SEC’s landmark Climate Disclosure Rule explained

The US Securities and Exchange Commission has passed a landmark Climate Disclosure Rule, introducing climate risk disclosure obligations for companies that will “provide investors with consistent, comparable, decision-useful information”, SEC chair Gary Gensler said in his introductory remarks on Wednesday. “It means, in effect, that investors are viewing some degree of this information as material, and the SEC is saying, ‘We should therefore do what we can to make that disclosure more meaningful.’”

All public companies will be obligated to identify material climate risks to their “business strategy, results of operations, or financial condition” and the “actual and potential material impacts” of these identified risks in their annual 10k reports. If companies have announced goals or plans for decarbonisation, net zero or to mitigate climate risks, their progress against these goals or pathways must also be disclosed. And the largest companies regulated by the SEC (‘accelerated filers’ and ‘large accelerated filers’ – companies with public floats of at least $75 million) must disclose their Scope 1 and 2 greenhouse gas emissions where material to their business. “It’s a paradigm change in terms of operational compliance” within a company, says Brad Caswell, US head of the Financial Regulation Group at Linklaters.

The rule has been both long-awaited and controversial. Gensler published a proposal for the rule in March 2022; it subsequently attracted 24,000 comment letters, a record for a single proposal from the SEC. Many institutional investors wrote letters in support of the proposed rule, including California State Teachers Retirement System, California Public Employees Retirement System, PIMCO, the New York State Insurance Fund and the New York State Common Retirement Fund.

NYSCRF, for example, said “the disclosures mandated by the proposed rule will greatly improve the Fund’s ability to assess its exposure to investment risks and opportunities.” Critics, meanwhile, cited the costs and resource burdens for companies of providing such disclosures and the unavailability and unreliability of materiality, the financial impacts of material risks and emissions data.

Many publicly traded companies are already publicly disclosing their climate risks, emissions and impacts, “though that’s generally in sustainability reports outside of their SEC filings,” Gensler said in his opening remarks at the meeting this week. “Bringing them into the filings will help make them more reliable. There are standard controls and procedures for filings, unlike for sustainability reports.”

How it affects private markets

The final rule is a markedly pared down version of the initial proposal. The proposal included mandatory emissions disclosures for all companies across Scope 1 and 2, and Scope 3 where materially relevant. “This generated a lot of controversy over the last two years,” says Linklaters’ Caswell. The Scope 3 requirements would have affected private companies: public companies would ask for emissions data from private companies up and down their supply chains, prompting much more widespread collection of this data across private markets.

But there are other impacts on private markets. Many private fund managers are themselves public companies and will be required to disclose material risks related to their business strategies. Moreover, if a private equity sponsor’s exit route is to IPO a portfolio company, “they will need to have systems in place to comply with all of this,” says Ken Rivlin, global head of environmental law at Allen & Overy. “Making sure you have the appropriate resources internally and externally to comply is critical.”

Harmonisation with other jurisdictions

The SEC’s material climate risk disclosure requirements are not very different to, or are not as rigorous as, other disclosure regimes that many companies are subject to – for example, the EU’s Corporate Sustainability Reporting Directive and California’s greenhouse gas and climate disclosure laws.

“This information is already being gathered and reported by so many companies,” says Kristina Wyatt, a former SEC lawyer and now chief sustainability officer at carbon accounting firm Persefoni. The EU’s Corporate Sustainability Reporting Directive requires companies to disclose Scopes 1, 2 and 3 emissions and material risks along a double-materiality framework (material risks posed by the company’s operations to the planet and society, as well as material physical and transition risks posed to the company’s financial wellbeing). Many countries are considering adopting the ISSB’s guidelines, Wyatt adds.

“The challenge for global companies is compliance with each jurisdiction’s requirements, which you have to do if you have business in those countries,” says Caswell. This involves “coming up with some common denominators” so that a company can use this data to effectively manage risks and make improvements. “California is marching ahead with a law which would require Scope 3 emissions disclosures as soon as 2026. If [a company] does business in California, it could be pulled into the California legislation and required to disclose Scope 3. And other states such as New York are also considering similar laws.”

The SEC’s rule has – intentionally – been formulated with a lot of alignment with the measurement standards and frameworks used in many other disclosure regimes, says Wyatt. The SEC’s rule, the EU’s CSRD, the ISSB and the California laws “all follow the Greenhouse Gas Protocol for their requirements to disclose the greenhouse gas emissions. And the climate risk disclosure requirements very much follow the recommendations of the Taskforce on Climate-Related Financial Disclosures. The CSRD, California’s SBT61 and the SEC all follow the TCFD recommendations. There are certainly differences in the details of what’s actually required to be disclosed, but in terms of the work that companies need to do to gather that information and conduct their risk analyses, I think we’ve reached a point where it’s quite harmonized.”

Will it stick?

The rule has been introduced amidst a fiery ESG backlash in the US and a closely-contested election. “There likely will be litigation” around whether the SEC has the administrative authority to introduce such a rule, says Linklaters’ Caswell. “But we expect that it would withstand litigation and would prevail, even in a Trump administration.”

“The presidential election could change the leadership and priorities for the SEC,” says Rivlin. The SEC has five commissioner seats; three are currently occupied by democrats, and two by Republicans. A new administration would not change the makeup of the Commission: each commissioner serves a five-year term, with one commissioner’s term ending each year; the Senate selects incoming commissioners. So the rule is unlikely to be repealed or replaced entirely by the SEC under a Republican president. “But there are questions about whether and to what extent a new administration would be enforcing those rules,” Rivlin explains.

“US issuers take the SEC seriously,” said Allen & Overy’s Rivlin. “The rule is now on the books. I think companies will take it seriously.”

There is “significant risk” if companies fall foul of their disclosure obligations, Linklaters’ Caswell adds. “There is enforcement risk, there is examination risk. There is civil litigation risk.”