SEC Adopts Long-Awaited Final Climate Disclosure Rules

On March 6, 2024, by a party-line vote of 3-2, the US Securities and Exchange Commission (SEC) adopted final rules (entitled “The Enhancement and Standardization of Climate-Related Disclosures for Investors”) requiring most public companies to disclose climate-related information in registration statements and annual reports filed with the SEC. The SEC first proposed climate disclosure rules in March 2022, and the proposal has been a source of much debate and controversy, generating over 24,000 comment letters, more than any regulation in the history of the SEC.

Signaling the controversial nature of the SEC’s action, multiple lawsuits challenging the new rules have already been filed in a number of different federal circuit courts of appeals. Several of the cases were filed in the U.S. Court of Appeals for the Fifth Circuit, which on March 15 granted, in a one-sentence order, a request for an administrative stay of the rules. Because the rules were challenged in so many courts, the stay is likely to remain in effect at least until a decision is made as to which court will hear the consolidated challenges to the rules. The wide-ranging litigation is not expected to be resolved before January 1, 2025, when, if a stay is not in place, certain large companies will be required to begin tracking information for disclosure.

Running almost 900 pages in length, the final rules purportedly aim to provide investors with consistent, comparable and reliable information about the financial effects of climate-related risks on a company’s business, as well as information about how the company manages those risks. At their core, the final rules impose a host of new qualitative and quantitative climate-related disclosure requirements on most public companies, including with respect to:

• Material climate-related risks as well as any governance and processes used by the company to manage climate-related risks;
• Material climate-related targets or goals, plans for achieving targets or goals and annual progress against targets or goals;
• Material expenditures directly resulting from activities to mitigate climate-related risks as well as transition plans and targets or goals;
• Scope 1 emissions (direct emissions) and Scope 2 emissions (emissions associated with energy purchases) when those emissions are material to a company as well as an attestation report with respect to those emissions; and
• Financial statement footnote disclosures on expenditures resulting from severe weather events and other natural conditions.

Similar to the proposed rules, the final rules use certain concepts and elements of pre-existing voluntary reporting frameworks (namely, the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol). The adopting release states that adopting a rule that uses similar definitions and is based on the TCFD will assist in standardizing climate-related risk disclosure and help elicit more consistent, comparable and useful information for investors, as well as limiting the reporting burden on companies, as many companies are already familiar with and provide disclosure based on the TCFD framework. At the same time, the adopting release also recognizes that the final rules diverge from both frameworks in certain respects to achieve the SEC’s goals of investor protection and capital formation.

While certain aspects of the final rules are consistent with the proposal, the SEC made several notable changes in the final rules, both by excluding major provisions and including new rule elements, to address the tremendous number of public comments received on the proposal. One significant change from the proposal is the elimination of the requirement to report Scope 3 emissions (indirect emissions in the upstream and downstream activities of a company’s value chain), which was arguably the most controversial aspect of the proposed rule, in part due to concerns about the availability and reliability of the underlying data for Scope 3 emissions. Other notable departures from the proposal include:

• Adding a materiality qualifier to certain climate-related disclosures, including, for example, disclosures regarding impacts of climate-related risks and Scope 1 and Scope 2 emissions, which was intended to address concerns that the proposed rule would result in the disclosure of large amounts of immaterial information;
• Narrowing the applicability of certain disclosure requirements for smaller companies, such as exempting smaller reporting companies, or SRCs (which generally include public companies with a public float of less than $250 million or annual revenue of less than $100 million, and that meet other SEC reporting criteria), and emerging growth companies, or EGCs (which generally include public companies that completed an initial public offering fewer than five years ago, have revenue less than $1.235 billion, and meet other SEC reporting criteria), from the Scope 1 and Scope 2 emissions disclosure requirement and related attestation requirement;
• Permitting larger companies whose Scope 1 and/or Scope 2 emissions are material to delay this disclosure until the quarterly report on Form 10-Q for the second fiscal quarter in the fiscal year immediately following the year to which the information relates;
• Scaling back the financial statement disclosure requirements, including removing the requirement to disclose the impact of severe weather events and other natural conditions and transition activities on each line item of a company’s consolidated financial statements, which was another area of significant controversy in the proposal; and
• Phasing in compliance over longer periods of time.

