JONES DAY TALKS®: Court Stays SEC’s Climate Disclosure Rule, but Companies Should Continue Preparations
On Friday, March 15, the U.S. Court of Appeals for the Fifth Circuit granted an administrative stay of the SEC’s final Climate Disclosure Rules, adopted just over a week earlier. All of the challenges to the Rules filed in various courts will be coordinated for review before one court. As written, the Rules will require publicly traded corporations to make significant, new climate-related disclosures. In the first of a series of JONES DAY TALKS® programs examining the new Rules and related topics, Amy Pandit and Olga Gidalevitz discuss key implementation considerations for affected companies.
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Dave Dalton:
On Friday, March 15th, a US Court of Appeal granted an administrative stay of the SEC's final Climate Disclosure Rule, which was adopted just over a week earlier. A federal appeals court will hear the challenges, and we will continue to gather information on the status of the rule, and we'll provide timely updates. As written, the rule requires certain publicly traded corporations to disclose climate related risks, potentially having material impact on business strategies or financial results. In the first in a series of Jones Day Talks programs examining the topic, Jones Day's Amy Pandit and Olga Gidalevitz discuss key implementation considerations for affected companies. I'm Dave Dalton. You're listening to Jones Day talks
Amy Pandit is a Pittsburgh-based Jones Day partner in our financial markets practice, which includes work with the firm's capital markets and ESG teams. She represents publicly traded corporations and counsels clients on corporate governance, executive compensation, and in federal securities laws, stock exchange, Sarbanes-Oxley Act, and Dodd-Frank Act compliance matters. And Olga Gidalevitz, based in Chicago, represents public and private companies, financial institutions, banks, and agents in connection with US and cross-border financing transactions. She has extensive experience advising clients on corporate governance and other environmental, social and governance ESG issues, including compliance with EU rules on ESG disclosures. Olga's PhD and postdoctoral research focused on climate change and ESG matters, a topic she has published and lectured on extensively.
Amy, Olga, thank you for being here today. Amy, Olga, thanks so much for being here today. As our listeners heard in the introduction, this is complicated. These new rules came out March 6th. There's a lot to unpack here. So we're going to take some time to talk about this. Let's go to Amy first. Amy, how would a company, a large corporate, even begin to get their arms around this? There's just so much going on. Where do you start?
Amy Pandit:
Hey, so Dave, you're absolutely right. The final rules dropped a number of significant elements from the proposed rules, which many of us were relieved to see, such as not requiring scope 3 GHG emissions of material in the disclosures. But they still include a lot of information that companies particularly large accelerated filers are going to have to provide what their 2026 filings relating to fiscal 2025 information. And so with that, the question really is, well, how do we start? How do we get our arms around all this information that is going to be disclosed particularly for large filers starting in 2026? And for me, I start with materiality. The SEC reiterated a number of times in the release that traditional concepts of materiality generally apply to these new disclosures. So basically what that means is if there's a substantial likelihood that a reasonable investor would consider the information important when determining whether to buy or sell securities or how to vote, or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information that's available, then that information is material.
And the SEC also went out of its way in adopting the release to say the materiality is both to be considered from a fact-specific perspective as well as looking at it for quantitative as well as a qualitative perspective. And so with that general definition, which is used throughout the securities rules, the place to really start, I think, in terms of understanding what is or is not material as called for by these rules, is looking to the disclosure committee. For most companies, they have a disclosure committee on equivalent body, which is typically tasked with determining whether information events or developments are material. This committee should similarly be tasked with making the materiality determinations with these new rules just like they're with many other questions under securities laws. I think the legal and finance teams can start that work now with them in terms of trying to organize these issues for them and making those materiality determinations.
One of those areas where there's materiality determination is with respect to whether or not companies will need to disclose scope 1 and/or scope 2 GHG greenhouse gas emissions. So scope 1 emissions just to review are direct emissions from operations. And scope 2 emissions are indirect greenhouse gas emissions from purchased energy, cooling, heat, et cetera, which are consumed by operations. And the question here is whether or not any of these emissions, either scope 1 or 2, are material to the company. The SEC release does indicate that 20% of public companies provide some information regarding scope 1 and/or 2 GHG emissions often outside of their SEC filings. And among Russell 1000 companies, that number really jumps up to about 90%. Again, mostly outside of their SEC filings. The disclosure will include if required calculation approach type and source of emissions factors and any calculation tools. So it's going to be a very detailed set of disclosures.
So what I recommend that companies do now, again in preparation for this, is that they consider this question carefully. And also that they think about whether or not the information that's in their sustainability reports is in fact material such that they should consider whether it would be also advisable to disclose it in their SEC filings. As you know, many companies have taken the position that this information is not material. It's not material to investors. And have not included it historically in their SEC filings. And instead have included in their sustainability reports on websites as information that is of interest to many stakeholders, not just investors, and not material to those investors. There needs to be discussion in companies where they should start having their disclosure teams and disclosure committee consider this with members of management, IR, finance, and ultimately, the board.
