SEC Climate Disclosure Act: Everything You Need to Know

The Securities and Exchange Commission (SEC) Climate Disclosure Act has been in the works for quite some time and was finally passed in March 2024. This landmark ruling from the SEC marks the first time in the US that public companies are required to disclose climate-related data. The SEC Climate Disclosure Act follows the lead of authorities worldwide that have made environmental, social, and governance (ESG) reporting mandatory for big companies. 

This article examines the Climate Disclosure Act Final Rules, discussing the ruling's intention, provisions, and requirements and how this new regulation will impact businesses registered with the SEC. 

Note: As of August 2024, the SEC has voluntarily stayed the Climate Disclosure Act Final Rules pending a judicial review. Many petitions were filed in court to put an administrative stay on implementing the Act and to review its requirements. It’s unclear whether the proposed timeline will be honored, as the judicial review may take several months. 

Background and Legislative Intent

Companies have been under increasing pressure to disclose their environmental impact for years. At the same time, investors also started demanding climate-related disclosures from companies. However, there wasn’t any government regulation in the US, unlike many other developed economies where environmental disclosures were mandated in some form. There was a strong need for some regulation for US companies in line with the international standards on reporting. 

Origins of the Act

The SEC proposed rules to require registered companies to disclose information regarding the governance of climate-related risks in 2022. It opened the proposal to feedback from stakeholders, including companies, investors, and even environmental groups. Dozens of stakeholders, including companies, investors, and environmental groups, voiced concerns about the Act’s implementation and consequences. 

The proposed changes in rules in 2022 initially required registrants to include climate-related information in the registration statements and further financial reporting at the end of each year. As part of this disclosure, companies must disclose their greenhouse gas (GHG) emissions. 

The proposed changes targeted both direct and indirect emissions from registrants. The requirement for indirect emissions fell on registrants for whom such emissions were material or if they’ve set targets for such emissions. 

This initial proposal came after years of advocacy from climate groups for the US government to adopt legislation requiring big companies to release ESG data publicly. Such disclosures have been mainly voluntary in the US, with most companies only reporting direct emissions, which tend to be far lower than indirect emissions (which are often responsible for most of the total emissions). 

Legislative Goals

The Act’s requirement for disclosing climate-related risks and opportunities encourages businesses to evaluate the long-term impacts of climate change on their operations and financial performance. The SEC provides investors with better information to make more informed investment decisions. 

According to the SEC, tens of thousands of investors showed interest in climate-related risks to safeguard their investments, especially in companies that may be at greater risk from climate change. The SEC also claimed that such disclosure would benefit both companies and investors as it increases transparency. 

In other words, the SEC aims to empower investors with more information and satisfy their demand for more ESG transparency. As such, its legislative focus isn’t reducing emissions, unlike ESG regulations in other parts of the world that are gradually pivoting toward regulating how much emissions a company can produce. The SEC wants to disclose climate-related information; it doesn’t put any caps on emissions. 

So, while climate advocates have welcomed the disclosure, it’s limited to reporting, not action. 

Key Provisions of the SEC Climate Disclosure Act

Under the SEC Climate Disclosure Act, companies registered with the SEC - both domestic and international - must disclose the following information. 

Disclosure Requirements

• Climate-related risks: Companies must identify and assess the potential financial impacts of climate-related risks, including physical risks (e.g., extreme weather events) and transition risks (e.g., regulatory changes). They should identify and report any material impact of such risks on their business model, strategy, and outlook. This is to be included in the footnotes of their financial report. 
  
  
• Climate-related opportunities: Companies should disclose any potential economic benefits or competitive advantages arising from climate-related initiatives. 
  
  
• Greenhouse gas (GHG) emissions: Companies must report their direct GHG emissions, Scope 1 emissions, per the GHG Protocol. They must also disclose Scope 2 emissions, which are from purchased energy. Scope 3 emissions (indirect/value chain) are not included in the latest ruling. The emissions reporting will be subject to assurance requirements which will be phased in at a later stage. 
  
  
• Climate-related governance: Companies must disclose their board and management's oversight of climate-related risks and opportunities, including the role of climate committees.
  
  
• Climate-related strategies: Companies should describe their approaches to address climate-related risks and seize opportunities, including any plans to reduce GHG emissions and transition to a low-carbon economy. They must also disclose any roll-forward of carbon offsets and renewable energy credits or certificates in the financial statement if such offsets are used to meet climate-related targets. 

Here are the audit and attestation requirements: 

• Audit and ICFR: Financial statement disclosures will undergo standard financial statement audits and management's internal control over financial reporting (ICFR) assessments. Large accelerated and accelerated filers (excluding Emerging Growth Companies or EGC) will also require independent auditors to evaluate ICFR for these disclosures.
  
