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The long-anticipated proposed rule for the Enhancement and Standardization of Climate-related Disclosures for Investors (the "Proposed Rule") was released by the Securities and Exchange Commission (SEC) on Monday, March 21st, 2022[1]. The Proposed Rule is intended to strike a balance between offering investors clear, consistent and comparable information when selecting investments and the potential additional costs of compliance it might impose on SEC filers. The Proposed Rule comes after a lengthy public input period on climate change disclosures that generated significant interest and many responses from individuals, organizations, academics, investors and the like. The release of the Proposed Rule opens an additional comment period (30 days after publication in the Federal Register or 60 days after the date of issuance and publication on sec.gov (May 20, 2022), whichever period is longer) in which responses can be submitted to the SEC.

The Proposed Rule would make amendments to Regulations S-X and S-K, which set reporting requirements for registrants subject to various SEC filings. The inclusion in these regulations is not only a matter of convenience but signals the importance that the SEC is placing on climate-related disclosures, which is reflected throughout the document, as well as in public comments from Commissioner Allison Herren Lee and the current SEC Chair Gary Gensler.

Some of the key areas the Proposed Rule covers are materiality, attestation requirements, metrics, backward versus forward-looking statements and granularity of the data reported. The Proposed Rule features an intent to align with the requirements and expectations set forth in the Task Force for Climate-related Financial Disclosures (TCFD). This includes disclosures of strategies and methods of managing climate-related risks, material impacts of climate-related risks on business strategy and outlook, climate-related risk management activities, climate-related goals and targets, GHG emissions and additional climate-related financial metrics to be disclosed in a note to a company's financial statements.

Similar to TCFD, the SEC Proposed Rule will directly tie climate-related risks and any adaptation or mitigation activities to a company's financials, as well as call for disclosures regarding management decisions and strategies for identifying and mitigating climate-related risks. Additionally, the SEC rule has adopted TCFD's methodology for identifying risk as "physical" (acute or chronic) or "transitional."

Examples of Related SEC Proposed Rule Disclosures / Governance: >The role of the board of directors and its ability to oversee climate-related risks >The role of senior leadership in identifying, assessing and managing climate-related risks >Reporting methods and cadence for ensuring that climate-related risks and risk management activities are communicated effectively / Strategy: >adaptation efforts to avoid climate-related risk exposure >Mitigation efforts for reducing climate-related risk impacts >Transition planning for moving to a low-carbon economy / Risk Management: >Risk identification and assessment process >Discussion of how climate-related risk is integrated into risk appetite statements and risk assessments >Discussion of the use of scenario analysis to assess the resilience of business strategy to climate-related risks / Metrics & Targets: For filers that have set climate targets: description of climate targets and discussion of how the filer planers to reach those targets > Any sub-targets or significant milestones set by the organization >Baselines and time periods anticipated for achieving goals

Figure 1: TCFD topics and SEC Proposed Rule requirements[2]

Examples of Related SEC Proposed Rule Disclosures
Governance
  • The role of the board of directors and its ability to oversee climate-related risks
  • The role of senior leadership in identifying, assessing and managing climate-related risks
  • Reporting methods and cadence for ensuring that climate-related risks and risk management activities are communicated effectively
Strategy
  • Adaptation efforts to avoid climate-related risk exposure
  • Mitigation efforts for reducing climate-related risk impacts
  • Transition planning for moving to a low-carbon economy
Risk Management
  • Risk identification and assessment process
  • Discussion of how climate-related risk is integrated into risk appetite statements and risk assessments
  • Discussion of the use of scenario analysis to assess the resilience of business strategy to climate-related risks
Metrics & Targets
  • For filers that have set climate targets: description of climate targets and discussion of how the filer plans to reach those targets
  • Any sub-targets or significant milestones set by the organization
  • Baselines and time periods anticipated for achieving goals
Significant Disclosure Areas of Focus

Companies will need to assess the Proposed Rule's impact and design a strategy for compliance with these new requirements. The areas we have identified as potentially large books of work for filers include the following disclosures:

Risk Identification and Risk Management Activities:

Filers will be required to disclose narratives and qualitative information regarding their approach and ability to manage climate-related risks.

