Newly adopted rules by the Securities and Exchange Commission are poised to have a transformative impact on climate-related disclosures by public companies and in public offerings.
The SEC’s climate disclosure rules seek to enhance and standardize disclosures, and they represent a significant overhaul of existing disclosure requirements and expand reporting obligations for public companies. While portions of the rules were scaled back compared to earlier proposals, they do require public companies to disclose, among other things:
- Material climate-related risks and activities to mitigate or adapt to such risks
- Information about their board of directors' oversight of climate-related risks and management’s role in managing material climate-related risks
- Information on any climate-related targets or goals that are material to their business, results of operations, or financial condition
“The rules were scaled back, that is the positive takeaway,” said Dan Romito, consulting partner at Pickering Energy Partners, who detailed how organizations can prepare for the rules to go into effect during a special AEM Member Education Webinar held late last month. “However, it is still very comprehensive in terms of what it will require. In addition, the SEC’s Final Climate Rule will address 94% of the U.S. market capitalization. So, the odds are you fall under its purview in one way or another.”
Key Takeaways
In addition, to facilitate investors' assessment of certain climate-related risks, the final rules require disclosure of Scope 1 and/or Scope 2 greenhouse gas (GHG) emissions on a phased-in basis by certain larger registrants when those emissions are material. In addition, they require the filing of an attestation report covering the required disclosure of such registrants’ Scope 1 and/or Scope 2 emissions, also on a phased-in basis; as well as disclosure of the financial statement effects of severe weather events and other natural conditions (including, for example, costs, and losses).
“Generally speaking, if you are a publicly traded company, or if you are a private company that is a supplier to a large accelerated filer, there is some aspect of disclosure that you're going to have to provide,” said Romito.
The following key takeaways of the final rule highlight the importance of adopting the Task Force on Climate-related financial disclosures (TCFD) reporting:
- The four categories of TCFD function as the foundation for the SEC’s final climate disclosure rule, focusing on climate-related risks and their impact on a company’s finance
- Scope 3 emissions did not make the cut, but are required from other state-level requirements (such as the California Climate Accountability Act)
- The adoption timeline has been lengthened to allow for a “phased-in” implementation plan
- Large accelerated filers have roughly
- One year to provide “basic climate disclosures”
- Two years to provide GHG emissions information
- Five years to obtain limited assurance over GHG emissions
- Exemptions for certain GHG emissions-related disclosures have been implemented
- Smaller reporting companies, emerging growth companies, and non-accelerated filers are exempt from GHG emissions disclosures
- Materiality threshold has been set for financial statement implications
- Financial statements impact when aggregate amounts exceed 1% of pretax income or total shareholders’ equity must be disclosed
- Large accelerated filers have roughly
“From a regulatory perspective, it is now a requirement to have TCFD in the registration documents,” added Romito, who also noted four distinct pillars comprise the TCFD – governance (S-K Item 1501), strategy (S-K Item 1502), risk management (S-K item 1503), and targets and goals (S-K item 1504).
“In most cases, targets and goals is where you are going to struggle the most, because it’s not only quantitative, but now that it’s in the registration documents, you don’t want to go overboard or be overly aggressive with any sort of target or climate-related goal you put in place in terms of GHG emissions,” he added.
GHG Emissions
In terms of GHG emissions, the SEC was very prescriptive in terms of how it defined Scope 1 and Scope 2. And while many companies track and disclose these emissions, there is a wide range of ways in which they are actually measured and defined.
“So, you have to be very mindful of how the SEC is defining Scope 1 and Scope 2 GHG emissions,” said Romito.
The SEC defines Scope 1 and Scope 2 metrics as follows:
- Scope 1 emissions: emissions from a registrant’s own or controlled operations
- Scope 2 emissions: emissions from purchased or acquired electricity, steam, heat, or cooling
Emissions are to be disclosed in the following manner:
- Metric tons of carbon dioxide equivalent
- Separate disclosure for each constituent GHG that is deemed individually material
These disclosures must be provided separately for Scope 1 or 2 on a gross basis (before considering any offsets)
- Registrants must disclose whether and, if so, how the organizational boundary materially differs from the entities and operations reflected in the consolidated financial statements
“What people tend to forget is there has to be a separate disclosure of each constituent GHG that is deemed individually material,” said Romito. “So, there are actually two separate considerations.”
According to Romito, the considerations are:
- Is it material? If it is, then organizations need an itemized list of the components of the GHG emissions
- Even though organizations often have some sort of carbon offset or renewable energy credit, Scope 1 or Scope 2 energy emissions need to be reported on a gross basis
In addition, according to Romito, statement footnotes include three new key disclosures:
- Severe weather and “other natural condition” financial statement impacts
- The aggregate expenditures incurred, and losses recognized in the income statement, as a result of severe weather events and other natural conditions (e.g., hurricanes, tornados, flooding, sea level rise) subject to the threshold of the greater 1% of the absolute value of pretax income (loss)
- The aggregate capitalized costs and charges recognized on the balance sheet because of severe weather events and other natural conditions subject to a threshold of the greater 1% of the absolute value of stockholders’ equity or deficit of $500,000
- Registrants must determine the aggregate amounts in the bullets above before consideration of any recoveries such as insurance, which would be disclosed separately, and also must disclose the amounts recognized in each financial statement line affected.
- Registrants are not required to attribute the cause of severe weather events or natural conditions to climate change. Instead, they must include the entire amount of the expenditure, losses, capitalized costs, charges, or recoveries in the disclosure when they determine that the severe weather event or other condition was a significant contributing factor in recognizing such amounts.
- Carbon offset and renewable energy credit (REC) information
- If carbon offsets and renewable energy credits are material to the registrant’s plan to achieve disclosed climate-related targets or goals (e.g., net-zero commitment), registrants must disclose a roll-forward of the beginning and ending balances, with separate disclosure of the aggregate amount of losses incurred related to such instruments during the year. Registrants must also disclose which financial statement line items are affected and the accounting policy for such instruments.
- Estimates and assumptions
- Whether, and, if so, how severe weather events and other natural conditions and disclosed climate-related targets or transition plants materially affected estimates and assumptions reflected in the financial statements.
“You do have to be very mindful that disclosure is not necessarily a net consideration, meaning if you're utilizing any sort of carbon offsets or renewable energy credits to get to a goal, you have to disclose your scope one at a gross level and disclose what offsets or renewable energy credits you're utilizing and provide the net,” said Romito. “So, it’s not just one or the other, it’s actually both.”
The Bottom Line
If Scope 1 and Scope 2 GHG emission metrics are material to the registrant, disclosure within its SEC filing of the GHG emission metrics is required for the fiscal year beginning in 2026 for large accelerated filers. Limited assurance comes into play in 2029 for large accelerated filers and reasonable assurance comes into play in 2033 for accelerated filers.
“Obviously, you want to get things ready and prepared today, but you can take a little bit of solace, and management teams and boards can be a little bit relieved, knowing that they do have a reasonable amount of time to prepare,” said Romito.
For more information, on the SEC’s climate disclosure rules, contact AEM’s Curt Blades at cblades@aem.org.
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