If the determination is made that disclosures scope 1 and/or 2 GHG emissions are not material, this disclosure will not be required by those new rules and we'll not need to include them in the SEC filings. Of course here, I think everyone needs to be aligned because if that disclosure is absent, it could be subject to challenge by the SEC and/or third parties. And so I think this is why there needs to be a coordinated consideration of these issues at companies. It's also important to start that conversation now because of the disclosure of scope 1 and/or scope 2 GHG emissions will apply beginning for fiscal year 2026, filed in 2027 for a large accelerated filer. But potentially prior fiscal years such as '24 and '25 may also need to include this kind of disclosure to the extent a company has previously disclosed this information in an SEC filing for those historical fiscal years.
So there could be in fact earlier years of disclosure than what was anticipated just by that 2027 disclosure date. Another area where materiality plays a big factor in these disclosure rules is in connection with climate related targets and goals that companies are setting. Companies will be required to disclose any climate related target or goal is such targeted goal has materially affected or is reasonably likely to materially affect the company's business, results of operations, or financial condition. Disclosure will be required whether the goals are internal or publicly disclosed. So companies have internal goals and they have not otherwise put them out there, and their sustainability could be disclosed or required to be disclosed in their SEC filings. Again, if they're material. One place to start here is to inventory related targets and goals. Many companies have five, six, seven, particularly large companies, environmental or GHG related goals in their sustainability reports.
They should go through those reports, understand what those goals are, whether they're set for 2030 or 2050, for example, net zero. They should then determine with the Disclosure committee and other stakeholders, whether any of them are material to investors. Most companies currently limit or do not include these goals in their SEC filings. If they are determined not to be material, companies should consider ceasing to disclose them in their SEC filings voluntarily. Not to create this record that you're putting this information into your SEC filings and then pulling it out in the event you don't continue to do so. Continued voluntary disclosure until the applicable compliance deadline may be problematic. If targets and goals disclosure is provided, companies will also have to disclose the use of carbon offsets or renewable energy credits if they are a material component of the plan to achieve such goals.
And as many of you know that these carbon offsets, and use of carbon offsets, and renewable energy credits have been somewhat criticized in the market. And so this is something, again, to think about in connection with disclosure. And also thinking about whether or not it's a material component of the plan to achieve those goals and what that may mean from a disclosure perspective. Be also mindful with targets and goals that it's not just putting those targets and goals out there. The companies will be required to annually update their requirements on the targets and goals and how they're progressing against these goals over time, and the related impacts on expenditures as well. Another area, again, where the SEC is asking companies to make a materiality judgment is with respect to climate related risks. Climate related risks are the actual potential negative impacts of climate related conditions and events on a company's business, results of operations, or financial condition. And include physical risks, acute risks, chronic risks, and also transition risks.
And transition risks here are actual or potential negative impacts on the business, or results, or financial condition attributable to companies adjusting their businesses essentially to comply with regulatory, technological, or market changes. For this reason, I think companies really need to inventory, again, their risk factors. The risk factors that you've included historically in your 10 K. And identify what if any risks are climate related and material. If material climate related risks are identified, companies will need to consider both short-term 12 months as well as long-term issues associated with those risks. And of course, this is a similar temporal standard that we've had in the MD&A for a number of years now regarding where companies have cash to meet their requirements. With material client related risks identified, companies should then start to think about how they materially impact strategy, business model, and outlook. If material climate related risks are identified, companies should also begin to gather information regarding material expenditures because this disclosure will be required, as well as quantitative and qualitative related to mitigating those risks, and also material impacts on financial estimates and assumptions.
This is all background work that's going to need to be done once you've identified material climate related risk. All this may require companies to develop new controls and procedures for accurate tracking and reporting of material expenditures and material impacts on financial estimates and assumptions, which will all be lead-time issues for companies. They prepare to produce disclosures. And so again, this is now the time to start thinking about putting these controls and procedures in place. The SEC also looked to materiality in connection with the scenario analysis. And this is if this analysis is material to assessing climate related risks on the business, and if based on that analysis that risk is likely to have a material impact on the business, disclosure is required. So many companies have included information about scenario analysis using TCFD and other frameworks in their sustainability reports. And the question will be whether or not these analyses are in fact material in connection with them assessing their climate related risks.
And for companies disclosing scenario analysis in those reports, they'll have to consider whether they should continue doing so. And if so, documenting whether or not such planning is material to the assessment and identification material climate risk. The information is in one place, which is not an SCC file. And it's not in the SCC filing. I think it's important for companies to think about why that is the case and why it's not material necessarily in connection with their risk assessments. Companies are not required to conduct a scenario analysis. But I do think a fundamental question here, both with this and other aspects of the rules is whether or not companies will feel compelled to do so. The disclosure is going to start driving behavior. So that's something for companies to be thinking about now and whether or not this will change what they're doing internally, but to the extent they're not currently doing the scenario analysis.
