7 March 2024

A practical guide to the SEC's climate disclosure rules

The U.S. Securities and Exchange Commission (SEC) has adopted final rules on climate-related disclosures. MBK Search has produced this practical guide to the rules, with examples and steps for implementing them within your firm.

What the new rule includes

On March 6, 2024, the SEC adopted final rules requiring registrants to disclose specific climate-related information in their registration statements and annual reports. This move comes as investors, companies, and markets increasingly recognize the potential impact of climate-related risks on businesses and their financial performance.

Key disclosure requirements include material climate-related risks, activities to mitigate or adapt to such risks, board and management oversight of climate-related risks, and Scope 1 and Scope 2 greenhouse gas (GHG) emissions for large accelerated filers (LAFs) and accelerated filers (AFs), subject to certain exemptions.

But, the final rule has been significantly scaled back from the original draft proposal. The rule will only apply to large businesses, and companies will only be required to disclose pollution from certain greenhouse gases if they consider the emissions “material” to their investors.

The final rule also does not require companies to disclose their “scope 3” emissions, which account for pollution generated by a company’s supply chain and the consumption of its products.

Some experts, such as former acting SEC chair Allison Herren Lee, criticized the weakening of the rule, stating that “it paves the way for greenwashing.” Environmental groups like the Sierra Club are considering challenging the SEC’s “arbitrary” removal of key provisions from the final rule, as reported in The Guardian.

1: Examples of Disclosure

The final rule requires registrants to disclose various aspects of their climate-related targets or goals if they have materially affected or are likely to affect the registrant’s business, results of operations, or financial condition. This comprehensive disclosure is intended to provide investors with detailed insights into the registrant’s strategy for managing transition risks associated with climate change. The key elements of this disclosure include:

  • The Scope of Activities Included in the Target: Registrants must describe the breadth of activities and emissions their climate-related targets or goals encompass. This could range from direct operational emissions (Scope 1) to indirect emissions from purchased electricity (Scope 2) and, where relevant, even broader value chain emissions (Scope 3) (but this is not a mandatory requirement).
  • The Unit of Measurement: It should be clarified whether the targets are absolute (measured in total greenhouse gas emissions) or intensity-based (emissions per unit of economic output or activity). This helps in understanding the scale and ambition of the targets set.
  • The Defined Time Horizon: Registrants must specify the timeline for achieving their targets or goals. This includes the start and end dates, providing a clear timeframe for action and evaluation.
  • The Baseline Period and Progress Tracking: The base year or period against which progress will be measured should be disclosed, along with the methodology for tracking progress towards the targets. This could include interim targets the registrant sets to ensure they are on track.
  • Qualitative Description of Meeting Targets: The registrant must provide a narrative description of how it plans to achieve its climate-related targets or goals. This might involve investment in new technologies, efficiency improvements, or carbon offsets and renewable energy certificates (RECs).

Example: EcoFriendly Corp

EcoFriendly Corp, a multinational in the renewable energy sector, announces its ambitious goal to achieve net-zero carbon emissions by 2040. This target encompasses all Scope 1 and 2 emissions across its global operations. The target is absolute, aiming to neutralize the company’s carbon footprint completely.

The company has set 2020 as the baseline year for measuring progress. EcoFriendly Corp commits to reducing its carbon emissions by 20% by 2030 as an interim target to ensure transparency and accountability. The strategies outlined to achieve these targets include:

  • A significant investment in renewable energy technologies.
  • Enhancing energy efficiency across all operations.
  • Purchasing RECs to offset emissions that cannot be eliminated immediately.

EcoFriendly Corp’s plan to meet these goals involves transitioning its entire vehicle fleet to electric models by 2025 and retrofitting all manufacturing plants with energy-efficient equipment by 2030. The company will regularly report on its progress towards these targets, ensuring stakeholders are informed of both achievements and challenges faced along the way.

2: Financial Implications and Strategic Adaptations

The SEC final rules require registrants to disclose both quantitative and qualitative aspects of the material financial impacts of climate-related risks and the actions taken to manage such risks.

