SEC's Climate Disclosure Rules

On March 6, 2024, the Securities and Exchange Commission (SEC) adopted new rules requiring registrants to include climate-related disclosures in their registration statements and annual reports¹. These new rules, adopted in a 3-to-2 vote, represent a significant step by the SEC in requiring companies to disclose climate-related information to investors⁴. The rules are facing legal challenges, prompting the SEC to issue a voluntary stay order while the rules are under judicial review⁵. If the rules take effect, investors will have access to more detailed climate information for decision-making, similar to what is already provided by companies in Europe and other global markets⁵. The SEC has emphasized that its focus is on investor protection and providing investors with access to comparable and consistent climate-related disclosures, rather than influencing registrants' decisions on managing climate risks⁷.

Rule Development

Before adopting the final rules, the SEC actively sought public input⁸. In March 2021, the SEC began soliciting public feedback on potential climate disclosure rules and published its proposed rules a year later⁸. The SEC received an unprecedented number of public comments—approximately 24,000—from various stakeholders, including business groups, lobbyists, and corporations⁸. This extensive feedback led to a two-year review process, culminating in the final rules approved on March 6, 2024⁸. Notably, the final rules were significantly scaled back from the original proposal⁸.

Final Rules

The SEC's final climate disclosure rules require registrants to provide climate-related disclosures in their annual reports and registration statements, including those for initial public offerings (IPOs)³. The final rule reflects several key differences from the initially proposed rule, scaling back requirements in several key ways¹. For example, the final rule removed the requirement to disclose Scope 3 greenhouse gas (GHG) emissions, instead requiring disclosure of Scope 1 and/or Scope 2 GHG emissions on a phased-in basis by certain larger registrants when those emissions are material¹⁰.

It is important to note that while these rules have been adopted, the full text of the final rule was not accessible during the research process¹¹. Readers are encouraged to refer to the SEC website for the complete and official text of the final rule.

Required Disclosures

The final rule requires a registrant to disclose information about the following:

• Material Climate-Related Risks: Companies must disclose material climate-related risks, including descriptions of the risks and how they may affect the business¹⁰.
• Mitigation and Adaptation Activities: Companies are required to disclose activities undertaken to mitigate or adapt to climate-related risks¹⁰.
• Governance and Risk Management: The rules require disclosure of information about the registrant's board of directors' oversight of climate-related risks and management's role in managing those risks¹⁰.
• Climate-Related Targets and Goals: Companies must disclose information on any climate-related targets or goals that are material to their business, results of operations, or financial condition¹⁰.
• Financial Statement Metrics: Companies must disclose certain financial statement effects of severe weather events and other natural conditions, including “hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise.” ⁹

Furthermore, the rules require accelerated and large accelerated filers to disclose Scope 1 and Scope 2 greenhouse gas (GHG) emissions, if material, and these disclosures will be subject to independent third-party assurance¹².

Legal Challenges

The SEC's climate disclosure rules are facing multiple legal challenges⁶. Seven lawsuits have been filed, including three consolidated in the Fifth Circuit, brought by state attorneys general, two energy companies, and oil industry groups¹³. These challenges question the SEC's authority to mandate climate disclosures¹⁴. Some argue that the SEC's enabling statute does not explicitly grant it the power to require such disclosures, and that the rules may result in immaterial and overly broad disclosures, leading to excessive costs for companies⁷.

In response to these legal challenges, the SEC voluntarily stayed the implementation of the rules on April 4, 2024, pending judicial review⁶. Despite these challenges, the SEC has stated that it will "vigorously defend" the final rules¹².

Implementation Timeline

Although the final rule was initially scheduled to become effective on May 28, 2024, the SEC's voluntary stay has put the implementation timeline on hold⁸. The mandatory compliance dates may be retained or delayed depending on the outcome of the legal challenges¹⁵. Assuming the rules withstand legal scrutiny, the following table outlines the compliance dates for registrants with a calendar year-end: ¹⁵

Potential Impact

The SEC's climate disclosure rules have the potential to significantly impact businesses and investors. While the compliance costs of these new disclosure requirements are estimated to be substantial, the rules could also bring about positive changes¹⁶.