This also similarly applies with internal carbon pricing, which is disclosing this price if material to how the company evaluates a climate related risk. Again, this is all based on materiality and whether it's a material component of this risk assessment. A company only discloses such use if it is material to how it evaluates and manages a climate related risk that it has identified as having material impact or that is reasonably likely to have a material impact on the company. Including its business strategy, results of operations, and financial condition. Similar, the scenario analysis, many companies do not maintain an internal carbon price. And so the question here as well is whether or not we might see companies start to do so. Again, the disclosure potentially driving the behavior even though it is not currently a tool used in connection with the risk assessment processes. Similarly, whether or not a climate transition plan is used to manage a material transition risk, if it is, then a company will need to disclose it.
And a transition plan for this purpose is a strategy and implementation plan to reduce related risk, which may include a company's plan to reduce its GHG emissions in line with its own commitments or commitments of jurisdictions within which it operates. Question's going to be, does the company have a transition plan? Does it need to be revised and reconsidered in preparation for disclosure? Similar to the task, many of us undertook with our clients in connection with the cybersecurity rules and revisiting incident response plans in order to make sure that we have the right controls and procedures and plans that we could then describe in the 10-K most recently that we just filed.
We'll also be subject to an annual update. So companies are going to have to annually provide updates in the 10-K of any changes they're making, both qualitative and quantitatively to these transition plans, including regarding material expenditures and material impacts on financial estimates and assumptions. So again, a lot of work here as well to the extent the companies putting that information forward and it's being used to manage a material transition risk. And with that, I'll turn it over to Olga with another [inaudible 00:15:05].
Dave Dalton:
Amy, that was a terriffic introduction. I asked how does a company even get started? That's a great introduction to all this. But yeah, let's go to Olga for a second and talk about how these new rules might work with the current disclosure frameworks that are out there already. So yeah, let's swing to Olga for a second. And Amy, please chime in where you will. But Olga take it from here.
Olga Gidalevitz:
So when we are discussing current disclosure frameworks, we need to differentiate between required frameworks like European CSRD and California bills, which will be a focus of our upcoming podcast in a couple of weeks. And there are a huge number of the voluntary disclosure frameworks like TCFD, SASB, GRI. And we see companies are using those voluntary frameworks already. However, the challenge here is also SEC indicated in the release that SEC rules are primarily informed by TCFD and GHG protocol. When you actually start preparing the disclosures in details, you can see a number of differences. So one takeaway from this is if the company is already reporting under any of the existing voluntary frameworks, the same disclosures will not necessarily be sufficient for the SEC requirements. For example, the TCFD requires that sustainability report will cover the same period as the typical financial filing. Greenhouse gas protocol on another hand, requires disclosure for the current reporting year. And the base year which is used as a comparable basis for the reporting.
The SEC rule is very interesting and unusual in this perspective because we have a look back period for two or three years depending on the nature of the information required. The choice of base year and the choice of operating boundaries when it comes, especially for the greenhouse gas emissions measurement, are critical components of any emissions related disclosures. Greenhouse gas protocol has extensive requirements for how to choose the base year and what are the options for the operating boundaries. SEC rules are silent about base year. There are no requirements for establishing or disclosing the emissions in the base year. So it would be complicated to have objective comparable tracking of the company progress when it comes to its efforts to reduce emissions.
And when it comes to the operating boundaries, SEC rule is also very interesting because it allows a company to choose a different boundaries than it is selected for the financial disclosure. Another interesting difference between SEC rule and the voluntary frameworks is most voluntary frameworks and even CSRD have certain industry-specific standards and industry-specific disclosures. We can go on for many, many differences. Spotting the last big one is the short, medium, and long time horizons. Because SEC rules is focusing on the financial disclosures, it is mirroring the same rules.
So to circle back where I started, it is critical to assess and align the disclosures that the company is already making and map them against the SEC-mandated disclosures. And when companies doing this, they should look not only at their official sustainability report PDF posted on the website, this analysis should also incorporate the website marketing and sales materials. And then the company will have a consistent and comprehensive picture of all the disclosures that are being made and all the changes that would be required. Amy?
Amy Pandit:
Thank you, Olga. What I would also say here is that another thing that companies need to be thinking about is whether or not they have the right management personnel, experts in-house in order to make these disclosures. Part of the rules require a description of management's role, and assessing and managing material climate-related risks. Relevant expertise as such positions or committee members in detail is necessary to fully describe the nature of the expertise, including prior work experience in climate-related matters, any relevant degrees or certifications, any knowledge skills or other background in climate-related matters. Similar to the cybersecurity rules, companies will need to describe the nature of the expertise of their in-house management team members who are responsible for assessing and managing climate-related risks among other matters. So I would say cybersecurity is something that almost every publicly traded company has to deal with. And many companies already had a very expertised group of folks involved in TOs and CISOs associated with information security and privacy matters on the climate side.