  
• Management Certification: All disclosures outside the financial statements will be subject to management's disclosure controls and procedures (DCPs), which will be certified by the registrant's principal executive officer and principal financial officer.
  
  
• Scope 1 and 2: These disclosures will require limited assurance for large accelerated and accelerated filers (excluding Smaller Reporting Companies and Emerging Growth Companies). A phase-in period will eventually lead to reasonable assurance for large accelerated filers.

Scope of Applicability

The Act does offer some exemptions, particularly for smaller companies and those in specific industries. The SEC Climate Disclosure Act applies to public companies registered with the SEC, including:

• Large accelerated filers: Companies with a market capitalization of $250 million or more and total assets of $1 billion or more.
  
  
• Accelerated filers: Companies with a market capitalization of $75 million or more and total assets of $700 million or more.
  
  
• Non-accelerated filers: Companies with a market capitalization of less than $75 million and total assets of less than $700 million.

Asset-backed issuers are exempt from the disclosures. Small Reporting Companies (SRCs), EGCs, and non-accelerated filers are not required to disclose Scope 1 and 2 emissions. 

Timeline for Compliance

Here’s a breakdown of how and when the SE Climate Disclosure Act will impact different types of companies:

Impact on Businesses

The SEC Climate Disclosure Act is a sweeping new requirement to standardize climate-related reporting from large public companies. It’s the first ruling in the US to impact most Fortune 500 companies and many others. By extension, it will affect a big chunk of the corporate sector, which previously only reported such data voluntarily in its yearly financial reports. 

Changes to Financial Reporting

The new legislation from the SEC significantly changes existing financial reporting practices by introducing new categories of climate-related disclosures. 

Registrants are now required to provide detailed information on their climate-related risks, opportunities, greenhouse gas emissions, governance, and strategies in their periodic filings, including Form 10-K (domestic issuers) and Form 20-F (foreign private issuers). 

This necessitates the development of robust climate risk management frameworks, the collection of granular data, and the integration of climate-related factors into financial reporting processes.

Registrants must also include these disclosures in their registration statements before offering securities to the public. 

The act will change how companies traditionally report financial data, focusing on revenue, operational costs, and profits/losses. Now, these companies will need to connect the economic data with climate-related disclosure for a more comprehensive understanding of climate-related risks and opportunities and their impact on the company’s finances. 

Compliance Costs and Challenges

These new sweeping changes to financial disclosures bring about additional costs for acquiring, processing, and assuring (at a later stage, though) climate-related data. In that sense, compliance with the requirements of the final rules of the Climate Disclosure Act may involve increased costs for regulatory compliance, including developing new systems for collecting and reporting data, enhancing internal controls, and engaging third-party auditors for assurance purposes. 

Additionally, the rules could impose significant administrative and operational burdens on companies as they adapt to new disclosure requirements and ensure the accuracy and completeness of their climate-related reporting. 

Currently, the Act only mandates reporting Scope 1 and 2 emissions for large accelerated and accelerated filers (except SRCs and EGCs). That simplifies things a bit, as these emissions scopes are under the companies' control and oversight, unlike value chain emissions, which have traditionally been costly and challenging to track. 

Strategic Implications for Companies

The Act’s requirement for disclosing climate-related risks and opportunities encourages businesses to evaluate the long-term impacts of climate change on their operations and financial performance. As companies adjust to these new disclosure requirements, they may need to develop and refine their strategies to manage climate-related risks and capitalize on potential opportunities. 

Companies will also need to consider how climate-related factors impact their business model, operations, and financial outlook. This may involve integrating climate-related risks and opportunities into their strategic planning and decision-making processes. 

Moreover, the Act may influence investor behavior, increasing scrutiny of companies' climate performance and potential shifts in capital allocation. In a recent Morgan Stanley survey, investors indicated they want to make sustainable investments. Over three-fourths of respondents said they want to invest in companies and funds with market-rate financial returns and positive ESG impact. More than half said they plan to move their allocations to such companies in the next year. 

Legal and Regulatory Considerations

How the SEC Will Enforce the Act

While the SEC hasn’t specified any penalties or repercussions for non-compliance, it’s generally understood that non-compliance will be prosecuted and fined, as the SEC usually does in cases of non-compliance and rule-breaking. 

The Climate Disclosure Act’s requirements vary by registrant category, but they’re mandatory. Any registrant failing to meet the specified requirements within the announced timeline may face legal consequences and be fined. This can also seriously damage the company's public image. 

As such, the SEC hasn’t outlined any enforcement mechanisms. The current ruling only describes the requirements and scope of applicability. Since the reporting will begin at the end of the calendar year 2025, it remains to be seen exactly how the SEC will ensure compliance and what actions it may take against companies that fail to comply or report erroneous data. 

