SEC Climate-Related Disclosure Rule: What You Need to Know

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SEC Climate-Related Disclosure Rule: What You Need to Know

Note: As of March 15, 2024, this rule has been temporarily paused by a U.S. appeals court. Despite this hold up in the courts, we don’t expect the legal process to slow company action on climate-related disclosures.

On March 6, 2024, the U.S. Securities and Exchange Commission (SEC) issued its final climate-related disclosure rule, “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” ushering in a new era of mandatory, regulated climate reporting in the United States. The long-awaited rule underwent review of over 24,000 comments on the initial draft, and notably emits disclosure of Scope 3 value chain emissions in the final version. Still, the rule represents a decisive shift toward requiring “consistent, comparable, and reliable information about the financial effects of climate-related risks” from publicly traded companies as soon as next year. 

This is big news! The organizations that have been working to prepare for this highly anticipated ruling since it was initially proposed back in 2022 are well on their way to meeting this mandate. Organizations that waited until the final rule will need to act quickly to keep pace with the disclosure timeline. 

Let’s break down a summary of key takeaways of the ruling and what organizations can do now to set themselves up for successful disclosure beginning in 2026. 

SEC RULE: KEY TAKEAWAYS

Part 1: Non-Financial Filings
#1: GHG emissions reporting 

In brief: Companies must disclose material Scope 1 and 2 emissions and obtain third-party assurance. Companies do not need to disclose Scope 3 emissions.

Who: SEC registrants who are large accelerated filers (LAFs) and accelerated filers (AFs) not otherwise exempted. Smaller reporting companies (SRCs) and emerging growth companies (EGCs) are exempted.

What: Companies must disclose: 

    • Material Scope 1 and Scope 2 emissions on a gross basis by scope, and by constituent greenhouse gas (GHG) if GHG is material. 
    • Assurance of Scope 1 and 2 emissions at the limited assurance level. Following an additional transition period, assurance at the reasonable assurance level will be required for large accelerated filers only. 

When: For large accelerated filers, GHG emissions disclosure begins in 2027, using fiscal year 2026 data; assurance begins in 2030, using fiscal year 2029 data. For accelerated filers, GHG emissions disclosure begins in 2029, using fiscal year 2028 data; assurance begins in 2032 using 2031 data. 

Where: Disclosure will take place outside of the financial statement disclosures in a new section of Form 10-K, Item 6 (foreign private issuers must use Form 20-F, Item 3 E). While not subject to financial statement audit requirements, disclosure will be subject to management’s disclosure controls and procedures. 

#2: Climate-Related Financial Risk

In brief: In alignment with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), companies must disclose climate-related financial risks and management of those risks. Companies must also disclose climate-related targets and goals. 

Who: All SEC registrants, including large accelerated filers, accelerated filers, non-accelerated filers, smaller reporting companies, and emerging growth companies.   

What: Companies must disclose the following information on governance; business strategy and outlook; risk management; targets and goals; and mitigation and adaptation expenditures: 

    • Climate-related risks that have had or are reasonably likely to have a material impact on business strategy, results of operations, or financial condition. 
    • The actual and potential material impacts of any identified climate-related risks on the company’s strategy, business model, and outlook. 
    • Specified disclosures regarding activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices. 
    • Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the material climate-related risks. 
    • Any processes for identifying, assessing, and managing material climate-related risks and, if the company is managing those risks, whether and how any such processes are integrated into the overall risk management system. 
    • If, as part of its strategy, a company has undertaken activities to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that directly result from such mitigation or adaptation activities. 

When: For large accelerated filers, disclosure begins in 2026, using fiscal year 2025 data. For accelerated filers, disclosure begins in 2027, using fiscal year 2026 data. For smaller reporting companies, emerging growth companies, and non-accelerated filers, disclosure begins in 2028 using fiscal year 2027 data. 

Where: Disclosure will take place outside audited financial statements in 1) a separate, appropriately captioned section of the company’s registration statement or Exchanger Act annual report; or 2) in another appropriate section of the SEC filing, e.g., Risk Factors, Management’s Discussion and Analysis; or 3) incorporation by reference from another Commission filing. While not subject to financial statement audit requirements, disclosure will be subject to management’s disclosure controls and procedures.

Part 2: Financial Statement Impacts 
Weather-Related Events, Renewable Energy and Carbon Offsets, and Uncertainties in Estimations 

In brief: Companies must disclose the financial impacts of severe weather events and of the material use of carbon offsets and renewable energy certificates (RECs), as well as the risks and uncertainties reflected in financial statements. 

