The SEC has proposed new rules for climate change disclosure

The Securities and Exchange Commission (“SEC”) of the United States announced long-awaited new proposed regulations to improve climate-related disclosures Wednesday, after the urging of investors and in line with the Biden Administration’s climate agenda. Once finalised, the SEC’s proposed rule, titled “Enhancement and Standardization of Climate-Related Disclosures for Investors,” would amend the SEC’s rules under the Securities Act of 1933 and the Securities Act of 1934 to require that registrants provide comprehensive climate-related information in their registration statements and annual reports. Although the regulation would apply to domestic and international corporations that are required to be registered with the SEC, it is possible that non-registrants who are part of a reporting company’s supply chain would be affected indirectly as a result of the rule.

Due to the explosive rise in Environmental, Social, and Governance (“ESG”) investment over the last several years with little to no regulation or structure, the SEC’s rulemaking is a big step forward. The Securities and Exchange Commission (SEC) proposes to give “[c]onsistent, comparable, and trustworthy disclosures” on climate-related risks and indicators to benefit both investors and the capital markets via its proposal.

Background

The Securities and Exchange Commission (SEC) issued its first advice on climate-related disclosures in 2010. According to the guideline, registrants should disclose information on climate change-related risks and opportunities in disclosures pertaining to the registrant’s business description, risk factors, legal proceedings, and management discussion in specific instances. It is acknowledged by the SEC that, although many corporations are presently disclosing climate-related risks in accordance with the 2010 advice and voluntarily via third-party frameworks, these disclosures are fragmented and inconsistent. The SEC also expressed concern that most of the climate-related information disclosed to investors is available outside of securities filings, such as in sustainability reports and on business websites, and that this should be addressed.

Rulemaking Proposal

The Proposed Rule, which is based in part on the recommendations of the Task Force on Climate-Related Financial Disclosure (“TCFD”), contains major new requirements for climate-related financial disclosures that are not already in place. In order to comply with the rule, registrants would be required to disclose information on the oversight and governance of climate-related risks, how such risks could have a material impact on the registrant’s business, how climate risk has affected or may affect the registrant’s strategy, how climate-related risks are managed, and the financial impact of climate-related events and transition activities.

A key feature of the Proposed Rule is that it would compel registrants to report greenhouse gas (“GHG”) emission measurements that might assist investors in assessing climate risks for the first time. The metrics used to measure these risks must be included in the disclosures, and they must include the registrants’ direct GHG emissions (Scope 1), indirect GHG emissions from purchased energy sources (Scope 2), and GHG emissions from upstream or downstream in a registrant’s value chain (Scope 3) if such emissions are material or if the registrant has established goals for Scope 3 emissions. Registrations with publicly stated goals or targets connected to climate risks would also be required to publish information defining the scope, methods, and timetables for reaching and monitoring such objectives. Another amendment proposed by the Securities and Exchange Commission is the addition of a new article to Regulation S-X that would require certain climate-related financial statement metrics and related disclosures to be included in an accompanying note to a registrant’s audited financial statements.

Registrants would be required to provide mandatory climate-related disclosures in dedicated parts of their registration statement or annual report, as well as in a note to their consolidated financial statements, under the terms of the Proposed Rule. Furthermore, for large or expedited filers, an attestation report from an independent source covering the disclosure of its Scope 1 and Scope 2 emissions would be needed in addition to the disclosure of its emissions. It is not necessary for the attestation service provider to be a licenced public accounting firm.

As part of an effort to reduce the burden placed on registrants by the disclosure requirements, the Proposed Rule provides a liability safe harbour for Scope 3 emission reports, as well as a Scope 3 exemption for smaller reporting organisations. To the extent that such disclosures include forward-looking statements, the safe harbour protections provided by the Securities Act and the Exchange Act would also be preserved.

What Comes Next

Beginning in the fiscal year 2023, the provisions of the Proposed Rule would be phased in with the relevant compliance date based on the registrant’s filer status, with the applicable compliance date determining the registrant’s compliance date. In the case of Scope 3 emissions, an extra phase-in time is offered.

The Proposed Rule will be open for public comment for a period of thirty (30) days after its publication in the Federal Register or until May 20, 2022, whichever comes first. Following receipt of comments, the SEC may make further changes to the rule before completing it. Once the regulation is completed, it may be susceptible to legal challenges in the courts of justice. In particular, several registrants expressed reservations about any regulation that would force them to report their Scope 3 emissions prior to the rulemaking’s issuance. It remains to be seen whether the safe harbour safeguards included in the Proposed Rule would be adequate to allay such fears and concerns.