Yesterday, the SEC unveiled its long-anticipated proposed climate risk disclosure rules. As expected, the implications are significant, and the proposal is clearly aligned with Larry Fink’s call for portfolio companies to report aligned with TCFD. Under the rule, companies must disclose their own direct and indirect greenhouse gas emissions, along with a bevy of additional data and details on operational actions that combat climate risk.

The proposed rule is now in the 60-day comment period, ending May 20^th, 2022. The SEC is expected to finalize the rule by year-end, although it will likely do so sooner.

The highlights

The proposal seeks revisions to Regulations S-K and S-X, providing for climate-related disclosures and financial metrics in company filings and financial statements. It encompasses both narrative and quantitative disclosures. Specifically, the proposed rule calls for the following types of disclosure:

• Governance: A description of board and management-level oversight and governance of climate-related risks
• Scope 1 and 2 Emissions: Metrics encompassing direct and indirect emissions from produced and purchased energy, expressed as:
  • Seven distinct greenhouse gas types
  • Aggregated CO2e
  • Absolute emissions and emissions intensity (per unit of economic output)
• Scope 3 Emissions: Metrics on emissions resulting from upstream and downstream value chain activities, are required only IF the emissions are material to the company or accounted for in an existing emissions reduction target
• Risk Statement: A description of applicable material climate-related risks including:
  • Physical risks, such as increased exposure to droughts and severe weather
  • Transition risks, such as regulatory changes and shifting consumer preferences
  • An explanation of how the identified risks are likely to impact business operations and financials and how they affect strategy, business model, and outlook
• Risk Management: A statement covering the company’s process for identifying and addressing short-, medium- and long-term climate-related risks including how these processes are integrated into the overall risk management and strategic planning process
• Financial Impacts: The financial impact of climate events and transition activities, represented in the existing line items of consolidated financial statements
• Situational Disclosures: Description of additional climate-related considerations (if any) used in risk assessment and management processes, including a description of any adopted climate transition plan and scenario analysis with relevant parameters, assumptions, analytical choices, and projected financial impacts as well as detailed disclosure of any internal carbon pricing
• Targets: For companies that have voluntarily adopted targets, increased details including the scope of activities and emissions included in the target; the time horizon and any interim targets; plans for reducing emissions to meet goals; relevant data to monitor progress, updated each fiscal year; and information about any carbon offsets or renewable energy certificates utilized
• Attestation Report from a Qualified Independent Service Provider: Covering Scope 1 and Scope 2 emissions and meeting minimum standards for acceptable attestation frameworks

Disclosure compliance dates are right around the corner

The proposed rule assumes that filers have a December 31^st fiscal year-end.  It sets different compliance dates for different types of filers and the various types of required disclosures:

• Large Accelerated Filers
  • Scope 1 and 2 disclosures and associated intensity metrics: Fiscal year 2023 (filed in 2024)
  • Scope 3 and associated intensity metrics (if required): Fiscal year 2024 (filed in 2025)
• Accelerated Filers and Non-Accelerated Filers:
  • Scope 1 and 2 disclosures and associated intensity metrics: Fiscal year 2024 (filed in 2025)
  • Scope 3 and associated intensity metrics (if required): Fiscal year 2025 (filed in 2026)
• SRC (Smaller Reporting Companies)
  • Scope 1 and 2 disclosures and associated intensity metrics: Fiscal year 2025 (filed in 2026)
  • Scope 3 and associated intensity metrics: Exempt

Financial reporting will require more resources

The SEC’s proposal aims to regulate existing pressure from investors and rating agencies to increase executive and board-level expertise on climate science. Companies cannot achieve this without investing time and resources in data collection, auditing, and verification processes. Just how big that investment must be depends, in part, on the number of facilities a corporation owns and the state of its current operational controls.  If the company must disclose Scope 3 emissions data, either because those emissions are deemed material or because the company has set targets encompassing them, then additional resources will be necessary to collect emissions data across the company’s value chain.

At a minimum, all companies will incur costs for increased data collection efforts and associated employee training. They will need to hire an independent registered public accounting firm to handle data auditing of climate-related impacts on financial statements. And they will need to work with an independent data verification firm that meets minimum requirements, as outlined in the proposed rule, for assessing the accuracy of the data and the calculation method. These qualified firms offer specialized expertise earned through rigorous processes, and it comes at a cost.

Additionally, the exercise of considering the near-, mid-, and long-term impact of climate risk and of adjusting risk management and strategic planning processes accordingly, consumes significant executive time. Indeed, the detailed requirements around the climate risk assessment process demand a certain level of climate risk expertise. Companies may want to consider creating a Chief Climate Officer, or comparable expert position, to oversee the company’s climate-risk disclosure initiatives.

While the costs can be steep, the good news is, the payoff is also considerable. This is particularly true for companies with low-carbon products and services that may benefit from the transition to a low-carbon economy. These companies now have an opportunity to report on these benefits and position themselves favorably in the wake of this regulation.

Key takeaways

• The only choice is to start the data collection process now. CFOs can’t put this off any longer, particularly for Scope 1 and Scope 2 emissions. Boards must also immediately begin considering specific expertise on climate change in their membership as well as specific climate risk oversight on a Committee or in the Board Charters. A climate-specific risk assessment is another probable must-do: the time horizons for climate-related risks are often different than other types of risks, so this exercise is essential to determining climate-related risk materiality.
• TCFD has become the de facto ESG framework, as the rule is clearly aligned with Larry Fink’s 2022 Letter to CEOs. The BlackRock CEO has called for all portfolio companies to report aligned with the TCFD framework. The SEC’s proposed requirements also align with the TCFD recommendations, specifically board and management oversight of climate risks and disclosure of Scope 1 and 2 metrics.
• Companies are off the hook on both Scope 3 emissions and target setting, with two powerful exceptions. The SEC is currently not requiring Scope 3 disclosures as long as they are not material to your business. (We think this means most technology, telco, and business services companies will be off the hook.) As to targets, the SEC’s proposed rule does not mandate the use of them but aims to give them a bit more teeth. If companies do voluntarily set targets, they are required to meet the same ESG verification and attestation requirements on those targets.
• It’s not clear that the verification and attestation requirements for scopes 1 and 2 GHG emissions will survive public comment. The costs may prove to be unduly burdensome to companies that are not serial emitters. We expect to see a significant number of comments on this subject during the 60-day comment period.

If you are interested in a discussion to learn more about how Riveron can help you prepare and report aligned with the proposed SEC regulation, contact us.