SEC Adopts Final Rules on Climate-Related Disclosures

On March 6, 2024, the Securities and Exchange Commission (the “SEC”) adopted its long anticipated rules, amending Regulations S-K and S-X to set forth the climate-related information that companies will be required to disclose in their filings with the SEC.  The final rules apply to both US domestic companies and foreign private issuers (“FPls”) who file periodic reports with the SEC.

Likely in response to evolving views among investors and other stakeholders on ESG matters generally and climate-related matters in particular, as well as concerns about legal challenges to the final rules, the SEC has taken “a less prescriptive approach” to climate-related disclosures compared to its March 2022 proposed rules.  Most notably, the SEC has revised a number of the rules to require disclosure only where the information is material to a company in an attempt to reduce the number of onerous, yet less significant, disclosures that companies are required to provide.

The new rules impose narrative disclosure requirements and financial statement requirements.  Climate-related disclosures must be presented in the body of registration statements or annual reports either (i) in a separate, appropriately captioned section, (ii) in another appropriate section (such as Risk Factors, Business or Management’s Discussion and Analysis) or (iii) by incorporation by reference from another SEC filing.  The financial statement disclosures must be presented in a new note to the financial statements.

Confronted with criticism that these rules would be duplicative of existing disclosure that many public companies already make regarding climate-related topics (either voluntarily or as a result of other applicable disclosure regimes), the SEC emphasized that one of its key goals was to bring climate-related disclosures within a company’s disclosure controls and procedures and internal controls over financial reporting, while at the same time providing investors with the standard protections that are applicable to other information filed with the SEC under the Securities Act of 1933, as amended (the “Securities Act”), or the Securities and Exchange Act of 1934, as amended.

Climate-Related Disclosure under Regulation S-K

Risks and Strategy

Companies will be required to disclose climate-related risks that have had or are reasonably likely to have a material impact on their business strategy, results of operations or financial condition, including whether the risks are reasonably likely to manifest in the short term (i.e., the next 12 months) and separately the long term (i.e., beyond the next 12 months) and whether the climate-related risk is a physical risk (and whether it is acute or chronic) or a transition risk.  The discussion must include qualitative and quantitative disclosure relating to the impact of such risks on the company’s business and strategy, to the extent any such impacts are material.  The definitions of these risks are similar to those included in the proposed rules, except that they no longer include risks to the company’s value chain.

To the extent companies have adopted a transition plan to manage a material transition risk, they are required to describe such plan and update such disclosure with qualitative and quantitative information on an annual basis to describe the steps taken in furtherance of the plan.

If companies use scenario analysis to assess the impact of climate-related risks on their business, results of operations or financial condition and, if, based on the results of such scenario analysis, they determine that a climate-related risk is reasonably likely to have a material impact on their business, results of operations, or financial condition, they are required to describe each such scenario including a brief description of the parameters, assumption and analytical choices used, as well as the expected material impacts, including financial impacts, on the company under each such scenario.

If companies use internal carbon pricing and the internal carbon price is material to how they evaluate and manage the identified climate-related risks, they are required to disclose certain information about the carbon pricing.

Contrary to the proposed rules, the final rules eliminate the requirement for companies to disclose any material change to the climate-related disclosures provided in a registration statement or annual report in their Form 10-Q (or Form 6-K for FPIs), which will help to reduce compliance costs.

Governance

Companies are required to disclose whether the board or a committee or subcommittee of the board has oversight of climate-related risks, how the board or committee receives information about climate related risks and, if applicable, oversight of progress against targets, goals or transition plans.

Similarly, companies are also required to disclose management’s role in assessing and managing their material climate-related risks including disclosure relating to the following non-exclusive list of items: which members of management are involved and their relevant expertise, the process management utilizes to assess and manage these risks and whether such members of management report to the board or relevant committee.

