The SEC’s Long Awaited Climate Disclosure Rule

Today, the Securities and Exchange Commission (the "SEC”) voted 3-2 to adopt rules that will enhance and standardize climate-related disclosures by public companies and in public offerings. The final rule, being the first nationwide climate disclosure rule in the US, will require about 5,300 corporations to explain how their businesses are affected by climate change and report on their greenhouse gas (GHG) emissions in a bid to provide investors with more consistent, comparable, and decision-useful information. The new rules will go into effect in 2026.

The rules, which were first proposed in March 2022, led to the SEC receiving over 24,000 comment letters (over 4,000 of which were substantive in nature), which is unprecedented for an SEC rule-making proposal. The breadth of disclosures required will be less burdensome/ambitious than first proposed, possibly to head off extensive legal challenges and to reflect the fact climate disclosure is in a very different place than when the SEC proposed its rules. No doubt, even though they have been watered down, these new rules will likely give rise to a number of lawsuits both on a political and corporate level which is evidenced by West Virginia Attorney General Patrick Morrisey announcing a coalition of nine states that will file a challenge to these rules. And there could be more.

Key takeaways include:

• Under the original proposal, all public companies would have been required to calculate and report specific GHG emissions. However, the final rule, by contrast, will apply only to large businesses, meaning that a large swathe of public companies will be exempt.
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• From 2025,  those larger public companies will be required to disclose short- and long-term physical climate risks to their assets, such as potential exposure to hurricanes and droughts, as well as spending related to their climate goals (e.g., purchases of carbon offsets or renewable energy credits). Unlike the original proposal, the final rule does not require companies to state the climate expertise of their board of director members.
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• From 2026, Scope 1 (direct emissions) and Scope 2 (purchased energy) emissions reporting will now be mandatory, but only if the corporations consider the emissions “material” or of significant importance to their investors. This is another major change from the original proposal, meaning that corporations will be able to exercise a degree of discretion on their GHG emissions disclosures.
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• Scope 3 emissions will not need to be reported, meaning that registrants will not have to disclose GHG emissions from their supply chains and the use of their products – emissions that often comprise a significant proportion of  a company’s emissions. For most companies, Scope 3 emissions represent >70% of their carbon footprint.

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Arguably, of all the requirements proposed today, this is the one that sticks in the craw most for investors who do not have all the relevant information they need in making investment decisions.
 

Although less strict than regulations passed last year by lawmakers in California and the EU, the SEC, for the first time, seeks to provide a federal baseline for companies to discuss business risks and opportunities associated with a changing climate. Their hope is that these (and forthcoming) regulations will make it easier for investors to compare the environmental impact of firms in the same industry.
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Other than those private equity firms with listed US securities or who have portfolio companies that are public or potentially becoming public, today’s announcement will have relatively little initial impact. That said, while not legally required to do so, the smart investment managers will be tracking and implementing some/all of the new rules for a variety of reasons, including for fundraising efforts, alignment to reporting frameworks (e.g., TCFD/ISSB), and/or the fact that they need to comply with more burdensome existing and incoming climate disclosures rules of other jurisdictions (e.g., the EU).

Time will tell what the new rule's lasting impacts will be on the investment community as a whole. While some see this as a step in the right direction in the fight against climate change, we expect others to see it as somewhere between overreach by a national regulator to an abdication of its authority and responsibility to address significant financial risks. Irrespective of where the disclosure needles end up, the time and costs of operationalizing the new reporting paradigm will be immense.