The Securities and Exchange Commission (SEC) has officially enacted long-awaited climate-related disclosure regulations, comprising over 900 pages, following a two-year delay since their initial proposal. While legal challenges are expected, potentially influencing the timeline and extent of their enforcement, companies subject to SEC regulations should prioritize acquainting themselves with these rules as the inaugural compliance period approaches in 2025. It’s crucial to note the varying requirements under other obligatory disclosure frameworks that may also apply to these registrants. This blog post will explore the recent climate disclosure legislation from the SEC and highlight important observations from it, before diving into the fundamentals of the law.
Understanding the SEC Climate Disclosure Rule
The SEC climate disclosure rule emphasizes the principle of materiality, requiring companies to disclose climate-related risks that could substantially impact corporate strategy, financial condition, and operational results. This includes disclosing transition plans, scenario analysis, internal carbon prices, and the financial implications of mitigation efforts. Assurance of data integrity is paramount, with climate-related data now subject to internal controls over financial reporting (ICFR) and external audits. Collaboration across teams is essential to ensure consistency across financial statements, management discussions, and sustainability reports. Assembling a cross-functional team can help identify existing ESG reporting processes and address reporting gaps. Moreover, companies must disclose how they identify, assess, and manage climate-related risks, providing investors with transparency into leadership’s strategic approach.
Guidelines for Compliance with the SEC Climate Disclosure Rule
In compliance with SEC climate disclosure regulations, companies are mandated to provide comprehensive disclosures regarding climate-related risks that could significantly impact corporate strategy, operations, or financial condition. This encompasses divulging the material impacts of risks, expenditures allocated towards mitigating these risks, and the consequential effects on financial estimates. Additionally, companies are required to disclose transition plans, scenario analyses, and internal carbon pricing strategies, with provisions ensuring compliance. Moreover, climate-related goals with substantial impacts must be transparently communicated to stakeholders.
To facilitate investor understanding of corporate decision-making processes, the SEC emphasizes the importance of disclosing how company leaders identify, assess, and manage material climate-related risks within their overall risk management frameworks. Furthermore, companies must disclose material impacts of natural disasters or extreme weather events, with exceptions granted for low-dollar impacts. The financial implications of carbon offsets and renewable energy credits (RECs) must also be disclosed if they significantly contribute to meeting established goals.
In terms of reporting, climate-related disclosures must adhere to iXBRL formatting standards to ensure readability by both machines and humans. The SEC’s regulatory framework draws inspiration from established standards such as the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol.
To navigate these regulatory requirements effectively, companies should prioritize data assurance, with climate-related data in financial statements subject to rigorous internal controls and external audits. Cross-functional collaboration is essential to ensure consistency across financial statements, MD&A in the 10-K, and sustainability reports. Leveraging integrated reporting software can streamline the compilation, review, and reporting processes, addressing concerns about insufficient reporting technology.
Preparation for compliance involves forming cross-functional teams comprising SEC reporting, legal, auditing, ESG, corporate communications, and investor relations personnel. These teams should identify gaps in data collection and establish robust methods for gathering, reporting, and assuring data. Embracing ESG technology solutions can automate reporting processes and facilitate compliance with regulatory mandates. Establishing a connected reporting hub for financial and non-financial reporting enables seamless collaboration and visibility across reporting processes, ensuring accurate and comprehensive disclosures to stakeholders. Moreover, Recent surveys indicate that institutional investors are increasingly inclined to invest in companies that obtain assurance of Environmental, Social, and Governance (ESG) data. This underscores the growing importance of sustainability in investment decision-making.
Key Dates for Compliance with the SEC’s Climate Disclosure Rule
In stages, the SEC climate disclosure rule is implemented. The following is an examination of the effective dates pertaining to larger, accelerated filers, non-accelerated filers, and smaller reporting companies (SRCs) and emergent growth companies (EGCs):
Compliance Considerations
- Revision of Reporting Practices: Registrants affected by the Final Rules need to reassess their current reporting methods to accommodate variations in requirements from other mandatory disclosure programs.
- Overlap with Other Regulatory Schemes: The Final Rules intersect with programs like California’s SB 253, SB 261, AB 1305, and the EU’s CSRD, but compliance with one may not fulfill all obligations under the others, raising questions of dual reporting requirements.
Recognition and Equivalency
- Recognition of Reporting Standards: Uncertainty surrounds whether reports compliant with the Final Rules will be considered equivalent to European sustainability reporting standards, potentially impacting the need for separate reporting.
- Potential Dual Reporting Obligations: It remains unclear if registrants must produce separate reports under both the Final Rules and California’s mandatory reporting framework.
Legal and Regulatory Challenges
- Legal Basis for Challenges: Anticipated legal challenges to the Final Rules may arise from claims of the SEC overstepping regulatory bounds and violating the First Amendment.
- Impact of Supreme Court Precedent: Precedents like the “major questions” doctrine, as seen in West Virginia v. EPA, could underpin legal challenges, compounded by concerns over administrative burdens on companies.
- NGO Criticisms: Climate-related NGOs may challenge the Final Rules, citing inadequacies compared to the 2022 Proposal, potentially influencing the scope of the regulations.
5 Key Highlights of the SEC’s New Climate-Related Disclosure Rule
- Mandatory Scope 1 and Scope 2 Reporting for Larger Publicly Traded Companies- Larger publicly traded companies will now be obligated to report Scope 1 and Scope 2 emissions. These categories focus on direct company emissions and emissions from energy providers, respectively. The obligation applies when GHG emissions are deemed material to shareholders.
- Scope 3 Reporting Removed from Final Rule- The controversial Scope 3 reporting has been entirely removed from the final rule. This aspect, while viewed as necessary by some congressional Democrats, presented legal challenges as it required data from privately held companies, falling outside the SEC’s regulatory authority.
- U.S. Materiality Standard Unchanged- The SEC maintains the single materiality standard focused on financial impacts, contrasting with double materiality standards used in other jurisdictions. While other standards consider impacts on people and the environment, the U.S. standard is rooted in fiduciary duty, prioritizing shareholder interests.
- SEC Filing Requirement for Climate Disclosures- Companies are now required to file climate-related disclosures directly with the SEC as part of their annual filings, rather than solely posting them on their websites. Accelerated and large accelerated filers must include attestation reports with their second quarterly reports.
- Reduced Footnote Requirements- Footnote requirements have been streamlined, shifting from Regulation S-X to Regulation S-K. This change reduces the burden on companies, as Regulation S-K does not require an audit but complies with reporting standards.
Conclusion
In conclusion, the Securities and Exchange Commission’s (SEC) enactment of climate-related disclosure regulations heralded a new era of corporate transparency and environmental accountability. Despite challenges, embracing sustainability not only ensures regulatory compliance but also positions companies to attract investors increasingly focused on Environmental, Social, and Governance (ESG) factors, thereby driving long-term value creation and contributing to a more sustainable future.
To prepare for compliance with the SEC climate disclosure rule, companies should assess their current data collection processes and identify areas for improvement. Leveraging technology can streamline reporting processes and enhance accuracy and efficiency. Integrated reporting software can facilitate collaboration among various teams and ensure consistent reporting across different platforms.