What: Companies must disclose: 

    • Capitalized costs, expenditures, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds. 
    • The capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates if used as a material component of a company’s plans to achieve its disclosed climate-related targets or goals. 
    • If the estimates and assumptions a company uses to produce the 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, a qualitative description of how the development of such estimates and assumptions was impacted. 

Who: All SEC registrants, including large accelerated filers, accelerated filers, non-accelerated filers, smaller reporting companies, and emerging growth companies. 

Where: Disclosure will take place within Form 10-K (foreign private issuers must use Form 20-F) in the footnotes to financial statement disclosures and will therefore be subject to existing audit requirements and internal controls for financial reporting. 

WHERE YOU CAN START NOW

How can companies – especially large accelerated filers and accelerated filersbegin working toward mandatory disclosure in 2025 and beyond? We recommend starting here: 

#1: Understand how the SEC rules apply to you and develop a pathway to compliance. 

Compliance dates for your company depend on your registrant status, the content of the disclosure, and any relevant accommodations. For additional details, see the SEC’s Fact Sheet. Understand what information you need to file by when, and what information is subject to financial auditing requirements versus management controls. Identify disclosure and control gaps between what exists today and what is needed. With this outline, you can then work back from filing deadlines to develop a workplan for gathering and processing the information, establishing and enhancing internal controls, and preparing the disclosures. 

An early and important step to this exercise is identifying the cross-functional team assigned to this effort. Internally, this team will include at minimum representatives from sustainability, finance, legal, and risk management. In addition, several companies are now establishing the new role of the ESG Controller, who sits at the nexus of accounting, finance, and sustainability, and who can help create the structure for efficiently operationalizing what needs to be done with sustainability data under new regulatory regimes. Externally, the cross-functional team is likely to include technical climate consultants, ESG legal consultants, and one or more third party auditors. 

#2: Once you have a sense of the data required for disclosure, establish formal collection processes and put in place appropriate controls. 

This can be done through a variety of mechanisms, both manual and automated. On the manual side, defining data governance and management procedures and developing a clean filing system to serve as a source of record are two critical steps toward ensuring consistency, accuracy, and transparency in your data and disclosures year over year. It’s also a key tool that can help streamline the third-party assurance process. 

On the automation side, software can help collect and validate underlying data as it’s generated. Most companies are likely to pull from more than one software system, e.g., financial data from one system and sustainability data from another. On the climate side, we encourage anyone considering new software to be thoughtful about vetting potential providers and considering the best time for implementation. Our experience with corporate clients new to GHG data disclosure has shown that software implementation is often best considered after the development of at least one annual GHG inventory when data inputs, processes, and challenges have been defined and can inform the selection of a best-fit software tool. 

#3: Develop a comprehensive GHG inventory inclusive of your operations and value chain emissions (Scope 1, 2, and 3). 

A GHG inventory will provide the exact data you need to meet a key aspect of the SEC’s disclosure rules. While much of this data may be estimated in 2024, an inventory will put you on the path to refining your data collection processes and calculations ahead of needing to disclose in future years. Although Scope 3 emissions are not required by the final SEC rule, we strongly recommend including value chain emissions in your GHG inventory for a full picture of your organization’s emissions and for alignment with more stringent reporting regulations, such as California’s latest climate legislation and the EU’s Corporate Sustainability Reporting Directive. Ensure that alongside the GHG inventory calculations, an Inventory Management Plan (IMP) is developed to support process consistency and documentation year-over-year as well as to support third-party GHG assurance. 

#4: Conduct a climate risk assessment. 

Risks related to climate change – which are becoming increasingly frequent and costly – are categorized into two types, both of which should be included in a climate risk assessment: transition risks and physical risks. 

    • Transition risks are the economic impacts that result from a shift to a lower-carbon economy and the resulting changes in regulatory standards and market trends. 
    • Physical risks are the impacts of adverse weather events, including extreme weather events, sea-level rise, and changing weather patterns. 

A climate risk assessment quantifies risk into a dollar value that companies can use for due diligence, disclosure, and prioritizing assets for risk mitigation measures. Risk assessments may be developed by technical consultants, including software firms that specialize in climate risk or that have integrated risk within a larger ESG data platform. Some third-party reporting platforms, including GRESB, also offer a TCFD Alignment Report. While not comprehensive, this can be a good place to start given SEC disclosures are largely in alignment with TCFD recommendations and the alignment report requires no additional information. 

The Stok team is here to support your disclosure efforts no matter where you are in the journey. Reach out to our sustainability and carbon experts to discuss how your organization can meet reporting requirements and set yourselves up for success.

Note: Stok does not provide legal services or auditing services related to regulatory compliance.