I read through the SEC’s 510-page proposed release on climate disclosures and am publishing a short series of articles this week examining key practical aspects of the document. Some of the articles will be member-exclusive. It is important to keep in mind that this rule is a long way from being finalized and the final release may contain notable differences from the proposal.
“The SEC’s climate disclosure proposal is the most extensive, comprehensive and complicated disclosure initiative in decades.”Meredith Cross, Wilmer Cutler Pickering Hale and Dorr partner and former Director of the SEC’s Division of Corporation Finance
Forms Affected by the Proposal
The proposal would require a registrant to include climate-related disclosure in Securities Act or Exchange Act registration statements (Securities Act Forms S-1, F-1, S-3, F-3, S-4, F-4, and S- 11, and Exchange Act Forms 10 and 20-F) and Exchange Act annual reports (Forms 10-K and 20-F), including the proposed financial statement metrics. Similar to the treatment of other important business and financial information, the proposed rules would also require registrants to disclose any material change to the climate-related disclosure provided in a registration statement or annual report in its Form 10-Q (or, in certain circumstances, Form 6-K for a registrant that is a foreign private issuer that does not report on domestic forms).
The climate-related disclosures would be “filed” and therefore subject to potential liability under Exchange Act Section 18, except for disclosures furnished on Form 6-K. The proposed filed climate-related disclosures would also be subject to potential Section 11 liability if included in or incorporated by reference into a Securities Act registration statement.
GAAP Would be the Applicable Accounting Standards
A registrant would be required to apply the same set of accounting principles that it is required to apply in preparation of the rest of its consolidated financial statements included in the filing, US accounting standards – GAAP. Financial statements filed with the Commission that are not prepared in accordance with GAAP will be presumed misleading or inaccurate unless the Commission has otherwise provided. The SEC felt it was important to clarify the application of this concept in the proposed rules, given the possible confusion that may arise between the current body of GAAP and the proposed requirements.
Foreign private issuers that file consolidated financial statements under home country GAAP and reconcile to U.S. GAAP, would be required to use U.S. GAAP as the basis for calculating and disclosing the proposed climate-related financial statement metrics. The same requirement would apply for the purpose of determining the proposed GHG emissions metrics.
Our view: This shouldn’t be a surprise given that this is a proposed US regulatory requirement. Anyone waiting for US alignment to/convergence with an IFRS climate-related accounting standard will have to wait awhile. Possibly quite a long while.
Proposed Disclosure of Targets and Goals
If a registrant has set any climate-related targets or goals (the proposal does not require these), then the registrant would have to provide certain information about those targets or goals. Despite the numerous commitments to reduce GHG emissions, SEC believes many companies do not provide their investors with sufficient information to understand how the companies intend to achieve those commitments or the progress made regarding them. The proposed disclosure requirements are intended to elicit enhanced information about climate-related targets and goals so that investors can better evaluate these points.
If a registrant has set climate-related targets or goals, the proposed rules would require disclosing, as applicable, a description of:
- The scope of activities and emissions included in the target;
- The unit of measurement, including whether the target is absolute or intensity based;
- The defined time horizon by which the target is intended to be achieved, and whether the time horizon is consistent with one or more goals established by a climate-related treaty, law, regulation, policy, or organization;
- The defined baseline time period and baseline emissions against which progress will be tracked with a consistent base year set for multiple targets;
- Any interim targets set by the registrant;
- How the registrant intends to meet its climate-related targets or goals;
- The baseline year for multiple targets; and
- Relevant data to indicate whether it is making progress toward achieving the target or goal and how such progress has been achieved.
Some companies might establish climate-related goals or targets without yet knowing how they will achieve those goals. They might plan to develop their strategies over time, particularly as new technologies become available that might facilitate their achievement of their goals. The fact that a company has set a goal or target does not mean that it has a specific plan for how it will achieve those goals. What is important is that investors be informed of a registrant’s plans and progress wherever it is in the process of developing and implementing its plan.
If the registrant includes carbon offsets or renewable energy certificates (RECs) in its plan to achieve climate-related targets or goals, it would be required to disclose the amount of carbon reduction represented by the offsets or the amount of generated renewable energy represented by the RECs, the source of the offsets or RECs, a description and location of the underlying projects, any registries or other authentication of the offsets or RECs, and the cost of the offsets or RECs.
A registrant’s disclosure of its climate-related targets or goals should not be construed to be promises or guarantees. To the extent that information regarding a registrant’s climate-related targets or goals would constitute forward-looking statements, which the SEC would expect, for example, with respect to how a registrant intends to achieve its climate-related targets or goals and expected progress regarding those targets and goals, the Private Securities Litigation Reform Act (PSLRA) safe harbors would apply to such statements, assuming all other statutory requirements for those safe harbors are satisfied.
Our view: A requirement to disclose this level of detail about Net Zero commitments may trigger dramatic changes in those commitments, pledges and public statements for companies that viewed Net Zero as simply a PR/marketing opportunity. If this component is included in the final release, I expect it will go a long way in very clearly separating those companies that are seriously managing climate-related business risks and those that aren’t.