Contrary to the proposed rules, companies are not required to disclose the identity of individual board members responsible for climate-related risk oversight, board members’ climate expertise, how frequently the board is informed of climate-related risks or whether and how the board sets climate-related targets or goals.

Risk Management

Companies must also disclose processes for identifying, assessing and managing material climate-related risks and whether and how any such processes are integrated into their overall risk management system or processes.

The risk management disclosure requirements in the final rules are significantly streamlined compared to the proposed rules and do not include a requirement to disclose certain information such as how the company determines the significance of climate-related risks compared to other risks, how the company considers existing or likely regulatory requirements or policies, how the company considers shifts in customer or counterparty preferences and how the company determines the materiality of climate-related risks.

Targets and Goals

Companies are required to disclose any climate-related targets that have materially affected or are reasonably likely to materially affect the company’s business, results of operations or financial condition as well as information necessary to understand the material impact or reasonably likely material impact of the target or goals and provide annual updates on actions taken to achieve such targets or goals. 

If a carbon offset or renewable energy credit or renewable energy certificate (“REC”) has been used as part of the plan to achieve a company’s climate-related targets or goal, the company must provide qualitative and quantitative information regarding such offsets.
Contrary to the proposed rules, companies will not be required to disclose interim targets although if a company has set an interim target that is material, it may need to include such information in its discussion of its plan to achieve its targets or goals. 

GHG Emissions Metrics

Larger public companies (accelerated filers or large accelerated filers), including FPIs, are required to provide Scope 1 (direct) and Scope 2 (indirect from purchased energy source) emissions, separately, for the most recent fiscal year only when those emissions are material and, to the extent previously disclosed in a SEC filing, for the historical fiscal year(s) included in the consolidated financial statements in the filing.  In a departure from the proposed rules, the final rules permit the aggregation of certain data unless the emissions of any constituent gas are individually material.  The company will also be required to provide contextual information including significant inputs and assumptions used, judgments made, and information needed to understand the impact on financial statements and policy reasons to calculate the disclosures. 

In a departure from the proposed rules, companies are not required to disclose Scope 3 (upstream and downstream activities in the value chain) emissions, which would have been required for companies that released climate-related transition or reduction plans that include the reduction of GHG emissions or if the emissions are material.  The final rules also do not require that companies disclose GHG emissions in terms of intensity.  The SEC made these changes to address concerns about the high cost of compliance with the proposed GHG emissions disclosure and concerns about the availability and unreliability of underlying data for Scope 3 emissions.  The final rules also exempt smaller reporting companies (“SRCs”) and emerging growth companies (“EGCs”) from the Scope 1 and Scope 2 emissions disclosure.  The final rules also allow registrants more time to file emissions disclosures, as discussed under the caption “Compliance Timeline and Accommodations” below. 

Attestation of Scope 1 and Scope 2 Emissions Disclosure

Larger public companies (accelerated filers or large accelerated filers), including FPIs (consistent with the categories of filers that are subject to the requirement to disclose GHG emissions metrics as described above) are required to include an attestation report that covers Scope 1 and Scope 2 emissions.  Large accelerated filers and accelerated filers must provide an attestation report at a limited assurance level beginning in the third fiscal year after they are required to comply with the GHG emissions disclosure requirement but only large accelerated filers will be required to include an attestation report at a reasonable assurance level beginning in the seventh fiscal year.  Contrary to the proposed rules, the final rules exempt SRCs and EGCs from the attestation report requirement since SRCs and EGCs are also exempt from the GHG emissions disclosure requirement.  

The final rules require that the attestation report must be signed by an independent attestation provider with expertise in measuring, analyzing, reporting or attesting to GHG emissions.  The final rules also require that the attestation report must be provided pursuant to standards publicly available at no cost or widely used for GHG emissions attestation and established by a body or group that has followed due process procedures, including broad distribution of the framework for public comment.  The form and content of the attestation report must follow the requirements of the attestation standard used, but unlike the proposed rules, the final rules do not include minimum report requirements.  Companies must disclose whether the attestation engagement is subject to any oversight inspection program and when there is a change in or disagreement with the attestation provider. 