This disclosure includes expenditures incurred and impacts on financial estimates and assumptions directly resulting from actions taken under a climate transition plan. This means registrants must report on significant financial statement impacts from climate-related risks, including costs related to climate-related research and development, as well as how these impacts affect the registrant’s financial condition or results of operations.

The disclosures are not limited to expenditures and impacts from mitigation or adaptation activities alone but include a broad range of actions related to managing climate-related risks.

Example: XYZ Corporation’s Climate-Related Financial Disclosure

During the fiscal year 2023, XYZ Corporation, a leading global manufacturer of renewable energy equipment, implemented several strategic initiatives under its climate transition plan to reduce its carbon footprint and align with global emission reduction targets. These initiatives included investing in advanced renewable energy technologies, enhancing energy efficiency across its manufacturing facilities, and adopting sustainable supply chain practices.

Material Expenditures:

  • XYZ Corporation incurred $25 million in capital expenditures to upgrade its manufacturing facilities with energy-efficient technologies, reducing energy consumption by 20%.
  • An additional $15 million was spent on research and development focused on next-generation solar panels, aiming to increase efficiency and reduce production costs.
  • The company invested $10 million in a sustainable supply chain program, including certifying pliers and optimizing logistics to minimize carbon emissions.

Financial Impacts:

These investments have directly impacted XYZ Corporation’s financial estimates, with projected savings of approximately $5 million annually in energy costs.

  • The research and development initiatives are expected to enhance product competitiveness and drive a 10% increase in revenue over the next five years due to the anticipated demand for high-efficiency solar panels.
  • The sustainable supply chain program is projected to improve operational resilience and reduce supply chain costs by 5%, mitigating the risk of raw material price volatility linked to environmental factors.

3: Targets, Goals, and GHG Emissions

The final rules significantly enhance transparency and accountability regarding a registrant’s climate-related objectives and reporting of greenhouse gas (GHG) emissions. This section encapsulates several crucial elements:

Disclosure of Climate-Related Targets or Goals:

Registrants are required to disclose any climate-related targets or goals they have set, which encompass a broad spectrum of objectives such as reducing GHG emissions, optimizing energy use, conserving water, restoring ecosystems, and generating revenue from low-carbon products.

This disclosure must include the scope of activities and emissions covered, the unit of measurement (absolute or intensity-based), the time horizon for achieving the targets, baseline periods and emissions against which progress will be measured, any interim targets, and strategies for achieving these goals.

Progress and Strategy Disclosure:

Alongside setting targets, registrants must disclose their progress towards these goals, including quantitative and qualitative data to demonstrate advancements and the strategies employed to achieve them. This involves detailing the actions taken within the fiscal year to progress towards the targets, explaining any material impacts these actions have had on the business’s operational and financial conditions, and providing insights into the costs and investments associated with these actions.

Use of Carbon Offsets and Renewable Energy Certificates (RECs):

Registrants utilizing carbon offsets or RECs as part of their strategy to meet climate-related targets must disclose detailed information about these tools. This includes the volume of carbon reduction or renewable energy generation represented by these instruments, their sources, the projects underlying these offsets or RECs, any relevant registries or authentication methods, and the costs associated with purchasing them.

Example: GreenTech Innovations

GreenTech Innovations, Inc. (GTI), a leader in sustainable technology solutions, is committed to reducing its environmental footprint and enhancing sustainability across its operations.

GTI has set ambitious climate-related targets to reduce its Scope 1 and Scope 2 GHG emissions by 40% over the next decade, using 2015 as the baseline year. This goal aligns with the Paris Agreement’s objective to limit global warming to below 2 degrees Celsius.

To achieve these targets, GTI has outlined a comprehensive strategy that includes investing in renewable energy sources, improving energy efficiency across its manufacturing facilities, and transitioning its vehicle fleet to electric models. In the fiscal year 2023, GTI has made significant progress by reducing its GHG emissions by 10%, primarily through installing solar panels at its headquarters and procuring 50% of its electricity from renewable sources. Additionally, GTI has purchased carbon offsets equivalent to 5,000 metric tons of CO2e to neutralize emissions from its business travel.

