The SEC's Climate Disclosure Rule: A Reminder That Climate-Related Risks May Be Material

On Wednesday March 6, 2024, the Securities and Exchange Commission (SEC) finalized the much-debated climate disclosure rule, citing the importance of providing investors with standardized and centrally located climate-related disclosures. The reporting requirements primarily apply to registrants with Securities Act and/or Exchange Act requirements. The SEC staff clarified in the final rule that this includes business development companies (BDCs), real estate investment trusts (REITs), and issuers of registered non-variable insurance contracts, while asset-backed issuers were excluded from the final rule.

The proposal, first released in March 2022, set a record for the most comment letters ever received by the SEC on a proposed rule, which resulted in a number of differences between the proposed and final rules. The final rule will require registrants to disclose their Scope 1 (direct GHG emissions from operations that are owned or controlled by a registrant) and Scope 2 (indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant) emissions only if deemed to be material. Scope 3 emissions (all indirect emissions which occur in the upstream and downstream activities of a registrant’s value chain) are not required to be disclosed by the final rule.

Materiality is important

Although Scope 3 was not included in the final rule, it cannot be ignored. The present materiality threshold – referenced by the SEC in the proposed rule – considers materiality to be where there is substantial likelihood that a reasonable investor would consider the information important when determining whether to buy or sell a security and when determining how to vote on a security. During a March 7, 2024, Investor Advisory Committee panel, the SEC reiterated that the current standard for materiality in today’s securities laws, including the new climate disclosure rule, uses a would standard, not a could standard. With that in mind, the final rule’s exclusion of Scope 3 emissions reporting achieves a similar goal to that of the proposal, requiring standardized climate disclosures, while maintaining much closer adherence to existing securities laws than when first published in 2022.

Who does the rule apply to?

The final rule applies to all SEC registrants that have reporting requirements under the Exchange Act, and to companies filing Securities Act or Exchange Act registration statements. Specifically, the rule denotes large accelerated filers (public float of $700 million or more), accelerated filers (public float of $250 million to less than $700 million), smaller reporting companies (an issuer that is not an investment company, an asset-backed issuer, or majority-owned subsidiary of a parent that is not a small reporting company where: i) the public float is less than $250 million, or ii) had revenues of less than $100 million with either no public float or public float of less than $700 million), emerging growth companies (a registrant with annual gross revenue of less than $1.235 billion in the most recent fiscal year and has not met the conditions to no longer be considered an emerging growth company), and non-accelerated filers (other issuers not captured by the definition of accelerated filer or large accelerated filer under the Exchange Act), as well as foreign private issuers. Canadian registrants using the Multijurisdictional Disclosure System (MJDS) and that file registration statements and annual reports on Form 40-F will be exempt from the final rule.

Reporting requirements

The following is a non-exhaustive summary of the core reporting considerations and requirements within the rule:

• By amending Regulation S-K and Regulation S-X, the final rule creates new requirements to provide disclosure of material climate-related risks within Securities Act and Exchange Act registration statements, financial statements, and annual reports.
• The SEC highlights that the materiality of an item should be based on whether a reasonable investor would consider the omission of the item from disclosures as significantly altering the total mix of available information. Disclosure of Scope 1 and/or Scope 2 emissions will be required for most registrants, but only as deemed material. Limited assurance will be required and reasonable assurance will later be required for large accelerated filers.
• In addition to these reporting requirements, the SEC also proposed that any climate-related risks identified by a registrant that have or would reasonably be expected to have a material impact on the registrant in the short-term (e.g., within the next 12 months) and long-term (e.g., outside of the next 12 months) would also need to be disclosed.
• Material information related to the registrant’s use of and determinations from scenario analysis and/or of an internal carbon price should be disclosed.
• Should a registrant have any capitalized costs, expenditures expensed, and losses incurred due to severe weather events or natural conditions, such information should be disclosed subject to a 1% de minimis threshold.
• Depending on the determined materiality, information on a registrant’s climate-related goals or targets, use of carbon offsets or renewable energy credits, transition plans, and/or scenario analysis will be required in disclosures.
• The rule provides guidance on the presentation of emissions metrics and disclosures of underlying methodologies. In summary, disclosure of Scope emissions should be “… expressed in the aggregate in terms of CO2e,” and in gross terms (e.g., excluding any offsets). If emissions are disclosed, description of the methodology, significant inputs, and significant assumptions are to be disclosed as well. In other words, the organizational boundaries of Scope 1 and/or 2 emissions should be provided, alongside the methodology to determine such boundaries, and whether there is a material difference between the organizational boundaries of the emissions calculations and consolidated financial statements. However, while the rule does not mandate a specific approach be used for the calculation of emissions, disclosure of the approach (e.g., GHG Protocol, a relevant ISO standard, etc.) must be provided along with the methodology (e.g., location-based, etc.), and whether the approaches and methodologies varied between Scope 1 and 2 emissions. The use and identification of any calculation tools and emissions factors must also be disclosed.

With this rule, the SEC has attempted to align significant portions of the disclosures with the well-known and widely-adopted Task Force on Climate-Related Financial Disclosures (TCFD) framework.

Implications

• Applicable registrants should begin to determine where and how their business and operations may be exposed to material climate-related risks. An assessment should also be made to determine whether the registrant’s transition plans, or climate-related goals or targets would be deemed material. Registrants should also begin to assess where, and in what manner, internal controls, processes, and policies may need to be enhanced or added to accommodate new reporting requirements.
• Private equity firms that expect to take a portfolio company public should similarly assess the potential for disclosure of material climate-related risks and assess whether the disclosure of details on transition plans or climate-related goals or targets, as deemed material, is necessary. However, the final rule notes that emerging growth companies are exempt from emissions reporting requirements.

Compliance Dates

* FYB refers to any fiscal year beginning in the calendar year depicted

^ Financial statement disclosures under Article 14 will be required to be tagged in accordance with existing rules pertaining to the tagging of financial statements (refer to Rule 405(b)(1)(i) of Reg S-T)

How we help

The ESG landscape is evolving at a rapid pace and requires additional resources to meet regulatory expectations.

ACA’s ESG Advisory Team can help you understand how these and similar upcoming rules that may impact your portfolios and assist with preparing for any changes in disclosure requirements

For personalized assistance with your firm's ESG needs, please reach out to your ACA consultant, or contact us directly. 

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