For registration statements, the final rules also amend Rule 436 of the Securities Act to exempt attestation reports covering emissions at a limited assurance level and, therefore, the attestation report provider will not be required to a provide a consent regarding the inclusion of such attestation reports in the registration statement.  Item 601 of Regulation S-K has also been amended to require that companies include as an exhibit to certain registration statements a letter from the attestation provider that acknowledges its awareness of the use of its report in such registration statements.  This letter may be filed as an exhibit to the registration statement or a report on Form 10-K, Form 10-Q or Form 20-F that is incorporated by reference into the registration statement. 

Safe Harbors

The final rules provide a safe harbor from private liability for climate-related disclosures (excluding historical facts) pertaining to transition plans, scenario analysis, the use of an internal carbon price and targets and goals.

XBRL

The final rules require climate related disclosures under Regulation S-K to be electronically tagged as climate-related disclosures in Inline XBRL.  The final rules provide a phased in approach for compliance, as summarized below under the below caption “Compliance Timeline and Accommodations.”

Financial Statement Requirements under Regulation S-X

Contextual Information

Under the final rules, companies must disclose contextual information to enable a reader to understand how it derived the financial statement metrics, including a description of significant inputs and assumptions used and any policy decisions made to calculate the metrics.  In addition, companies must separately disclose the aggregate amount of any recoveries recognized during the fiscal year as a result of severe weather events and other natural conditions where quantitative data is required below and identify where the impacts are presented in the financial statements. 

Quantitative Information

Companies are also required to include the following quantitative information in their financial statements and separately identify where the impacts of the items below are presented in the financial statements:

• The aggregate amount of expenditures expensed as incurred and losses incurred during the fiscal year in connection with severe weather events and other natural conditions, if the aggregate amount of expenditures expensed as incurred and losses equals or exceeds 1% of the absolute value of income or loss before income tax expense or benefit for the relevant fiscal year.  Such disclosure will not be required if the aggregate amount of expenditures expensed as incurred and losses is less than $100,000 for the relevant fiscal year.
• The aggregate amount of capitalized costs and charges incurred during the fiscal year in connection with severe weather events and other natural conditions, if the aggregate amount of the absolute value of capitalized costs and charges equals or exceeds 1% of the absolute value of stockholders’ equity or deficit at the end of the relevant fiscal year.  Such disclosure will not be required if the aggregate amount of the absolute value of capitalized costs and charges is less than $500,000 for the relevant fiscal year.
• The aggregate amount of carbon offsets and RECs expensed, the aggregate amount of capitalized carbon offsets and RECs recognized and the aggregate amount of losses incurred on the capitalized carbon offsets and RECs in connection with carbon offsets and RECs or certificates used as a material component of a company’s plans to achieve its disclosed climate-related targets, during the fiscal year.
• The beginning and ending balances of the capitalized carbon offsets and RECs in connection with carbon offsets and RECs or certificates used as a material component of the company’s plans to achieve its disclosed climate-related targets, for the fiscal year.

The final rules include an attribution principle that limits a company’s required disclosure to circumstances where the severe weather event or other natural condition was a significant contributing factor in incurring the capitalized cost, expenditure expensed, charge or loss. If the estimates and assumptions the company uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, the company is required to provide a qualitative description about how the development of such estimates and assumptions was impacted.

Contrary to the proposed rules, which contained a 1% disclosure threshold applied on a line item basis, the final rules will not require disclosure of the impact of severe weather events and other natural conditions and transition activities on each line item of the company’s consolidated financial statements.  The final rules also do not require disclosure of expenditures expensed and capitalized costs incurred to reduce GHG emissions or to mitigate exposure to transition risks and do not require that a company determine whether a severe weather event or natural condition was caused by climate change to trigger the disclosures required under the final rules.