Costs and Challenges

When the SEC first proposed the rule in 2022, its estimates suggested that disclosure-related compliance costs would nearly double for the average publicly listed company¹⁶. Beyond these direct costs, companies may also face indirect costs associated with adjusting their operations to meet the new reporting requirements¹⁶. These costs could have broader implications for employment in certain jobs and sectors¹⁶.

Some key challenges for companies subject to the rules include: ⁴

• Compliance Timeline: The relatively short initial compliance timeline may pose challenges for companies in preparing for the new disclosure requirements.
• Interpretive Challenges: Interpreting and applying the rules, particularly regarding materiality and the financial impact of severe weather events, may increase reporting complexity.
• Litigation and Regulatory Risks: The rules may increase companies' exposure to litigation and regulatory risks, with limited safe harbor provisions.
• Uncertainty: Ongoing legal challenges to the rules create uncertainty for companies in terms of compliance and implementation.

Even companies already publishing climate disclosures aligned with the Task Force on Climate-related Financial Disclosures (TCFD) framework may need to make significant adjustments to meet the specific requirements of the SEC rules⁴. This includes ensuring compliance with disclosure controls and procedures and supporting Sarbanes-Oxley officer certifications⁴. Additionally, the new financial statement disclosures will be subject to audit and will fall within the scope of internal controls over financial reporting⁴.

Potential Benefits

Despite the challenges, the SEC's climate disclosure rules could also have positive impacts. By providing investors with consistent and comparable information about climate-related risks and opportunities, the rules could: ¹⁷

• Drive Better Risk-Adjusted Returns: Investors can use this information to make more informed investment decisions, potentially leading to better risk-adjusted returns.
• Facilitate Comparisons: The standardized disclosures will allow investors to compare companies, funds, and buildings more effectively, promoting transparency and informed investment choices.

Impact on Investors

The increased availability of climate-related information is likely to have a significant impact on investor decision-making⁵. Investors will be better equipped to assess the climate-related risks and opportunities associated with different companies and investments¹⁷. This could lead to a shift in investment towards companies with stronger climate performance and more sustainable practices.

Comparison to Other Countries' Regulations

The SEC's climate disclosure rules are part of a growing global trend towards mandatory climate-related reporting¹⁸. While these rules share similarities with other frameworks, such as the EU's Corporate Sustainability Reporting Directive (CSRD) and California's climate disclosure laws, there are also notable differences¹⁸.

EU CSRD

The EU CSRD has a broader scope than the SEC rules, covering most EU companies, companies listed on EU-regulated markets, and even some non-EU companies with substantial activity in Europe¹⁹. Unlike the SEC rules, which primarily focus on financial materiality, the CSRD requires companies to consider "double materiality"—meaning both the financial impact of climate change on the company and the company's impact on climate change²⁰. The CSRD also requires disclosure of Scope 3 emissions, while the SEC rules only require Scope 1 and 2 emissions if deemed material¹⁹.

Other Jurisdictions

California and New York State require mandatory disclosure of Scope 1, 2, and 3 emissions²⁰. The Federal Acquisition Regulation (FAR) Council rules also require public emissions data, although Scope 3 emissions are only required from major contractors²⁰.

Conclusion

The SEC's climate disclosure rules represent a significant development in the landscape of ESG reporting and the broader effort to address climate change. By requiring companies to disclose more comprehensive information about their climate-related risks and opportunities, the rules aim to empower investors with the information they need to make informed decisions. This increased transparency could drive a shift towards more sustainable business practices and investments.

However, the rules are not without their challenges. Legal challenges and implementation hurdles may create uncertainty and complexity for companies. The SEC's voluntary stay order highlights the need to address these challenges and ensure the rules are implemented effectively.

Despite these challenges, the SEC's commitment to climate-related disclosure signals a growing recognition of the importance of climate change in financial markets. The rules are likely to have a lasting impact on how companies manage and report on climate-related issues, potentially influencing global reporting standards and accelerating the transition to a more sustainable economy. It remains to be seen how the legal challenges will unfold and how the final implementation of the rules will shape corporate behavior and investor actions in the years to come.

Works cited

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