On March 21, 2022, the Securities and Exchange Commission (SEC) proposed new rules to enhance and standardize disclosures related to climate-related risks, their climate-related targets and goals, their greenhouse gas (GHG) emissions, and how the board of directors and management oversee climate-related risks. The proposal would also require registrants to quantify the effects of certain climate-related events and transition activities in their audited financial statements.
What the proposal could mean for you
While relief from certain requirements would be provided to small entities, the proposed rules are expected to have a widespread effect on all registrants, including smaller reporting companies, emerging growth companies and foreign private issuers. They also would apply to companies entering the US capital markets for the first time by initial public offering, and acquisition targets of public companies in a Form S-4. As companies review, comment on and work toward potential implementation of the proposal, they may want to consider the following factors:
Far-reaching impacts, even for companies with a history of disclosing detailed climate-related information
The proposal refers to the Task Force on Climate-related Financial Disclosure (TCFD) and the Greenhouse Gas Protocol (GHG Protocol) and leverages certain aspects of each.¹ Many companies already report, usually outside of their regulatory filings, climate-related information under frameworks that are, at least in part, aligned with the TCFD and GHG Protocol. Companies that already voluntarily follow such frameworks could be at an advantage. However, there could be far-reaching impacts even for companies with a history of disclosing climate-related information. Consider the following:
- Partial application — While the proposal is broadly based on themes that can be found in the TCFD recommendations and GHG Protocol, companies that partially report under those frameworks would need to re-evaluate their disclosures based on the explicit requirements under the proposal.
- Boundaries — The proposal would align reporting boundaries with a registrant’s consolidated financial statements. Registrants that currently report emissions voluntarily under the more flexible GHG Protocol should evaluate how this might impact their reporting.
- Assurance — The proposal would require large accelerated filers and accelerated filers to obtain assurance over the GHG-related disclosures on Scope 1 and 2 emissions. Although assurance requirements would be phased in one year after the required disclosure, companies voluntarily obtaining assurance may need to comply with the assurance requirements at an earlier date.
- Climate-related goals and targets — The proposal would require registrants to provide certain information about climate-related targets or goals that have been set, including a description of the scope of activities or emissions included in the target, the intended time horizon and process for achievement, and progress toward meeting the target. In addition, the proposal would require disclosure of Scope 3 GHG emissions if the registrant has set a GHG emissions target that includes Scope 3 emissions.
Re-evaluation of existing processes
To implement the proposal, registrants may need to reconsider their existing processes for determining materiality. For much of the suggested new requirements, the proposal does not explicitly redefine materiality in comparison to other SEC requirements. However, the proposal would require registrants to disclose certain quantitative metrics about climate-related events, transition activities and expenditures in a note to the audited financial statements if those impacts are 1% or greater of any financial statement line item in a fiscal year.
Organizations may need to create or formalize processes to identify events and transactions that are climate-related and track information at a more granular level than they do for most financial statement disclosures.
Opportunity for improved ESG reporting
Apart from limited required disclosures, environmental, social and governance (ESG) reporting has largely been voluntary. Some companies with more experience in voluntary ESG reporting have used ESG reporting to give a broader picture of the long-term value of their business. Companies with less mature ESG reporting functions may not have had the opportunity to develop clear messages on how ESG topics integrate with their strategy, governance and risk management.
Consideration of implementing the proposed rules may provide an opportunity for such companies to rethink how they approach ESG reporting overall and integrate it into their strategic, governance and risk management decisions.
What you can do now
Adopting climate-related disclosure rules is likely to be a large undertaking for any organization. Although the proposal isn’t finalized, companies may want to identify potential implementation challenges and opportunities. Outlined below are some actions that companies may want to consider now.
Depending on its particular facts and circumstances, implementation of the proposal may look different from one registrant to another. Certain proposed disclosures require a qualitative assessment to determine what key climate-related information companies should disclose and how. Determining the overall scope of a company’s climate-related disclosures will lay the foundation for the rest of the implementation effort.
An important next step is ensuring that the company can appropriately identify and collect climate-related information within applicable organizational boundaries. Registrants may be able to reduce the cost of implementing the proposal by leveraging data already published in the company’s annual sustainability report and other internal and external communications.
Identifying, collecting and managing the disclosure of climate-related information is a large undertaking that will likely require cross-functional involvement from internal and external parties. Companies may want to identify or establish committees devoted to handling climate-related initiatives and reporting, including groups within the company that are expected to provide the climate-related data.
Determining who will be responsible in the organization is key in successful implementation of the proposal and provides an opportunity to involve different functions to make sure climate-related reporting reflects a comprehensive effort.
Controls and risk management
Each of the proposed disclosures would be subject to disclosure controls and procedures (DCPs) that registrants are required to have in place so that all of the information required in the SEC filing is reported accurately and timely. Each quarter, a registrant also must disclose whether its DCPs are effective, and the chief executive and chief financial officer each take responsibility in a signed certification required by the Sarbanes-Oxley Act for the design and evaluation of DCPs. In addition, certain disclosures would be included in a note the financial statements and would be subject to audit by an independent registered public accounting firm and come within scope of the registrant’s internal control over financial reporting.