual reports will include any climate-related risks that are reasonably likely to have a material impact on the business, results of operations, or financial condition.

Carbon offsets and renewable energy credits: Registrants will be required to disclose the role that carbon offsets or renewable energy certificates (RECs) play in their climate-related business strategy. A registrant that purchases and uses carbon offsets or RECs to attain its emission goals would need to disclose the additional associated short- and long-term costs and risks, including the risk of limited availability of RECs or the potential for future legislation truncating the value of these RECs.

Internal carbon pricing: Determined by estimating the cost of carbon emissions used internally within the organization, registrants may use internal carbon pricing for various reasons; however, if it is used to assess climate-related factors, disclosure of the price and associate rationale will be required.

Greenhouse gas (GHG) emissions metrics disclosures and phased compliance: Issuers will be required to disclose their GHG emissions for the most recent fiscal year. GHG data, which is required to be reported in terms of CO2e, is quantifiable and easily comparable across industries. The SEC will not provide a GHG emissions calculation methodology, thus allowing issuers flexibility to determine the most appropriate calculation for their operations; however, issuers must describe their calculation and methodology used. The proposed GHG emissions disclosure is divided into scopes based on direct and indirect emissions:

• Scope 1: direct GHG emissions from operations owned or controlled by the registrant
• Scope 2: indirect emissions from the purchase of acquired electricity, steam, or other forms of energy that are consumed by operations owned or controlled by the registrant
• Scope 3: indirect emissions from upstream and downstream activities within the registrant’s value chain. If these emissions are material, then the registrant must disclose them and set emission reduction goals.

For Scope 1 and 2 emissions, registrants must use the same scope of assets, entities, and operations included in, and based on, the same accounting principles used for its consolidated financial statements. The proposed GHG rules would be phased in for all issuers whose compliance dates depend on the filing status (“as a large accelerated filer, accelerated or nonaccelerated filer, or SRC”) and the disclosure content. In addition, the SEC notes that parties subject to disclose to Scope 3 emissions have one additional year to comply with those requirements.

Considerations impacting business strategy, governance, risk, and financial reporting

Scenario analysis: Registrants will be required to expound on the resilience of their business strategy and approach in relation to potential impacts of climate-related risks on the business and consolidated financial statements. The proposed rules will not require issuers who do not already conduct scenario analyses to complete them for different climate-related instances; however, those issuers who do use scenario analysis, or other analytical tools, will be asked to provide information surrounding their analyses.

Governance disclosures: Similar to the Task Force on Climate-Related Financial Disclosures (TCFD) framework created in 2015, the proposed rules will require issuers to disclose information on the oversight of the company’s board and management’s role in assessing climate-related risks. The purpose is to provide investors with insight into the organization’s governance structure, in line with the SEC’s existing rules under Regulation S-K that call for disclosure regarding corporate governance.

Risk management disclosures: Issuers will be required to describe their overall risk management system and the integrated processes surrounding the identification, assessment, and management of climate-related risks. Issuers will also be required to disclose whether they have implemented a transition plan to reduce climate-related risks and how they plan to achieve their GHG emissions reduction goal. These plans may also shed light on the transition risks arising from technological change, changes in market prices, or customer changes. If a transition plan has been adopted, the registrant will be required to disclose the metrics and targets used to identify and manage the transition risks.

Financial statement metrics: Registrants will be required to disclose in a note to their financial statements certain disaggregated climate-related financial statement metrics mainly derived from existing financial statement line items such as metrics on financial impacts, expenditure metrics, and financial estimates and assumptions. Disclosure of the financial impacts on each consolidated financial statement line item and identified climate-related risks will also be required unless the aggregated impact is less than one percent of the total line item for the relevant fiscal year. If the estimates and assumptions used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with climate-related events, this should be included in the disclosure, along with a qualitative explanation of how such events have influenced the development of the estimates and assumptions.