Overview of the SEC Climate Risk Disclosure Proposed Rule

Overview of the SEC Climate Risk Disclosure Proposed Rule

May 17, 2022
Overview of the SEC Climate Risk Disclosure Proposed Rule
On March 21, 2022, the Securities and Exchange
investors price climate risks accurately and allocate capital
Commission (SEC) voted 3-1 to issue sweeping proposed
prudently and efficiently through access to comparable
climate-related disclosure rules for public companies. In
specific, and decision-useful climate risk information.”
issuing the proposed rules, the SEC cited its existing
statutory authorities under the federal securities laws—
Echoing a common criticism of the proposal, the U.S.
specifically, the Securities Act of 1933 (P.L. 73-22) and the
Chamber of Commerce asserted: “[T]he prescriptive
Securities Exchange Act of 1934 (P.L. 73-291). The
approach taken by the SEC will limit companies’ ability to
proposal represents a more prescriptive and detailed
provide information that shareholders and stakeholders find
approach to climate-related disclosures relative to the
meaningful while at the same time requiring that companies
existing broad, principles-based climate-related disclosure
provide information in securities filings that are not
regime embodied in the SEC’s 2010 “Guidance Regarding
material to investors.”
Disclosure Related to Climate Change.” Among other
things, it would require all public companies, as a growing
The proposal earned praise from Senator Sherrod Brown
number voluntarily do, to report on their direct greenhouse
and Representative Maxine Waters, the respective chairs of
gas (GHG) emissions and under certain circumstances their
the Senate Banking and House Financial Services
upstream and downstream GHG emissions.
Committees. It was criticized by the ranking Members of
those committees—Senator Pat Toomey and Representative
Public companies would also be required to report on the
Patrick T. McHenry.
impacts of climate-related natural events and transitional
activities to mitigate such impacts on their consolidated
If adopted, the disclosure requirements would direct
financial statements. According to the SEC, both the current
domestic or foreign SEC registrants to include climate-
and proposed disclosure regimes are grounded in the federal
related information in their registration statements, such as
securities laws’ concept of materiality—the notion that
Form S-1, and their periodic reports, such as Form 10-K.
required disclosures should encompass the types of
The proposed disclosures can be divided into four broad
information that investors consider important when they
types described below: climate-related risks, GHG
make investment or corporate voting decisions.
emissions, targets and goals, and audited financial
statement disclosures.
Some SEC officials say that the current voluntary reporting
protocol has often resulted in incomplete and inconsistent
Proposed Disclosures
significant climate-related disclosures due to differences in
Climate-Related Risks. The proposal includes a number of
methodology and in assessing what is material. Various
provisions that involve non-financial disclosures
investors and observers have said that these shortcomings
surrounding corporate climate-related risks. They are
have compromised the complete disclosure of the financial
modeled in part after the recommendations of the Task
risks related to climate change. And according to some SEC
Force for Climate-Related Disclosures—a group of
officials, the proposed rules are aimed at addressing such
financial experts created by the Financial Stability Board.
perceived drawbacks.
They also draw from the Greenhouse Gas Protocol, a global
initiative that provides standards for business and
Other SEC officials have, however, argued that the current
government to monitor GHG emissions. These provisions
reporting protocol has generally resulted in firms
would require a covered company to disclose:
consistently reporting materially significant climate-related
impacts. They also asserted that the proposed rules go
 A description of its climate-related risks and relevant
beyond the SEC’s statutory authority, will not result in
risk management processes.
consistent and comparable inter-firm reporting due to
unreliable data and modeling based on potentially
 How identified climate-related risks have had or are
speculative assumptions, and discards the materiality
likely to have a material impact on its business and
qualifier for some disclosures while employing an overly
financial statements during the short, medium, or long
expansive definition of materiality for some others.
term.
At the time of the vote, Chair Gary Gensler remarked,
 How identified climate-related risks have affected or are
“Today’s proposal would help issuers more efficiently and
likely to affect its strategy, business model, capital
effectively disclose [climate risks] … and meet investor
allocation, financial planning, and outlook.
demand, as many issuers already seek to do.” Some
environmental groups have supported such measures based
 How climate-related events (including severe weather
on similar arguments. For example, the Environmental
events and other natural conditions) and transition
Defense Fund said that, if finalized, the rules would “help
activities (to help mitigate or adapt to climate-related
https://crsreports.congress.gov

