It’s been a long and bumpy road to reach this point, but on March 6, 2024, the Securities & Exchange Commission (SEC) finalized and adopted its rules to unify climate-related disclosures. Known as The Enhancement and Standardization of Climate-Related Disclosures for Investors, the rules are intended to simplify climate disclosure for the business community.
With various court challenges to the initial proposal and detailed reporting requirements in the finalized version, however, you may well feel the rules are anything but simple.
For those feeling a little confused, we’ve put together a brief guide to the SEC Climate Disclosure Rules covering everything you need to know about reporting: why it matters, who should file a report, and when to get started compiling data. (Spoiler alert: the answer is now.)
Who Will Have to Disclose?
Ultimately, all publicly traded companies operating in the US will have to conform to the SEC’s climate disclosure rules. This will include companies in a host of sectors from retail and technology to oil and gas, as well as several hundred foreign companies with US operations.
The final rules will be phased in for all US publicly traded companies with the compliance date dependent upon the status of the business as a large accelerated filer (LAF), accelerated filer (AF), non-accelerated filer (NAF), smaller reporting company (SRC), or emerging growth company (EGC).
Why Is the SEC Mandating Climate Disclosures?
For most publicly traded companies, sustainability reporting and ESG are nothing new. Rising demand for this information from investors, stakeholders, and customers means that many companies already prepare some kind of annual sustainability report. In fact, 90% of S&P companies already publish sustainability reports.
With so many different ESG frameworks out there, however, it can be hard to consistently compare data across reports. The aim of the SEC climate disclosure rules is therefore to standardize these reports into a format that can be easily accessed and interpreted by the SEC and investors.
Despite this, some have objected to the rules. They state that the SEC does not have the authority to mandate this type of reporting, yet this isn’t strictly the case. SEC-registered organizations have been providing business costs related to environmental compliance since the 1970s. Thus, reporting on climate-related risks and opportunities can be seen as an extension of that 50-year-old mandate.
Why Is Consistency Important?
Demand for climate disclosures is constantly growing. For financial managers and investors, it’s a way to make climate-responsible decisions, which is why they have called for reporting that is consistent with the Task Force on Climate-Related Financial Disclosures (TCFD) and GHG Protocol.
In fact, including climate-related financial disclosures is becoming standardized globally. To understand this growth in popularity, we can look at how sustainability standards have evolved.
The TCFD was part of the expert panel that helped develop standards for the International Sustainability Standards Board (ISSB). You may be familiar with the ISSB’s parent organization, the International Financial Reporting Standards Foundation, which also administers the International Accounting Standards Board (IASB). IASB standards are adopted around the globe and since the ISSB standards were finalized they are slowly being adopted too.
What Is Included in the SEC Climate Disclosure Rule?
We will discuss the detailed climate reporting requirements later, but in general, you will be required to disclose:
- The role and responsibility of corporate governance in relation to identifying and managing climate-related risks
- Potential and actual impacts of climate-related risks on business operations or financial performance over the short-, medium- and long-term
- How climate-related risks have, will, or might impact business strategy and outlook
- Processes for identifying, assessing, and managing climate-related risk and a description of how these processes are integrated into wider risk management systems
- The impact of climate-related events, like severe weather, or transition activities, like changing business operations to mitigate climate-related risk, on financial statements
- Scopes 1 and/or Scope 2 GHG emission metrics
- Any climate-related targets, goals, or transition plans
Despite the fact that Scope 3 emissions can account for 50% or more of a company’s total emissions, the SEC has removed this requirement in response to comments on the original proposal. Unfortunately, this may dramatically impact the effectiveness of emissions reduction initiatives.
Is the SEC Climate Disclosure Rule Final and When Will It Come Into Effect?
Now that the climate disclosure rules have been finalized, they will become effective 60 days after publication of the SEC’s adopting release in the Federal Register. Compliance dates will be phased in as per the table below depending on your status: https://www.sec.gov/files/33-11275-fact-sheet.pdf
How Will Climate-Related Disclosures Be Reported?
Climate-related disclosures should be included in your annual financial statement including Securities Act or Exchange Act registration statements and Exchange Act annual reports.
They will be made in a separate and clearly identified section of the report, which will include quantitative disclosures along with a narrative assessment of climate-related risks and opportunities as part of management discussion and analysis (MD&A).
What Climate Risks Will Be Reported to the SEC?
To simplify reporting, the SEC has defined two types of climate-related risks that should be included in your report: physical and transitional risks.
Physical risks are those that pose an actual tangible risk to business operations such as facilities located in areas prone to drought, wildfires, or hurricanes. You will need to document the nature of the risk and details of the facility, including a physical address, along with the size and number of employees who work there.
Transitional risks are those that could occur as a result of efforts to reduce climate impacts or market changes effected by a more climate-conscious economy. These might include production downtime as a facility is retrofitted or operations are relocated. It could also include changes in consumer buying habits that leave your company vulnerable until you can adapt.
