March 14, 2024
On March 6, 2024, the Securities and Exchange Commission (SEC) adopted rules to enhance and standardize climate-related disclosures by U.S. public companies. Once they start taking full effect in 2025 through 2027, the final rules will require public companies to disclose Scope 1 and 2 emissions, climate-related risks, governance and oversight of climate strategy and reporting, and, in some cases, secure third-party assurance. Read the SEC’s announcement here.
The issuance of the final rules concludes a two-year rulemaking process. The five-member SEC commission/board approved the rules by a 3-2 vote (with the three Democratic appointees voting in favor of the rule and the two Republican appointees opposing it).
It was a long, complicated process, and the final rules are nearly 900 pages long. Given the political environment, legal considerations and business realities, the discussions about next steps are just beginning.
Here are my 10 observations about the new rules.
1. The new rules do not break much new ground. The most notable development may be that the rules bring some clarity and consistency to climate disclosure expectations by referencing the Greenhouse Gas (GHG) Protocol, Taskforce on Climate-related Financial Disclosures (TCFD), and Sustainability Accounting Standards Board (SASB) / International Sustainability Standards Board (ISSB) frameworks. They also confirm the importance of materiality by requiring disclosure if climate-related risks have been found to have a material impact on the business.
2. The new rules are not the end of American democracy and capitalism. The most stringent proposed measures, including Scope 3 reporting and sweeping requirements for third-party assurance, were dropped from the final rules. Compliance will still be challenging for many companies, but the rules are not as far-reaching as originally proposed or as proponents of mandatory GHG emissions and climate action reporting had hoped.
3. Other recent regulatory developments are significantly more aggressive. Two new climate laws in California and the EU’s Corporate Sustainability Reporting Directive (CSRD) are more demanding (including Scope 3 provisions) than the SEC rules. The good news is the various climate rules across jurisdictions appear to be mostly complementary. On the other hand, where there are differences, it remains to be seen how additional disclosures under one regulation could impact the others.
4. Opponents of the rules are already pursuing litigation, but they will have a difficult time attacking the process. The SEC considered more than 24,000 comment letters, including more than 4,500 unique letters. It took two years from proposal to final rules; in fact, the SEC nearly ran out of time to make a final decision by March 2024. There’s little doubt that the process was comprehensive and deliberate.
5. Regulatory compliance is “the floor, not the ceiling.” The floor is the minimum to keep a company in good legal standing, and the ceiling is the best practices to help a company stand out. It will be interesting to see if a compliance mentality sets in or if companies will want to go beyond compliance to tap into some kind of competitive or stakeholder advantage. I’m not sure which way the trend is going to go.
6. Scope 3 remains the elephant in the room. For many companies, Scope 3 comprises the majority of their GHG emissions, and is the most difficult to calculate and control. The SEC noted that the final rules are “eliminating the proposed requirement to provide Scope 3 emissions disclosure.” Nonetheless, the rules include provisions for a comprehensive analysis of climate risks and opportunities, which will likely lead to Scope 3 considerations. In other words, the discussion about Scope 3, which has 15 categories and a lot of nuance, is just beginning.
7. Call me a skeptic, but I am wary of some consultants and pundits who say the rules don’t go far enough. They may be making scientifically and technically valid points, but it is difficult to find an authoritative, truly “independent” voice with no vested interest in the outcome. The fact is outside advisers often flourish in complexity and ambiguity. From my vantage point, the new rules remove some of those challenges. I’d say that’s a positive (and, don’t worry, we consultants will be just fine).
8. Taking immediate action based on these new rules would be an overreaction. With phase-in periods scheduled to begin in 2025 at the earliest, now is not the time to panic. But it is the time to carefully review the key requirements and timelines, evaluate internal capabilities, consult legal counsel and implement other preparatory measures (including considering lessons learned from your TCFD disclosures, or at a minimum, get more familiar with TCFD). Think of this as the “off-season”; use the time wisely to prepare for what’s to come, based on the compliance deadlines.
9. Third-party assurance is not as prominent in the final rules as it was in the proposal, but the issue of data accuracy and reliability is still important. Under the rules, limited assurance requirements begin to take effect in the third fiscal year after the compliance date and reasonable assurance requirements begin in the seventh fiscal year – which means assurance requirements will be triggered between 2029 and 2033. The long and more limited phase-in is partially due to the reality that there are not enough verification organizations to cover the demand created by the SEC rules.
It’s also worth noting that some of the disclosures will need to be included in financial statements such as the Annual Report on Form 10-K, which will put a premium on the availability and accuracy of emissions data. For now, companies should focus on the quality, reliability and documentation of their emissions data, and engage the finance, legal and internal audit teams to begin developing a verification mindset and determining when and how to integrate the new climate disclosures into financial statements.
10. The future of the rule depends in large part on politics and the legal process. The November 2024 general election will go a long way in determining if the Democratic administration is able to continue implementing the rules or if a new Republican administration and its allies in Congress will be able to roll them back or defund them. Litigation on a variety of grounds is inevitable – with arguments about the authority of the SEC to regulate environmental issues; varying interpretations of the value, cost and burden of the rules; and whether the reporting requirements force companies to engage in “compelled speech,” which could be a violation of freedom of speech provisions of the First Amendment. The legal challenges are underway – with Republican leaders in at least 25 states filing suit against the SEC, and an appeals court already issuing an administrative stay, which temporarily prevents the SEC from implementing any next steps. The rules are final, but the final outcome of the rulemaking is far from settled.
Contact me if you have questions about how the SEC rule might impact your company’s situation.