Overview of the SEC Climate Risk Disclosure Proposed Rule
risks) would impact the line items of its consolidated
dioxide or its equivalent. A REC represents a tradeable
financial statements, as well as the financial estimates
amount of energy from renewable energy sources.)
and assumptions used in the statements.
Footnoted Financial Statement Disclosures. Companies
 Its estimated cost of carbon emissions (if it uses an
would be required to add disclosures about certain climate
internal carbon price). Information about that estimate
risks to their audited financial statements as footnotes when
and how it is formulated must be disclosed.
the risks are likely to have a material impact on line items
and the firms’ related expenditures. These footnotes would
 Disclosures that enable investors to understand those
require disaggregated metrics that explain the impact of
aspects of the registrants’ climate risk management
climate-related events (e.g., severe weather events, other
strategy (if the firm has undertaken scenario analysis,
natural conditions, and identified physical risks) and
developed transition plans, or publicly issued climate-
transition activities (including identified transition risks).
related targets or goals).
Financial estimates and assumptions impacted by these
developments must also be noted. As part of a firm’s
GHGs. Under the proposal, firms would generally be
financial statements, the notes would be subject to auditing
required to disclose their direct GHG emissions from
by an independent registered public accounting firm.
operations that they own or control (Scope 1 emissions) and
indirect GHG emissions from purchased electricity and
Materiality
other forms of energy (Scope 2). They would also be
A central tenet of the proposed rule is that the information
required to describe the methodology, significant inputs,
to be disclosed is material to investors. SEC Chair Gensler
and assumptions used for their calculations. For both, the
argued in a statement on the rule that the mandated
disaggregated constituent GHG emissions would also have
disclosures follow the materiality principles laid out by the
to be disclosed.
U.S. Supreme Court. He also contended that substantial
investor demand for such information is evidence of its
Firms would also be required to disclose their Scope 3
materiality. Specifically, Gensler cited requests for such
emissions if they deem them material or have established
disclosures from investors with $130 trillion in assets under
GHG emissions targets or goals. Scope 3 emissions are a
management. He noted that the Supreme Court has
consequence of a firm’s activities but derive from its
explained that information is material if “there is a
upstream and downstream activities, which may be neither
substantial likelihood that a reasonable shareholder would
owned nor controlled by it. Examples of Scope 3 emissions
consider it important” in making an investment or voting
include emissions associated with the production and
decision or if it would have “significantly altered the total
transportation of goods, purchases from third parties,
mix of information made available” (Basic v. Levinson and
employee commuting or business travel, waste generation,
TSC Industries, Inc. v. Northway, Inc.). The SEC stated in
the processing or use of the registrant’s products by third
the rule that GHG emissions have become a commonly
parties, the processing of sold products, the use of sold
used metric to assess a company’s exposure to climate-
products, franchises, and investments. The required
related risks that are reasonably likely to impact its
reporting of Scope 3 emissions has been one of the most
business, operations results, or financials.
controversial aspects of the proposal.
In a dissent, Commissioner Peirce stated the rule lacked “a
The proposal provides for a “safe harbor” that would shield
materiality limitation,” “an adequate statutory basis,” and a
firms from legal liability under the federal securities laws
“credible rationale for such a prescriptive framework” when
for their Scope 3 reporting if done in good faith. It would
existing disclosure requirements already capture material
also exempt smaller reporting companies from Scope 3
risks from climate change. Other commenters disagree. For
disclosure requirements. (Smaller reporting companies are
example, Emory School of Law Professor George Georgiev
public companies with (1) a public float of less than $250
opined that “materiality” should be considered from the
million or (2) annual revenues of less than $100 million and
lens of a “reasonable investor” and that the SEC should not
either (i) no public float or (ii) a public float of less than
“second-guess” the validity of investor-driven demands,
$700 million.)
such as from BlackRock, State Street, Vanguard, CalPERS,
and others who requested such disclosures. Then-Harvard
Targets and Goals. If a firm has publicly established
Business School Professor Robert Eccles additionally noted
climate-related targets or goals, the proposal would require
(prior to the rule) that SEC Staff Accounting Bulletin No.
it to disclose a number of related items. Among them are
99, from 1999, states that “exclusive reliance on certain
(1) the scope and time horizon for the targeted activities and
quantitative benchmarks to assess materiality … is
emissions, (2) how the targets will be met, and (3) data that
inappropriate” and that both qualitative and quantitative
tracks progress toward the goals. In addition, if carbon
factors must be considered in determining materiality.
offsets or renewable energy certificates (RECs) have been
part of a firm’s plan to meet its climate-related goals, then
Related CRS Products
the firm must disclose certain information, including the
CRS Report R46766, Climate Change Risk Disclosures and
amount of carbon reduction represented by the offsets or
the Securities and Exchange Commission, by Rena S.
the amount of generated renewable energy represented by
Miller, Gary Shorter, and Nicole Vanatko.
the RECs. (A carbon offset is a transferrable instrument that
represents an emission reduction of a metric ton of carbon
Gary Shorter, Specialist in Financial Economics
Rena S. Miller, Specialist in Financial Economics
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Overview of the SEC Climate Risk Disclosure Proposed Rule

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