Regardless of whether a risk is identified as physical or transitional, you should disclose not only actual risks, but potential ones as well. As we’ve learned through the COVID-19 pandemic, market and business conditions can change almost overnight and you will need to be prepared to address potential risks quickly.
Identifying Material Risks
As these guidelines indicate, the scope and scale of ESG reporting can quickly get out of hand if you don’t define boundaries up front. What’s more, the payback for risk management declines rapidly if time and energy is spent on risks that have little material impact on an organization’s operations.
In order to help you decide where to focus your energies, you should conduct a climate risk materiality assessment. This addresses two elements: the importance of the risk to business operations and to your external stakeholders including investors and the community at large.
Naturally, priority should be given to those risks that are material to both your business and stakeholders, but if there is additional bandwidth to address them, additional risks can be added.
Time horizons are another factor in materiality. For example, one risk might be high priority to stakeholders, but is only likely to become an issue over the medium term, while another may be low priority, but with impacts in the near future. In this case, the second risk might be more material initially while the first could be addressed at a later date.
Ultimately, the SEC—following Supreme Court rulings—views materiality as the degree to which a risk would influence an investor’s decision to purchase or sell securities, or how they would vote as a shareholder.
If you’re not sure how to go about identifying material climate-related risks for your organization, check out our Materiality Workbook for additional guidance.
What Climate Impacts Will Be Reported to the SEC?
One of the challenges in disclosing climate-related risks is that they are largely hypothetical. For example, a hurricane may impact operations at a plant near the Gulf of Mexico. Market demand for low-carbon products may accelerate dramatically in the next 1-5 years.
Against this backdrop, it can be easy to reiterate boilerplate scenarios in each annual report, so it’s important to document known and quantifiable climate-related impacts. This could include impacts on:
- Business operations
- Products or services
- Suppliers or customers up and down the value chain
- An organization’s ability to mitigate climate-related risks or adopt new climate-friendly technologies
- Funding for research and development
By not only disclosing risks but also impacts, you will provide a narrative discussion of how these impacts have affected your financial statements, similar to what is already required for MD&A as described above.
What About Carbon Offsets or Renewable Energy Credits?
As part of disclosures on climate impacts, the report also needs to include details on carbon offsets or renewable energy credits (RECs) if you have used them. This applies to organizations across all sectors and can provide important context regarding how you are meeting your GHG reduction targets.
While carbon offsets and RECs can be part of a broader approach to help balance climate-related expenditures in the short- or medium-term, as carbon reduction targets become more and more stringent, they may not be an effective management strategy long term. These types of disclosures will help investors better understand future performance in a carbon-neutral economy.
What Isn’t Included in the SEC Climate Disclosure Rules?
Words like environmentally-friendly, sustainable, low-carbon and climate-conscious often get used interchangeably when in fact they aren’t the same thing. In relation to the SEC rules on climate disclosure, it’s important to understand which terms are and aren’t relevant.
Specifically, the climate disclosure reporting requirements reference various ways to reduce carbon intensity and emissions through approaches like:
- Transitioning to lower carbon economies, both in terms of production and also using low emissions modes of transportation and supporting infrastructure
- Renewable power generation and use
- Producing and using low waste, recycled or other low-carbon-intensive consumer products and production methods
- Setting conservation goals and targets to reduce GHG emissions
- Providing goods and services to support other efforts in the transition to the low carbon economy
In addition to these tactical strategies, the rules also require documented details of sustainability governance and a narrative review of how all of this integrates into business operations, similar to the MD&A.
What isn’t included in the rules, however, are other elements of environmental and sustainability reporting that you may be familiar with. For example, forestry stewardship may be top of mind for some companies, depending on their location or industry, but are not explicitly called out in the SEC’s climate disclosure requirements.
This may require some organizations to set new targets, while others will have to look more closely at how carbon reduction is tied to sustainability efforts.
Finally, bear in mind the SEC’s finalized climate disclosure rules also left out Scope 3 emissions reporting due to pushback on the difficultly and cost of collecting this data from the supply chain.
Ready to Start?
When it comes to making your SEC climate disclosure, you may be relieved to see there is a lot of overlap with other ESG standards, but they will not be interchangeable. If you’re already reporting to other frameworks, it won’t be enough to simply attach a copy of that report to SEC filings.
To avoid unnecessary duplication, you need to know exactly how the SEC’s final ruling and requirements are similar to other ESG programs, and where it differs. With that in mind, a software tool like the AMCS Sustainability Platform can be a critical element of streamlining your reporting efforts and managing staff and resources effectively and efficiently.
If your organization is likely to be impacted by the SEC’s new climate disclosure requirements, the time to start compiling information is now. To begin on the right foot, speak with an AMCS advisor today.