Breaking Down the SEC Climate Disclosure Rule
The U.S. Securities and Exchange Commission (SEC) promulgated its final Climate-Related Disclosure Rule on March 6, 2024. In the first significant update to its initial 2010 material climate risk rule, the SEC has aimed to strike a middle ground while providing investors with a certain level of clarity on the climate risk profile of registered companies, including foreign issuers. The rulemaking significantly expands the climate reporting requirements for covered companies.
The SEC Climate Disclosure Rule marks a significant step forward in corporate transparency, compelling publicly traded companies to disclose climate-related risks and their direct greenhouse gas emissions within their key public filings. This rule breaks new ground in the United States to provide stakeholders with a clearer understanding of climate risk impacts on businesses, towards more informed investment and voting decisions.
Set to take effect for financial years ending after December 31, 2025, for certain filers, the rule encompasses a comprehensive range of disclosures, including greenhouse gas emissions, risk management, and climate targets, aligning with global trends in ESG disclosures. The SEC received more than 24,000 comments on the proposed draft rule, amplifying the ongoing dialogue on sustainability and corporate responsibility. While many other jurisdictions and market-leading companies around the world have already committed to measuring and reporting on their full value chain emissions (Scope 1, 2, and 3), the agency walked back that requirement as had been proposed in the draft rule of March 21, 2022.
Key Provisions of the Final Rule
The SEC Climate Disclosure Rule encompasses several key provisions designed to enhance transparency and provide stakeholders with critical information on how companies are addressing climate-related risks. These provisions include:
1. Greenhouse Gas Emissions Reporting
Accelerated Filers (AFs) and Large Accelerated Filers (LAFs) are required to disclose Scope 1 and Scope 2 emissions data, if those emissions are material, with phased-in assurance requirements.
Scope 3 emissions reporting, which pertains to indirect emissions in a company's value chain, has been eliminated from the requirement.
2. Climate Risk Management, Governance, and Strategy
Companies must disclose the material impact of climate risks (both short- and long-term risks) on their strategy, business model, and outlook.
Disclosure of management responsibility and board of directors oversight of material climate-related risks, including risk management processes, must be detailed.
Registrants must disclose climate targets and goals, if material to the business, operations, or financial condition.
Companies with plans addressing material transition risks must disclose details about those plans including scenario analysis and internal carbon prices if used, and quantify expenditures incurred.
3. Financial Statement Disclosures
In financial statement footnotes, companies must disclose impacts and material impacts on financial estimates and assumptions due to severe weather events.
Disclosures must include capitalized costs, expenditures, and losses related to carbon offsets and renewable energy credits (RECs) if they are a material component to achieving climate targets.
The rule also provides a safe harbor from liability for certain climate-related disclosures. By integrating these provisions, the SEC aims to provide investors with consistent, comparable, and decision-useful information, ensuring clear reporting requirements and fostering greater corporate accountability in the face of climate change. The rule, while scaled back from its original proposal, still represents a significant advancement in climate-related financial disclosure.
Compliance Deadlines and Phased Implementation
The SEC Climate Disclosure Rule establishes a staggered timeline for compliance, allowing companies of different sizes to adapt at a pace that aligns with their reporting capabilities. The phased implementation is as follows:
Large Accelerated Filers (LAFs): These companies are at the forefront, with the first compliance period for fiscal years ending on or after December 31, 2025. This means LAFs will need to include the required disclosures in filings due by March 2026.
Accelerated Filers (AFs): AFs will follow the LAFs, with their compliance starting for fiscal years ending on or after December 31, 2026, and disclosures due by March 2027.
Smaller Reporting Companies (SRCs), Emerging Growth Companies (EGCs), and Non-Accelerated Filers (NAFs): These entities have an additional year to prepare, with compliance required for fiscal years ending on or after December 31, 2027, and disclosures due by March 2028.
For GHG emissions disclosures, the rule introduces a phased-in approach for attestation: LAFs will not need to obtain limited assurance over their GHG emissions until fiscal years ending on or after December 31, 2029, and reasonable assurance is deferred until fiscal years ending on or after December 31, 2033.
There are limited exceptions for asset-backed issuers, smaller reporting companies, and emerging growth companies. The SEC considered but did not include a provision for substituted compliance for foreign private issuers in the final rule.
Comparison with Other Jurisdictions
As implementation begins to take shape, it is instructive to compare the SEC Climate Disclosure Rule with other jurisdictions that are also advancing their climate-related disclosure frameworks. The landscape of climate disclosure is becoming increasingly complex, with different regions adopting their own unique requirements.
In the European Union (EU), under the Corporate Sustainability Reporting Directive (CSRD), companies must report all greenhouse gas emissions, including Scope 1, 2, and 3, highlighting the EU's comprehensive approach to climate transparency. It’s important to note that the EU and other jurisdictions began with financial-related regulations and have now matured and moved into non-financial related and broader sustainability oversight, while the United States lags behind at the national level.
Within the United States, California got out ahead of the powers that be in Washington once again with the enactment of the Climate Corporate Data Accountability Act and the Climate-Related Financial Risk statute in 2023. The text upon passage of the CA climate bills extended beyond direct emissions to the full value chain, mandating the disclosure of aggregate climate risks and emissions.
The variations in climate disclosure norms underscore the challenge for multinational corporations, which will need to navigate and comply with multiple and potentially conflicting frameworks simultaneously. The SEC rule’s reporting standards are built upon the gold-standard Greenhouse Gas Reporting Protocol (GHG Protocol) and the now-disbanded Task Force on Climate-related Financial Disclosures (TCFD) framework, which has essentially been subsumed by the International Sustainability Standards Board (ISSB). While progress has been made on international standards alignment particularly with the IFRS Sustainability Disclosure Standards developed by the ISSB, the global regulatory patchwork illustrates the continued need for harmonization.
Impact on Companies and the Broader Market
During the year the draft rule was considered and in the subsequent two years in which it was pending, the Chair of the Securities and Exchange Commission repeatedly stated that a primary driver for the rule was to provide consistent and decision-useful information to investors. Investors and financial services providers will benefit from the transparency, uniformity, and comparability of information that will result from the SEC Climate Disclosure Rule. The rule will provide stakeholders with a clearer picture of climate-related financial risks and strategies. It is also anticipated that will lead to business operational improvements. This is a transformative period in corporate climate accountability.
The rule has incited legal challenges from certain states and industry groups, reflecting a contentious debate over the SEC's regulatory reach. It is not unusual for trade associations and states to file suits on administrative law and other grounds in an attempt to carve away or overturn a final agency action. The SEC prepared for this and the importance of establishing the record partly explains why the rule numbered 886 pages upon issuance.
Many global, market-leading companies have been preparing for compliance within the EU and have announced that they will be undertaking full value chain reporting. That will maintain consistency across jurisdictions and risk management, compliance, and audit function integrity for companies. The rule’s ripple effect will be felt beyond registered companies as it will reach private company suppliers and vendors across supply chains, as well as asset managers and other market players.
Companies are encouraged to begin preparing for compliance with the rule. Best practices for preparation include:
Identifying the rule’s application to the company and reconciling any conflicting jurisdictional requirements
Establishing or refining corporate governance frameworks
Evaluating board oversight and management responsibilities
Assessing the current state of climate disclosures and identifying gaps, including for data collection and management, in the control environment, and in the audit function
Reviewing risk management practices and updating to be fit-for-purpose
Developing a matrixed plan that encompasses the above and continuously revise it to comply with evolving regulatory requirements
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