SEC signals landmark for US climate change regulation

Proposed disclosure rule would dramatically alter the landscape for US and foreign issuers, argue Ulysses Smith and Isabelle Glimcher

On Monday, the US Securities and Exchange Commission issued its much-anticipated Proposed Rule on mandatory climate change disclosures.

The Proposed Rule is a milestone in US climate regulation, and if enacted, would dramatically alter the disclosure landscape for US domestic and foreign issuers. For the first time, registrants (that is, entities required by law to make filings with the SEC) would be required to disclose climate-related information in SEC statements and annual reports.  

Among other things, the Proposed Rule would create new subparts of the SEC’s Regulation S-K, which primarily governs qualitative disclosures, and Regulation S-X, which governs financial statements. As part of the new Regulation S-K disclosures, registrants would be required to outline (1) any climate-related risks and their actual or likely material impacts on the registrant’s business, strategy and outlook; (2) the registrant’s efforts to address climate-related risks and relevant risk management processes; (3) the registrant’s greenhouse gas (GHG) emissions, which would be subject to assurance requirements for accelerated and large accelerated filers (that is, issuers with a public float of $75m or more for accelerated filers, or a public float of $700m or more for large accelerated filers), and with respect to certain emissions; and (4) information about the registrant’s climate-related targets, goals and transition plan if one exists.
The Proposed Rule would also require a registrant to disclose information on the impact of climate-related risks on the registrant’s business and consolidated financial statements under Regulation S-X.

The extent of disclosures related to GHG emissions has been the subject of much debate, particularly as pertains to so-called Scope 3 emissions. In brief, Scope 1 emissions refers to a company’s “direct” emissions from owned or controlled sources; Scope 2 refers to “indirect” emissions from the generation of purchased electricity, steam, heating or cooling consumed by the reporting company; whereas Scope 3 emissions includes all other indirect emissions that occur in a company’s value chain, ranging from purchased goods and services to employee commuting and investments. Scope 3 emissions are considerably more challenging to quantify and many commentators have argued against requiring mandatory disclosures for Scope 3. The Proposed Rule requires disclosure of Scope 3 emissions when they have been deemed “material” by the registrant, or when the registrant has set GHG targets or goals that encompass Scope 3 emissions. 

 A central question likely to drive debate around the Proposed Rule is the extent to which climate information should be considered “material.” Many investors view climate-related risks as crucial to business and investment decision-making, thereby rendering that information “material” and thus within the SEC’s established regulatory authority. Others, however, view climate information as not essential to such decision-making and therefore outside the SEC’s authority. The question as to the materiality of climate information is likely to be central to the legal challenges the final rule, once issued, is expected to face.

If adopted, the final rule would be phased in for all registrants, with the date of compliance determined by the registrant’s filer status. The Proposed Rule also provides for additional phase-in periods for Scope 3 emissions disclosures and for the assurance requirement, an exemption from Scope 3 emissions disclosures for smaller reporting companies and a safe harbour related to forward-looking statements to the extent included in disclosures.

In the period following the issuance of the SEC’s Proposed Rule, financial institutions and public companies can take a number of steps to position themselves for the new disclosure rules when they take effect and to mitigate potential enforcement risks: 

  • First, companies can review current climate disclosures for accuracy and consistency. Despite the phased-in approach and the likely delay in the Proposed Rule’s application, the Division of Corporate Finance issued a “Sample Letter to Companies Regarding Climate Change Disclosures” in September 2021. The letter serves as an example of a potential request for information from the agency to public companies “regarding their climate-related disclosure or the absence of such disclosure.” Companies should therefore review their current SEC disclosures, as well as any public statements regarding their climate-related commitments, in order to ensure their accuracy and consistency.  
  • Second, companies can evaluate company- and business-line climate-related risks – physical, transitional, legal and reputational – and ensure mitigation measures are built into compliance and due diligence processes.  
  • Third, companies can take steps to position themselves well for the new regulatory requirements to come, ensuring they are apprised of key developments, leveraging internal and external expertise to provide necessary insight and training for relevant personnel and looking ahead to how governance and compliance frameworks might be adapted to meet the new regulatory challenges to come.

The public comment period for the Proposed Rule ends on May 20, 2022. 

Ulysses Smith is ESG senior advisor and Isabelle Glimcher is an associate at Debevoise & Plimpton

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