The U.S. Securities and Exchange Commission on March 6, 2024, adopted a final rule that will require climate-related disclosures in registrants’ annual reports and registration statements. The final rule, “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” was adopted after a 3­ to 2 vote by the SEC commissioners and becomes effective 60 days after being published in the Federal Register.

The SEC’s action comes on the heels of similar regulatory steps in the European Union, legislative measures in California, and a flurry of standard-setting activity related to sustainability matters. The final rule introduces new disclosures of greenhouse gas (GHG) emissions; governance and oversight of material climate-related risks; impact of climate risks on the company’s strategy, business model and outlook; risk management processes for climate-related risks; and climate targets and goals. The requirements are subject to certain materiality thresholds, registrant applicability and an adoption phase-in timetable.

Materiality and the location and timing of disclosures

The final rule states that materiality should be defined consistently with the definition as determined by the U.S. Supreme Court, which states that “a matter is material if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.” Also noted is that materiality should be based on both facts and circumstances as well as qualitative and quantitative factors.

The required financial statement disclosures (discussed below) are required to be included as a note to the financial statements. Therefore, the disclosures will be subject to audit as part of the financial statement audit and will be covered by management’s assessment of internal control over financial reporting (ICFR), and, if applicable, covered by the auditor’s report on ICFR.

"A matter is material if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available."

Disclosures within the financial statements

Registrants should disclose the following amounts on a gross basis before any insurance or other recoveries, and any recoveries also should be disclosed. Registrants are required to disclose the aggregate amount of:

a)    Expenses and losses incurred as a result of severe weather events and other natural conditions, if such amount equals or exceeds 1% of the absolute value of income or loss before income tax expense (benefit) for such fiscal year, and

b)    Capitalized costs and charges recognized because of severe weather events and other natural conditions, if such amount equals or exceeds 1% percent of the absolute value of stockholders’ equity (deficit) at the end of the fiscal year.

The above disclosures are not required if they are below a de minimus threshold, which is defined in the final rule as an income statement amount that is less than $100,000 or a balance sheet amount that is less than $500,000.

Further, registrants must attribute and disclose the full amount of the cost, expense, loss or recovery to the severe weather event or natural condition, when such event or condition is a significant contributing factor in incurring such cost, expense, loss or recovery.

Additionally, registrants are required to disclose the aggregate amounts of:

a)    Carbon offsets and renewable energy credits (RECs) expensed

b)    Carbon offsets and RECs capitalized

c)    Losses incurred on capitalized carbon offsets and RECs during the fiscal year

Registrants also need to disclose the beginning and ending balances of capitalized carbon offsets and RECs on the balance sheet for each fiscal year. Registrants are also required to disclose where on the income statement or balance sheet that these amounts are presented. This disclosure is not subject to the above 1% threshold but rather disclosure is required if the carbon offsets or RECs have been used as a material component of the registrant’s previously disclosed plan to achieve climate-related targets or goals.

Governance

The final rule requires disclosures about a registrant’s board of directors’ governance and oversight of climate-related risks, including, among other matters:

• A description of the board of directors’ oversight of climate-related risks
  
• Identification of the board or committee responsible and the process by which the board is informed of such risks
• If a target goal or transition plan is otherwise disclosed, the governance disclosure must include whether and how the board oversees the progress against the target, goal or transition plan

The final rule also requires governance disclosures related to management's role in assessing and managing material climate-related risks, considering the following list of items, which is not all-inclusive:

• The identity of management positions or committees responsible for assessing and managing climate-related risks and the relevant expertise of such position holders or members
  
• The process by which such positions or committees are informed about and monitor climate-related risks
• Whether and how frequently such positions or committees report to the board or a board committee on climate-related risks

Registrants that do not monitor climate-related risks, either at the management or the board of directors’ level, are not required to include any disclosures.

Definitions of climate risks

A registrant is required to describe any climate-related risks reasonably likely to have a material impact on its business strategy, or financial condition or results of operations.

A registrant must describe its climate-related risks, specifying whether an identified material climate-related risk is a physical risk or a transition risk, as follows:

• For physical risks, registrants must further describe the nature of the risk, including whether it may be categorized as an acute risk (event-driven risk related to shorter-term extreme weather events) or chronic risk (resulting from longer-term weather patterns and related effects). Registrants must also include in the description of an identified physical risk, among other matters, the location of the properties, processes or operations subject to the physical risk.
  