Even with the SEC’s changes to the final rules, there is no question that the new regime under the final rules will require public companies to devote significant resources to establish (or enhance) internal control systems and disclosure control procedures to collect and report climate-related information, including GHG emissions and information related to physical and transition risks and severe weather events and other natural conditions. Even the most dedicated and well-resourced public companies, including those that already voluntarily report on similar climate-related information, will be required to expand and enhance their climate reporting systems and processes. For the many companies that have not yet started their climate reporting “journey” on a voluntary basis, the undertaking will arguably be even more substantial.

Core Elements of the Final Rules

The final rules reside in a new Article 14 added to Regulation S-X (the SEC rules regulating the contents of SEC filed-financial statements) and a new Subpart 1500 added to Regulation S-K (the SEC rules regulating narrative disclosures in SEC filings). The new rules apply to both domestic issuers and foreign issuers, other than certain Canadian companies reporting under the multijurisdictional disclosure system rules.

The final rules are summarized briefly below.

Governance: Companies must describe the board of directors’ oversight of climate-related risks. These disclosure requirements are intended to enhance investors’ ability to evaluate a company’s overall management of climate-related risks by improving their understanding of the board’s role in overseeing these risks. For boards that exercise oversight of climate-related risks, such disclosure should include the identity of board committees or subcommittees responsible for the oversight of climate-related risks; and the processes by which the board, committee, or subcommittee is informed about such risks. Further, if a company has targets or goals or a transition plan, the company must disclose whether and how the board oversees progress against the target, goal, or transition plan.

The adopting release states that the final rules are not intended to shift governance behaviors, including board composition or board practices, or to influence company decisions about how to manage climate-related risks. To address the concern that certain elements of the proposal could have unintended effects on a company’s governance structure and processes, the final rules eliminate certain of the more prescriptive elements of the proposal, including the proposed requirements to disclose the identity of specific board members responsible for climate risk oversight; information about board member expertise in climate-related risks; the frequency with which the board is informed of climate-related risks; and information regarding whether and how the board sets climate-related targets or goals.

Under the final rules, companies also must describe any role by management in assessing and managing material climate-related risks. These disclosure requirements are intended to provide investors with information about how management-level staff assesses and manages material climate-related risks. Given the large number of climate-related matters that may be overseen by management, the final rules limit this disclosure to material climate-related risks. The final rules also provide a non-exclusive list of disclosure items when describing management’s role in assessing and managing a company’s material climate-related risks, including whether and which management positions or committees are responsible for assessing and managing climate-related risks, and the relevant expertise of such positions or committees; the processes by which such positions or committees assess and manage climate-related risks; and whether such positions or committees report information about such risks to the board or a committee or subcommittee of the board.

Strategy, Business Model and Outlook: A company must describe any climate-related risks (including physical risks and transition risks) that have had or are reasonably likely to have a material impact on the company, including on its strategy, results of operations or financial condition in the short-term (i.e., the next 12 months) and in the long-term (i.e., beyond the next 12 months). This disclosure provision, which is specifically focused on climate-related risks and separate from a company’s general risk factors, is intended to help investors better understand a company’s assessment of whether its business is, or is reasonably likely to be, exposed to a material climate-related risk. In an effort to mitigate some of the compliance burdens on companies, the final rules eliminate certain prescriptive disclosure requirements and modify some of the definitions, among other changes.

Companies also must disclose the actual and potential material impacts of any identified climate-related risks on the company’s strategy, business model and outlook. According to the SEC, this information is central to understanding the extent to which a company’s business strategy or business model has changed, is changing or is expected to change to address those impacts and central to evaluating management’s response to the impacts and the resiliency of the company’s strategy to climate-related factors as it pertains to the company’s results of operations and financial condition. The final rules include a non-exclusive list of potential material impacts of climate-related risks, which is largely consistent with the proposal, including material impacts to the company’s business operations; products or services; suppliers, purchasers or counterparties to material contracts; activities to mitigate or adapt to climate-related risks; and R&D expenditures. The non-exclusive list is intended to help elicit meaningful and relevant disclosure without overburdening companies or investors with the presentation of irrelevant information.