Legal Challenges and Court Rulings

Less than a month after the announcement of the SEC Climate Disclosure Act Final Rules, the SEC used its right to put a stay on the Act. After the announcement, several petitions were filed in the US District Court of Appeals for the Eighth Circuit to review the requirements in the Act and put an administrative hold while it was being reviewed. These petitions have since been consolidated, and the SEC continues to defend the Act. 

The SEC says it issued the stay to facilitate the judicial process and address its challenges. It aimed to avoid uncertainty should the judicial process not be completed by the proposed timeline by which registrants may become the subject of the Act. In simpler terms, it puts a stay on the implementation, so there’s no confusion for companies about whether they’re required to comply beginning at the end of 2025. 

As of mid-2024, it’s unclear when the judicial review will end and what outcome it will bring. Since the first reporting year is 2025, the timeline may remain the same if the judicial review completes within 2024. Otherwise, the SEC may postpone the timeline to give companies ample time to comply. The requirements may also change after the judicial review, which has changed significantly since the Act was first proposed. 

Irrespective of the process duration and outcome, companies may need to rethink the implementation of the Act and prepare for the changes it will bring to their financial reporting and other additional disclosures. 

International Climate Disclosure Standards

The US has lagged behind other regions in mandating climate-related reporting for companies. Europe and Asia had regulations similar to, and even stricter than, the Climate Disclosure Act for some time. In response, California has introduced its own bill for climate-related disclosures, which is set to affect over 10,000 companies. 

The European Union has enacted the most comprehensive environmental reporting regulation with the Corporate Sustainability Reporting Directive (CSRD). This new directive, which replaces previous ESG reporting directives, will go into effect at the end of 2024. It impacts not just EU companies but also non-EU companies with subsidies and operations in the 26 member states. Consequently, many US companies will also need to start reporting ESG data to EU authorities by 2026. 

The SEC’s Act differs from CSRD and other existing regulations. Notably, the Climate Disclosure Act doesn’t accommodate interoperability—the ability to multiple frameworks with one set of reports. Unlike the CSRD, there are equivalency provisions in the Act. additionally, while the CSRD will eventually require assurance on all disclosures, the SEC only mandates assurance for large companies and at a much later stage. 

There are also differences in the scope of these regulations. The SEC requires only public companies to make climate-related disclosures, whereas the regulations in California and the EU also target private companies with significant workforces and earnings. As a result, the CSRD is expected to impact over 49,000 companies in the region, many of which are not listed on any exchanges. 

It’s important to note that the SEC’s Climate Disclosure Act focuses solely on climate-related disclosures. In contrast, the EU’s CSRD encompasses broader sustainability and ESG disclosures, imposing more stringent requirements than the SEC’s proposal. 

FAQs

What is the SEC Climate Disclosure Act?

The SEC Climate Disclosure Act is a regulation implemented by the Securities and Exchange Commission (SEC) that requires public companies in the US to disclose climate-related information. The goal is to give investors more transparency regarding a company's exposure to climate change and its efforts to address related challenges.

Who is affected by the SEC Climate Disclosure Act?

The Act applies to public companies registered with the SEC, including large accelerated, accelerated, and non-accelerated filers. However, certain exemptions may apply to smaller companies (SRCs) or those in specific industries.

What are the potential challenges for companies in complying with the SEC Climate Disclosure Act?

Compliance with the Act can be challenging for companies due to:

• Data collection and analysis: Gathering accurate and comprehensive data on climate-related risks, opportunities, and emissions can be time-consuming and resource-intensive.
  
  
• Financial reporting changes: Integrating climate-related information into financial statements may require significant adjustments to existing reporting practices.
  
  
• Risk assessment: Identifying and assessing climate-related risks can be complex, especially for companies with global operations or complex supply chains.
  
  
• Strategic implications: The Act may necessitate changes to business strategies, risk management practices, and governance structures.

What is the difference between the SEC Climate Disclosure Act and CSRD?

The SEC Climate Disclosure Act and the Corporate Sustainability Reporting Directive (CSRD) are regulatory frameworks that enhance corporate transparency regarding climate-related risks and opportunities. The SEC Act focuses specifically on climate-related disclosures for public companies in the US. In contrast, the CSRD applies to a broader range of companies in the EU and mandates disclosures on a more comprehensive range of sustainability topics. 

Will the SEC Climate Disclosure Act impact IPOs?

During an Initial Public Offering (IPO) with the SEC, companies will need to comply with the exact Climate Disclosure Act requirements as existing listed companies. They will need to make climate-related disclosures in their registration statements. However, exact requirements may vary depending on the company's categorization. For instance, smaller companies will not be required to report their emissions.