Compliance Timeline and Accommodations

The final rules will become effective 60 days after the SEC’s adopting release is published in the Federal Register, which will likely occur in May 2024.  The compliance date will be phased in for all companies and is dependent upon (i) the content of the disclosure and (ii) the status of the company (as a large accelerated filer, an accelerated filer, non-accelerated filer, SRC or EGC). 

With respect to the financial statement disclosures, disclosures for historical fiscal year(s) included in the company’s consolidated financial statements are required on a prospective basis, with disclosures required for an additional fiscal year each year until the required disclosure is provided for the entire period covered by the company’s financial statements.  Companies engaged in an IPO that has a fiscal year subject to the final rules will be required to provide disclosure for the company’s most recently completed financial year for which audited financial statements are included in the filing. 

The final rules also provide more time for disclosure of Scope 1 and/or Scope 2 emissions and related attestation reports in periodic reporting filings and registration statements:

• Domestic registrants may delay disclosure until the Form 10-Q for the second fiscal quarter in the fiscal year immediately following the year to which the GHG emissions metrics disclosure relates.
• FPIs may disclose such information in an amendment to their annual report on Form 20-F, no later than 225 days after the end of the fiscal year to which the GHG emissions metrics disclosure relates.
• Disclosure in registration statements is required to be provided as of the most recently completed fiscal year that is at least 225 days prior to the date of effectiveness of the registration statement.  For example, if a calendar year-end large accelerated filer files a Form S-1 registration statement in 2028, which goes effective on or after August 7, 2028, its GHG emissions metrics disclosure must be as of 2027 since the Form S-1’s date of effectiveness is at least 225 days after the 2027 fiscal year-end.

Note: This table provides a summary of the phased in compliance dates of the final rules for both subpart 1500 of Regulation S-K and Article 14 of Regulation S-X.  The compliance dates in this table apply to both annual reports and registration statements.  For registration statements, compliance would be required beginning in any registration statement required to include financial information for the full fiscal year indicated in this table.

Takeaways

Although the SEC has revised the final rules to significantly reduce the burden imposed on companies, compliance with the final rules will nonetheless require a substantial amount of effort and expense.  In addition to assembling the required disclosures and calculating the financial statement impacts, each of which will require a careful determination as to materiality and the consistent application of policies and complex assumptions and judgments, companies should carefully review their disclosure controls and procedures and internal control over financial reporting to ensure that data is collected in a reliable and consistent manner and that any disclosure is accurate.

In addition, many of the companies that are subject to the SEC’s final rules also are (or will be) subject to similar disclosure requirements in other jurisdictions, including California and Europe.  Although some of these regimes may allow for accommodations for companies that are required to prepare disclosures under multiple frameworks, for the moment, no such accommodations exist under the SEC’s final rules.  Companies may have already made determinations regarding materiality or may have already provided for disclosure of metrics such as Scope 3 emissions or targets, which may impact the type and extent of disclosures they are required to include in their SEC filings pursuant to the SEC’s final rules.  Careful analysis of the requirements under each applicable regime will be necessary to ensure consistency of disclosure, avoid unnecessary liability risk and carefully manage stakeholder expectations.

We expect that the final word has not yet been written about the SEC’s final rules on climate-related disclosures.  As anticipated, given the unprecedented level of controversy surrounding the proposed rules, immediately following the release of the final rules on March 6, 2024, a coalition of ten states filed a petition for review to challenge the SEC’s authority to adopt the final rules.  On the same day, two energy companies filed a petition challenging the SEC’s final rules.  On March 8, 2024, three more states brought their own legal challenge to the SEC’s final rules and additional litigation challenging the final rules is likely to follow, all of which may call into question the fate of the final rules.  Even if the final rules survive these legal challenges, we expect a raft of guidance and interpretation to impact the ultimate implementation of these rules. 

Feel free to reach out to your usual Freshfields contact if you would like to discuss this development, or the implications of preparing to report under the SEC's climate-related disclosure rules.