If, as part of its strategy, a company has undertaken activities to mitigate or adapt to a material climate-related risk, the company must include a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that, in management’s assessment, directly result from such mitigation or adaptation activities. Additional disclosure regarding a company’s activities, if any, to mitigate or adapt to a material climate-related risk include the use, if any, of transition plans, scenario analysis or internal carbon prices.

Risk Management: A company must describe any processes it has for identifying, assessing and managing material climate-related risks. If the company is managing material climate-related risks, it must describe whether and how any such processes are integrated into the company’s overall risk management system. The final rules adopt a less prescriptive approach in an effort to avoid a one-size-fits-all disclosure model that fails to account for industry and business differences and that could result in the disclosure of immaterial information, while at the same time eliciting information for investors about companies’ risk management practices.

Targets and Goals: If a company has set a climate-related target or goal that has materially affected or is reasonably likely to materially affect the company’s business, results of operations or financial condition, it must provide certain disclosures about the target or goal, including material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal. According to the SEC, investors need detailed information about a company’s climate-related targets or goals in order to understand and assess the company’s risk strategy and how the company is managing the material impacts of its climate-related risks.   

While some commenters recommended that the SEC require the disclosure of only public goals, the final rules will require the disclosure of both public and internal targets or goals that are material to the company. The SEC declined to limit this requirement to public goals due to a concern that companies would keep material targets or goals non-public in order to avoid disclosure, which would deprive investors of this information. The final rules, however, eliminate the proposed requirement to disclose interim targets or goals.

Similar to the proposal, but with some modifications, disclosure should include information necessary to an understanding of the impact of the target or goal, including, without limitation, the scope of activities included in the target; the unit of measurement; the time horizon by which the target is intended to be achieved; the baseline time period, if applicable, and the means by which progress will be tracked; and a qualitative description of how the company intends to meet its climate-related targets or goals. The adopting release clarifies that the listed items are non-exclusive examples of additional information or explanation, in an effort to address concern that the disclosure in the proposal was too prescriptive and burdensome.

The final rules further require disclosure of how the company intends to meet its climate-related targets or goals, leaving it up to the company to determine which specific factors to highlight as part of the qualitative description. As a departure from the proposal, a company is only required to disclose certain information about carbon offsets or renewable energy credits or certificates (RECs) if they have been used as a material component of a company’s plan to achieve its targets or goals. Companies also will be required to disclose progress toward meeting targets or goals and must update this disclosure annually to describe the actions taken during the year to achieve targets or goals. The SEC views this information as important to better enable investors to monitor impacts on a company as it attempts to meet its targets or goals. While the final rules eliminate the Scope 3 disclosure requirement, as discussed below, as a practical matter a company may still be required to disclose some information about Scope 3 emissions if it has a Scope 3 target or goal as part of the requirement to provide annual progress updates on targets and goals.

GHG Emissions Metrics: According to the SEC, investors view information about a company’s GHG emissions as a central measure and indicator of a company’s exposure to transition risk as well as a useful tool for assessing its management of transition risk and understanding its progress towards climate-related targets or goals. The GHG emissions metrics disclosure requirements in the proposal, which would have required the disclosure of Scope 1 and Scope 2 emissions by all registrants as well as Scope 3 emissions by all registrants other than SRCs, in both cases regardless of materiality, received widespread criticism. The final rules include scaled back GHG emissions disclosure requirements to address concerns about the significant compliance burdens and associated costs related to the proposed requirements.  

The final rules differ from the proposed rules in several notable ways. For example, the final rules:

• Eliminate the Scope 3 emissions disclosure requirement for all registrants;
• Exempt certain smaller companies (SRCs and EGCs) from the Scope 1 and Scope 2 emissions disclosure requirement;
• Clarify that larger companies—large accelerated filers, or LAFs (which include seasoned issuers with a public float of $700 million or more), and accelerated filers, or AFs (which include seasoned issuers with a public float between $75 million and $700 million)—are required to disclosure Scope 1 and/or Scope 2 emissions, only if such emissions are material; and
• Extend the phase-in compliance period.

While materiality determinations are based on the specific facts and circumstances and involve the assessment of both qualitative and quantitative factors, the adopting release provides some guidance on when Scope 1 and/or Scope 2 emissions may and may not be material. For example, the adopting release states that emissions may be material when a company faces a material transition risk that has manifested as a result of a requirement to report GHG emissions metrics under foreign or state law because those emissions are currently or are reasonably likely to be subject to additional regulatory burdens through increased taxes or financial penalties. Conversely, the adopting release notes that the fact a company is exposed to a material transition risk does not necessarily result in Scope 1 or Scope 2 emissions being de facto material.