  • Impacts of climate-related risks on business operations, products and/or services, suppliers and other value chain parties, mitigation or adaptation activities, and expenditure for R&D
  • Climate-risk management and strategy, including adaptation and mitigation efforts
  • The role of the board of directors, including information regarding the board’s expertise and ability to oversee climate-related risk management
  • The role and activities of management in identifying and managing climate-related risk, as well as plans for adapting to and mitigating climate-related risk
  • Description of scenario analysis activities, if applicable, including what scenarios are used, where data is sourced, parameters, assumptions, analytical approach and how resilient the business is to climate change based on the scenario results
  • Transition planning, including how the business plans to address and transition away from material climate-related risks
  • The role that carbon offsets or renewable energy credits (RECs) play in any climate-related risk planning and identification and validation information regarding their purchase and legitimacy
  • Any targets or goals that have been set by the organization regarding climate-related risk and mitigation or adaptation activities
Financial Metrics:

Filers will be required to disclose disaggregated metrics that show the impact of climate-related risk events on the consolidated financials.

  • Financial impact metrics, which describe any impacts climate-related risks have caused on the financials included in the consolidated financial statements
  • Financial expenditure metrics, which describe any significant expenditures as a result of climate-related risks
  • Financial estimates and assumptions, which are any estimates or assumptions made as part of the consolidated financial statements and how those have been impacted by climate-related risks
Greenhouse Gas (GHG) Emissions:

Registrants will also be required to disclose Scope 1 and Scope 2 GHG emissions, with larger filers required to disclose Scope 3 GHG emissions.

  • Scope 1: direct greenhouse gas emissions that occur from sources that are controlled or owned by the organization
  • Scope 2: indirect GHG emissions that are purchased from outside sources
  • Scope 3: emissions resulting from activities that are not owned by the organization but that the organization incurs through its supply chain (upstream and downstream)

GHG emissions disclosures are to be disclosed individually, by scope and at both an aggregated and disaggregated level by constituent gas. The Proposed Rule defines constituent gases in alignment with the GHG Protocol, Kyoto Protocol, U.N. Framework, U.S. Energy Administration and EPA. GHG emissions calculations cannot include any offsets or RECs.

In addition to gross GHG emissions, filers will be required to disclose GHG emissions in terms of intensity, normalized to revenue or a production number.

Given the complexity and challenges presented by Scope 3 GHG emission inventorying, data collection and calculation, the SEC is proposing a phased approach to Scope 3 disclosure. The Proposed Rule would require Scope 3 GHG emissions disclosure by fiscal year 2024 (filed in 2025) for large accelerated filers.

Assurance

Because these metrics, in part, will be included in annual financial statements, they will be subject to the same rigors and controls testing as other audited consolidated financial statements. In particular, the financial metrics (financial impact, expenditure metrics, estimates and assumptions) will be subject to audit and internal control over financial reporting. GHG emissions disclosures will also require various forms of assurance depending on the size of the organization. This assurance requirement would apply to Scope 1 and Scope 2 GHG emissions and would be phased in beginning with limited assurance and transitioning to reasonable assurance over a two-year period.

In conclusion, the incorporation of risk management activities, board and management oversight discussions and GHG emissions in the required disclosures will mean that compliance is not simply an activity for the office of the CFO, but rather an enterprise-wide initiative. Risk management, sustainability professionals, environmental management, IT, facilities and operations, among others, are all likely to have a hand in the data and narratives that are required for comprehensive reporting. Filers will benefit from a clear and well-defined disclosure strategy along with robust project management routines. This will aid in identifying, sourcing and compiling the necessary data points to provide high quality quantitative and qualitative disclosures, as well as maintain that climate-related risks and opportunities are appropriately and properly integrated into business operations.

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Sources

[1] https://www.sec.gov/rules/proposed/2022/33-11042.pdf

[2] https://www.fsb-tcfd.org/about/

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