• For transition risks, registrants must further describe the nature of the risk, including whether it relates to regulatory, technological, market (including changing customer, business counterparty and investor preferences), or other transition-related factors. Registrants must also disclose their assessment of how these factors may affect the registrant.

Additionally, if a registrant has significant operations in a jurisdiction with a current GHG emissions reduction commitment, the registrant should consider whether it may have a material transition risk related to such commitment.

Lastly, the final rule provides a time horizon for describing climate-related risks. This means registrants should disclose whether the risks are considered short-term (within the next 12 months) or long-term (after the next 12 months). These definitions are consistent with the existing disclosure standards for management’s discussion and analysis (MD&A) with regard to liquidity disclosures.

Risk management

Registrants are required to disclose their processes for identifying, assessing and managing climate-related risks and whether those risks are integrated into the registrant's overall risk management system or processes.

Strategy business model and outlook

A registrant should disclose the actual or potential impact on the registrant’s strategy, business model or outlook, of general climate-related risks as well as those climate-related risks specifically identified. Registrants should also disclose the following, if applicable:

• The internal carbon price and other related information, if the usage of an internal carbon price is material to how the registrant evaluates climate-related risk.
  
• A description of the scenarios, assumptions and expected financial impacts of a scenario analysis, if the usage of a scenario analysis caused the registrant to determine that a climate-related risk is reasonably likely to have a material impact on the registrant.
• A description of the climate transition plan and the progress over time, to the extent the registrant has adopted such a plan.

GHG emissions metrics (if material)

The final rule requires Scope 1 (direct GHG emissions from operations owned or controlled by the registrant) and Scope 2 (indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat or cooling that is consumed by operations owned or controlled by the registrant) emissions to be separately disclosed, on a gross basis, before consideration of any offsets. Registrants must also disclose the relevant protocol or standard utilized to report the GHG emissions, including the methodology and significant inputs and assumptions used in the calculation.

Registrants are also allowed to use judgment when defining their organizational boundary for the purposes of these disclosures, and it does not have to be the same as for its financial statement disclosures. However, registrants must disclose if and how the organizational boundary differs materially from the organizational boundaries used in deriving the consolidated financial statements.

The above GHG emission disclosures are required for large accelerated filers and accelerated filers (other than EGCs and SRCs) and, following a phase-in period, are subject to limited assurance (and eventually, for large accelerated filers, reasonable assurance).

Domestic registrants must file the required information by the due date of the Form 10-Q for their second fiscal quarter, while foreign private issuers must file any required GHG information within a similar timeline.

Targets and goals

Registrants are required to disclose climate-related targets or goals if they have materially affected or are reasonably likely to materially affect its business, results of operations or financial condition. Such disclosures should include:

• Description of the activities to be performed and how the targets and goals will be met
  
• Scope and timing of the related activities, and where applicable, the baseline being measured against
• Impact of carbon offsets or RECs if they are expected to be a material part of the plan for achieving these climate-related targets or goals.
• Annual updates on the progress toward the targets or goals

Material expenditures and impacts

Registrants are required to present both quantitative and qualitative information about material expenditures and their impact on estimates and assumptions that result from:

• Mitigation of climate-related risks
  
• Previously disclosed transition plans
• Actions taken on disclosed targets or goals to make progress toward such goals

Presentation requirements

Registrants are required to present the information required by the final rule as follows:

• Climate-related disclosures should be included in registration statements and Exchange Act filings (e.g., Form 10-K)
  
• Include the Regulation S-K required climate-related disclosures in one of the following:
  • In a separate, appropriately labeled section of the registration statement or annual report or in another section within the filing, such as risk factors, description of business or MD&A
  • Incorporating the information by reference from another filing as long as the electronic tagging requirements are met
    
  • Electronically tag such climate-related disclosures in eXtensible business reporting language (XBRL)
    

Relationship to other sustainability frameworks and regulations

The final rule includes elements based on established frameworks such as the Task Force on Climate-Related Financial Disclosures (TCFD) framework and the GHG Protocol.

However, the final rule includes many significant differences from other standards and regulations, including the California climate disclosure laws, the EU’s Corporate Sustainability Reporting Directive (CSRD) and the first two standards issued by the International Sustainability Standards Board (ISSB).

Notably:

• The California laws apply to both private and public companies, as applicable, and include Scope 3 disclosure requirements
  
• The CSRD covers sustainability and environmental, social and governance (ESG) matters that extend well beyond climate disclosures that are the focus of the SEC’s rule
• The SEC’s final rule does not allow registrants to comply with the disclosure requirements by using other standards including those promulgated by the ISSB.