In a change from the proposal, which would have required the disclosure of GHG emissions both disaggregated by each constituent GHG and in the aggregate, the final rules require the disclosure of Scope 1 and/or Scope 2 emissions to be expressed in the aggregate in terms of CO2e. This change was intended to alleviate some of the compliance burdens and associated costs. While the scope of emissions must be disclosed on an aggregate basis, if any constituent gas of the disclosed emissions is individually material, a company must also disclose the constituent gas disaggregated from the other gases.

Consistent with the proposal, emissions should be disclosed in gross terms by excluding the impact of any purchased or generated offsets. Also consistent with the proposal, the final rules require companies to describe the methodology, significant inputs and significant assumptions used to calculate the disclosed GHG emissions. The SEC notes in the adopting release that this information is important to investors because it provides important contextual information, such as the scope of the entities included in the GHG emissions results that may be subject to transition risk, and informs comparability across companies. The final rules permit companies to use reasonable estimates when disclosing GHG emissions so long as the company also describes the assumptions underlying the estimates and its reasons for using them. Further, in an effort to alleviate compliance burdens and associated costs, the final rules eliminate the proposed requirement to disclose GHG emissions in terms of intensity.

To address concerns that a company may have difficulty measuring and reporting its GHG emissions as of fiscal year-end by the same deadline for its annual report filed with the SEC on Form 10-K, the final rules provide companies that are required to provide Scope 1 and/or Scope 2 emissions with the option to delay this disclosure until the quarterly report on Form 10-Q for the second fiscal quarter in the fiscal year immediately following the year to which the information relates.

A company that is otherwise not required to disclose its GHG emissions or to include an attestation report must nonetheless disclose certain information if it chooses to voluntarily disclose its GHG emissions in a SEC filing and subject those disclosures to third-party assurance. 

Attestation of GHG Emissions: Companies that are required to disclose Scope 1 and/or Scope 2 emissions must file an attestation report covering the disclosure of its GHG emissions on a phased-in basis. The SEC asserts that mandatory assurance improves the accuracy, comparability and consistency of a company’s GHG emissions disclosure and obtaining assurance over GHG emissions disclosure provides investors with an additional degree of reliability regarding the figures that are disclosed as well as the key assumptions, methodologies and data sources the company uses to arrive at the figures.

In response to concerns about the significant compliance burdens and associated costs of the proposed requirements, the potential shortage in the current supply of assurance providers and the evolving state of assumptions, standards and methodologies, the SEC made several modifications in the final rules. The final rules limit the assurance requirements to a subset of companies (LAFs and AFs), exempting SRCs and EGCs from the requirement to obtain an attestation report. In addition, while both LAFs and AFs are required to provide limited assurance, the reasonable assurance requirement applies to a more limited pool of registrants (LAFs), exempting AFs from the requirement to provide reasonable assurance. The final rules also extend the phase in compliance period for assurance. LAFs and AFs are required to obtain limited assurance beginning the third fiscal year after the compliance date for GHG emissions disclosure (i.e., fiscal year 2029 and fiscal year 2031, respectively). LAFs are further required to obtain reasonable assurance beginning the seventh fiscal year after the compliance date for GHG emissions disclosure (i.e., fiscal year 2033), while AFs will not be required to obtain an attestation report at a reasonable assurance level. The SEC reasoned that this scaled approach will avoid increasing compliance burdens for AFs that may be smaller or less sophisticated issuers. 

The attestation report should be filed with a company’s GHG emissions disclosure, and the extension of the deadline for the filing of GHG emissions metrics also applies to the deadline for the filing of an attestation report.

Financial Statement Disclosure Requirements: In a notable change from the proposal, the final rules remove the proposed requirement to disclose the financial impacts from severe weather events and other natural conditions and transition activities on any relevant line item in a company’s consolidated financial statements. Commenters expressed significant concern about the burdens associated with this aspect of the proposal because of the updates that would be necessary to internal systems and controls. These concerns ultimately led the SEC to adopt a narrower set of requirements focused on requiring the disclosure of a discrete set of actual expenses that companies incur and can attribute to severe weather events and other natural conditions.

