SEC adopts rules to enhance and standardise climate-related disclosures

The Final Rules, that were proposed two years earlier in March 2022, generated a huge response. Over 4,500 unique comment letters and 18,000 form letters were submitted to influence and support ‘The Enhancement and Standardisation of Climate-Related Disclosures for Investors’.

The SEC’s efforts to issue these new rules are the result of investor demands for consistent, reliable, and comparable information regarding climate-related risks. More specifically, these Final Rules set out the information needed to help investors assess how climate risks affect a registrant’s business and financial condition, and assess the registrant’s management and board oversight of its climate-related risks.

What distinguishes the SEC requirements from those issued by other sustainability standard setters, most notably the IFRS Sustainability Disclosure Standards (IFRS SDS) issued by the International Sustainability Standards Board (ISSB) and the European Sustainability Reporting Standards (ESRS) as required by the Corporate Sustainability Reporting Directive (CSRD) in the European Union, is that there is no requirement to disclose Greenhouse Gas (GHG) Scope 3 emissions.

Summary of new requirements

The Final Rules set out in a new subpart 1500 of Regulation S-K and Article 14 of Regulation S-X require reporting entities to make robust climate-related disclosures, which include details of:

• Climate-related risks reasonably likely to materially impact the registrant’s business strategy, results of operations or financial condition
• Actual and potential material impacts of identified climate-related risks on strategy, business model and outlook
• Quantitative and qualitative description of material expenses incurred and material impacts on financial estimates and assumptions that directly result from mitigation or adaptation activities
• Specific activities to mitigate or adapt to a material climate-related risk, including the use of transition plans, scenario analysis, or internal carbon prices
• Oversight by the board of directors of climate-related risks and role of management in assessing and managing the registrant’s material climate-related risks
• Processes for identifying, assessing, and managing material climate-related risks and whether and how these are integrated into the overall risk management system or processes
• Information about climate-related targets or goals that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition
• Information about material Scope 1 emissions and Scope 2 emissions. (This is specific to large accelerated filers (LAFs) and accelerated filers (AFs) that are not otherwise exempted)
• Capitalised costs, expenses incurred, charges and losses incurred as a result of severe weather events and other natural conditions, subject to applicable one percent and de minimis disclosure thresholds
• Capitalised costs, expenses incurred, and losses in relation to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of plans to achieve disclosed climate-related targets or goals, and
• A qualitative description of how the development of estimates and assumptions are impacted if estimates and assumptions used to produce financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans.

If required to disclose Scope 1 and Scope 2 emissions, reporting entities are required to obtain an assurance report at the limited assurance level which, after an additional transition period, will move to being reasonable assurance for a LAF (Lightweight Auditing Framework).

Comparison to ISSB Standards and ESRS Standards

Although the new rules require climate-related disclosures, there are significant differences between the Final Rules and the IFRS SDS and the ESRS in several main areas. Below is a snapshot of some of these differences:

Scope and effective date

These new rules apply to all SEC registrants. The SEC has implemented a phased-in approach for complying with the new rules based on registration filing status.

In addition to the phased-in approach by filing status, the SEC has also implemented a phased-in approach for certain more complex requirements in deference to the additional time needed for registrants to comply.

• Item 1502(d) requires a registrant to provide a narrative discussion of whether and how any climate-related risks described have affected or are reasonably likely to affect the registrant’s consolidated financial statements
• Item 1502(e) requires a registrant to describe a transition plan if it has adopted the plan to manage a material transition risk, and
• Item 1504(c) requires a registrant to disclose any progress toward meeting a target or goal and how such progress has been achieved. 

These three items, as well as the assurance requirements, will come into effect at the specified later dates.

This table illustrates the compliance dates required for each type of filer and requirement, with the date indicating that compliance is required in the financial year beginning in the calendar year listed.

Next steps for SEC registrants

Reporting entities in scope of the Final Rules should start getting ready to comply as soon as possible. These rules will require the collection of data that entities may not yet be able to collect due to system or process restrictions and involve topics that many entities may not yet have expertise in. Due to these complexities, it may take longer than anticipated to prepare the required disclosures and prompt action should enable registrants to comply in a timely manner as the deadlines set are demanding. 

Our thoughts

We welcome the adoption of these Final Rules because they are a first step towards U.S. public companies providing climate-related information to both investors and global entities that are involved in their value chains. These Final Rules will further improve the transparency of U.S. public company reporting on climate-related matters which are increasingly becoming of great interest to investors.

The extent of climate related disclosures that are set out in these Final Rules in many instances will require registrants to build new systems and controls, so there is likely to be a significant increase in compliance costs, not only in the first year of application, but in subsequent periods as well.