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  • March 21, 2024

    The Impact of the SEC’s New Rule on Climate-related Risks

    The SEC adopted an amendment that will require public companies to disclose information on climate-related risks, mitigation measures, and environmental targets starting in in fiscal year 2025. Grace D’Souza discusses the final rule mandating Scope 1 and Scope 2 emissions disclosures, which represents a departure from a more all-encompassing proposed rule.

    Grace D'Souza

    On Wednesday, March 6, 2024, the Securities and Exchange Commission (SEC) adopted an amendment to the Securities Act of 1933 and the Securities and Exchange Act of 1934, titled “The Enhancement and Standardization of Climate-Related Disclosures for Investors.”

    After a two-year process involving intense lobbying from global industry leaders and influential climate groups, the 3-2 vote in favor of adopting the rule prevailed.

    The final rule seeks to meet investors’ demand for “consistent, comparable, and reliable information” about climate-related risks on the financial condition of SEC registrants. SEC Chair Gary Gensler noted that “these rules will enhance the disclosures that investors have been relying on to make their financial decisions.”

    A significant number of companies already report emissions data and climate-related risk data, but investors struggle to parse through inconsistent and unstandardized data. As a result, important information is not effectively considered and reflected in investment decisions.

    Grace D’Souza headshot Grace D’Souza, Marquette Class of 2024, is a student liaison to the executive board of the State Bar of Wisconsin Business Law Section.

    The New Rule at a Glance

    Beginning in fiscal year 2025, public companies will be required to report Scope 1 and Scope 2 Greenhouse Gas (GHG) emissions as well as climate-related risks, mitigation processes, and losses incurred as a result. Scope 1 includes all emissions direct from operations, while Scope 2 includes emissions from energy purchases such as electricity, heating, and cooling.

    Scope 3 emissions were included in early iterations of the proposed rule but were notably dropped from the final rule amid industry and congressional backlash. Scope 3 emissions encompass all indirect emissions – including both upstream (everything required to produce the product or service) and downstream (everything required to consume the product or service) emissions. Indirect emissions are further divided into 15 different reporting categories, ranging from waste generated in operations to downstream leased assets. Recent reports show that Scope 3 emissions account for roughly 70% of all greenhouse gases produced by businesses.

    Under the new rule, public companies will be required to provide (1) qualitative disclosure under 1500-1508 of Regulation S-K and (2) financial statement disclosure under Article 14 of Regulation S-X.

    In general, the rule requires these statements to cover:

    • climate-related risks that have had or may have a material impact on business strategy, business operations, or financial condition;
    • the identification, oversight, and mitigation efforts on behalf of the registrant and the board of directors;
    • GHG emission data and processes for identifying and assessing climate-related risks; and
    • capitalized costs, expenditures expenses, charges, losses, and impacts on business operations and financial condition as a result of severe weather events and renewable energy credits or certificates.

    The rule will become effective 60 days after publication in the Federal Register. Compliance dates will be phased in for all registrants, dependent on the registrant’s filer status.

    A complete description of compliance requirements can be found in the Final Rule and the accompanying high-level Fact Sheet.

    Anticipated Challenges and Political Pushback

    The mandated reporting will prove difficult to track. Different corporate structures embody a plethora of emissions profiles that can result in inaccurate accounting.

    For example, companies employing a vertically integrated supply chain may inadvertently include shipping and distribution emissions at multiple levels of reporting. Estimates suggest that the new rule will raise the cost of complying with disclosure requirements from $3.9 billion to $10.2 billion. For larger businesses, this represents an estimated additional cost of $530,000 per year just to maintain compliance with the SEC.

    The adoption of this rule reflects one of the Biden Administration’s key aims to slash U.S. emissions, evidenced by billions of dollars in loans and grants put toward clean-energy companies. Additionally, these policies reflect an extension of international efforts to “decarbonize” the economy. At the United Nations Climate Conference in 2023, more than 190 governments approved an agreement for a global transition away from fossil fuels.

    Despite global buy-in, opponents of the new rule describe it as “overly burdensome and complex.”

    Publicly critical comments from lawmakers claim that the rule will make U.S. capital markets less attractive to companies. The American Securities Associates, an organization representing small to midsize financial firms, asserts the rule does nothing more than force the disclosure of non-material information at a high cost to businesses.

    Recently, a coalition of 10 states has filed a lawsuit against the SEC, calling the new rule “illegal and unconstitutional.”

    Gensler voiced confidence in the face of lawsuits primarily because the motivation behind the mandate aims to provide necessary information to investors. Gensler also stated that “the SEC has clear statutory authority to mandate additional climate-related disclosures.”

    Preparation as Lawyers and Businesses

    While many companies already voluntarily disclose this information, facilitating compliant reporting and designing systems to streamline data collection is essential for all public companies. Companies should work to deploy an implementation plan and train the appropriate personnel to execute policies, procedures, and controls.

    As advisors, lawyers must stay apprised of legal developments and requirements, as well as suggest the following action items:

    • assess the scope of current disclosures;
    • evaluate current processes and controls on climate-related risk;
    • consider and modify the current board oversight;
    • inventory current human capital and resources used for disclosure compliance;
    • enhance governance and reporting systems;
    • identify goals and targets for climate-related risks; and
    • develop policies, procedures, and controls to implement goals.

    Understanding the scope of the new SEC disclosure requirements will require robust action on behalf of businesses. The enhanced accounting and financial reporting requirements will undoubtedly increase compliance costs for businesses and require deeper inquisition into climate-related risks.

    However, the mandatory rule will hopefully bring pertinent financial information to investors and transition U.S. public companies toward more environmentally conscience operations.

    This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section webpages to learn more about the benefits of section membership.

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    Disclaimer: Views presented in blog posts are those of the blog post authors, not necessarily those of the Section or the State Bar of Wisconsin. Due to the rapidly changing nature of law and our reliance on information provided by outside sources, the State Bar of Wisconsin makes no warranty or guarantee concerning the accuracy or completeness of this content.

    © 2024 State Bar of Wisconsin, P.O. Box 7158, Madison, WI 53707-7158.

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