The final rules require the disclosure of the financial statement effects of severe weather events and other natural conditions including, for example, costs and losses. Companies will need to disclose the capitalized costs, expenditures expensed, charges and losses incurred as a result of severe weather events and other natural conditions (such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures and sea level rise), subject to applicable one percent and de minimis disclosure thresholds; and the capitalized costs, expenditures expensed and losses related to carbon offsets and RECs if used as a material component of a company’s plans to achieve its disclosed climate-related targets or goals. If the estimates and assumptions a company uses to produce the financial statements are 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 must include a qualitative description of how the development of such estimates and assumptions was impacted.

Because the new Article 14 disclosures require presentation in the financial statements, they will be subject to internal controls over financial reporting and external audit. Notably, the SEC typically defers to the Financial Accounting Standards Board to set US generally accepted accounting principles, or GAAP, so the new rules represent a rare SEC departure from the standard practice. The final rules make clear that foreign issuers reporting under International Financial Reporting Standards, or IFRS, must also comply with the new financial statement requirements.

Safe Harbor: The final rules extend the protections under the Private Securities Litigation Reform Act of 1995 (PSLRA), which includes safe harbors under the federal securities laws for forward-looking statements, to disclosures (other than historical facts) concerning transition plans, scenario analysis, the use of an internal carbon price, and targets and goals. In general, the safe harbors provide that in any private action under the Securities Act of 1933 or the Securities Exchange Act of 1934 based on an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading, a person covered by the safe harbor (e.g., issuers and those acting on their behalf) shall not be liable for any forward-looking statement if certain conditions are satisfied, such as the statement is identified as a forward-looking statement and accompanied by meaningful cautionary factors that could cause actual results to differ materially from those in the forward-looking statement or is immaterial.

Recognizing that transition plans, scenario analysis and internal carbon pricing involve assumptions, judgments and predictions about future events, the final rules include a provision stating that disclosure (other than historic facts) concerning transition plans, scenario analysis and internal carbon pricing are “forward-looking statements” under the PSLRA safe harbors. Similarly, the final rules state that the PSLRA safe harbors would apply to forward-looking statements made in the context of targets and goals because a company is required to disclose how it intends to achieve its climate-related targets and goals.

The final rules do not adopt a safe harbor for the disclosure of Scope 3 emissions. The SEC justifies this decision because the final rules remove the requirement to disclose Scope 3 emissions metrics. 

Phased-In Compliance

The final rules will become effective 60 days after they are published in the Federal Register. 

The final rules provide for phased-in compliance depending upon the status of the company as an LAF, an AF, a non-accelerated filer (NAF), SRC or EGC, and the content of the disclosure. For LAFs, some reporting is due as early as the 2026 annual report (reporting on the fiscal year beginning in 2025), with AFs following in the 2027 annual report and SRCs, EGC and NAFs beginning in the 2028 annual report. Scope 1 and 2 reporting begins for LAFs in the 2027 annual report and for AFs in the 2029 annual report; SRCs, EGCs and NAFs are exempt from Scope 1 and 2 reporting as noted above. The SEC provides a complete chart of compliance dates in the final rules and in its fact sheet summarizing them.

What’s Next?

The adopting release for the final rules will undoubtedly create a number of interpretive and implementation challenges for companies. The new rules also enhance litigation risk around climate disclosure.

While the SEC notes in the adopting release the development of mandatory climate reporting regimes in California, Europe and elsewhere, the SEC rules are intended to exist on a stand-alone basis, and companies subject to other mandatory reporting regimes around the world will need to address each one separately. Also, some (but not all) of the SEC’s new rules purport to be couched in terms of the traditional materiality test under Supreme Court precedent, whereas many other mandatory reporting regimes use “double materiality” or some other standard for reporting. 

LAFs should begin to develop systems, or re-evaluate existing systems in light of the new requirements, to collect and report required data without delay. Even companies that determine they need not report material climate risks or expenditures will still need to establish systems and processes to reach that conclusion. Further, companies that report under multiple disclosure frameworks will need to develop a strategy to maximize consistency across reports, including by harmonizing data sets and preparation of partially overlapping reports.