GTI’s investments in sustainability initiatives have totaled $15 million in the past fiscal year, reflecting its commitment to achieving our climate-related goals and contributing to a more sustainable future. These efforts are a testament to GTI’s dedication to environmental stewardship, innovation, and responsible business practices.

Actionable Takeaways for GRC Professionals

GRC teams should undertake thorough actions to align with the new regulatory requirements. Below is a list of practical actions to consider:

A. Climate-Related Risks and Governance

  1. Strengthen Board Oversight: Ensure the board of directors oversees climate-related risks, including forming dedicated committees if necessary.
  2. Define Management’s Role: Clarify the roles and responsibilities of management positions or committees in assessing and managing climate-related risks.
  3. Enhance Expertise: Through training or recruitment, Foster climate-related risk management expertise among board members and management. MBK Search can advise on a practical hiring strategy.
  4. Improve Reporting Mechanisms: Establish reporting mechanisms that ensure climate-related risk information is communicated effectively from management to the board.
  5. Review and Adapt Governance Structures: Regularly review governance structures and processes to ensure they remain effective in identifying and managing climate-related risks.

B. Financial Implications and Strategic Adaptations

  1. Integrate Climate Risk into Financial Analysis: Develop processes to assess the financial implications of climate-related risks on the company’s operations and strategies.
  2. Disclose Financial Impact: Prepare for comprehensive disclosures on how climate risks and adaptation or mitigation efforts impact financial statements.
  3. Adopt Scenario Analysis: Utilize scenario analysis to understand the potential future financial impacts under different climate change scenarios.

C. Targets, Goals, and GHG Emissions

  1. Set and Disclose Climate Goals: Establish and publicly disclose clear, measurable climate-related targets or goals, including GHG emissions reduction targets.
  2. Implement GHG Tracking and Reporting: Develop robust systems for tracking and reporting Scope 1 and Scope 2 GHG emissions and prepare for third-party verification.
  3. Communicate Progress Towards Goals: Regularly report progress towards achieving climate-related targets, including strategies employed and investments made.

D. Cross-Sectional Actions

  1. Foster Transparency and Accountability: Develop disclosures that transparently convey the company’s approach to managing climate-related risks, its governance structures, financial implications, and progress toward sustainability targets.
  2. Leverage Technology for Compliance: Utilize technology and software solutions to streamline data collection, analysis, and reporting for climate-related disclosures.
  3. Engage Stakeholders: Maintain open lines of communication with stakeholders, including investors, customers, and employees, regarding the company’s climate-related strategies and progress.
  4. Stay Informed on Regulatory Changes: Keep abreast of evolving regulations and guidelines on climate-related disclosures to ensure ongoing compliance and best practices.

More from MBK Search:

Subscribe to This Week in GRC, MBK Search’s newsletter exploring the news, views, and analysis from the week in governance, risk, and compliance.

Discover more here.

Recent posts
24 April 2024
The FTC's rule on non-competes: What you need to know
The FTC issued a final rule that alters the landscape for non-compete agreements in the USA. Here's MBK Search's guide to the new rule.
22 April 2024
Combating Elder Financial Exploitation: Key Insights for GRC Professionals
Elder financial exploitation (EFE) has emerged as a significant threat, with the Financial Crimes Enforcement Network (FinCEN) receiving reports of over $27 billion in suspicious activity between June 2022 and June 2023. As the population ages, this issue becomes increasingly pressing for financial institutions, regulators, and society.
17 April 2024
2024 FSB Recommendations to Boost Non-Bank Liquidity
16 April 2024
5 Ways the Internal Audit Code of Practice Will Transform the Profession
The Chartered Institute of Internal Auditors has taken a bold step towards revolutionising the internal audit profession in the UK and Ireland by releasing its draft "Internal Audit Code of Practice."