I would say that that really isn't so much the case. For a lot of companies, climate and climate-related risks are not an acute significant risk that the necessarily had a staff in-house dealing with these issues, identifying these issues, and managing these issues in coordination with management. And so I think here in light of this disclosure, disclosure, potentially driving behavior. Companies are need to think about whether or not they have these individuals in place, including their degrees and their background and experience in order to demonstrate that they have a credible team in place to identify climate-related risks and otherwise manage those risks. And so here as well, this is going to be a lead-time issue for companies as they continue to prepare for these disclosures that'll be made in a few years.
Olga Gidalevitz:
Yeah. Thank you, Amy. Another thing that companies should start doing right now is identifying an attestation provider. It is important because if a big company determines that, it'll be providing certain disclosures regarding their either scope 1 or scope 2, they will have to provide reports prepared by independent attestation provider, which has to be an independent from the company or from its affiliates. And it'll have to provide an attestation report for the attestation and professional engagement period. For independence, companies need to consider whether there is mutual or conflict of interest between the provider and the company. And if this conflict puts the provider in a position of attesting to provider's own work, then this provider is not suitable and we need to continue the search.
It has been raised in many comments that public submitted for the proposed rule that SEC released in March, 2022. And those feedback we're talking about insufficient number of attestation providers. If many of the companies will have to provide attestation report, that is a lot of work. And to find the suitable attestation provider will take time. It is important to retain qualified companies early to secure and have this done.
Dave Dalton:
All right, let's go back to Amy. Amy, as companies start to prepare and think about preparing for these new disclosures, are there areas of ambiguity they should be concerned with?
Amy Pandit:
Yeah, so as we've discussed, materiality is not withstanding the definition that's provided in the release and that we've all lived with for years in terms of thinking about what's material information that needs to be disclosed. That itself is ambiguous for many of us. But here as well, we've got other things, particularly in the financial statement disclosures that are being called for that raise a level of ambiguity as well, where I think if companies start thinking about this now, it will help them down the road as they start to think about these disclosures. So one of the disclosure requirements that'll be in the financial statement relates to defining and tracking severe weather events and other natural conditions. And other natural conditions are defined as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise. Those are examples. And if those events arise, then companies would need to provide disclosure of capitalized cost, expenditures, expense, charges, losses incurred as a result of emphasis on as a result of, severe weather events and other natural conditions. They'll all need to be disclosed basically subject to a 1% disclosure threshold to apply.
The final rules require companies to attribute a cost, expenditure, charge, loss or recovery to a severe weather event or other natural condition. And disclose the entire amount of the expenditure or recovery when the event or condition is a significant contributing factor in incurring the cost. So if the severe weather event is a significant contributing factor associated with the cost associated with a severe weather event, the entire cost of that, even if there are other factors that may have played a role, will need to be disclosed again, assuming you surpass the thresholds disclosure threshold set forth in the rule. And so this is something, again, I don't think a lot of companies think in terms of what is or what is not a severe weather event and defining whether what a significant contributing factor or not.
And so I think here companies are going to need to think about what are those related weather events that are affecting their operations or some companies globally. To what extent are these significant contributing factors associated with costs and expenditures and charges that companies are taking so that they can consider whether or not there needs to be this additional financial statement disclosure in any particular year regarding them. As a side note, also on the financial statement side, companies will be required to disclose capitalized costs, expenditures, expense, and losses related to the purchase and use of carbon offsets and RECs in the financial statements. Under the final rules, companies are required to disclose the aggregate amounts of carbon offsets and RECs expense, carbon offsets and RECs capitalized and losses incurred on the capitalized carbon offsets and RECs during the fiscal year.
What's important here to note is that this disclosure requirement is not subject to the 1% disclosure thresholds that apply to disclosure severe weather events and other natural conditions. Instead, disclosure is required if carbon offsets or RECs have been used as a material component of a company's plan to achieve disclosed climate related targets or goals.
Dave Dalton:
It's been a great discussion. Covered a lot of material already. Olga, why don't you summarize what we've talked about today. Give us the key takeaways and get us ready for the next podcast. It'll be out in just a couple of weeks. But what does the listener need to make sure he or she takes away from today's discussion?
Olga Gidalevitz:
Thank you, David. The number one is the climate governance is going to be in the focus. The company needs to start educating the board, its management, its employees about the final rule. Need to establish or refine the board and management oversight to have clear roles and responsibilities. Then it is very important to start as soon as possible doing the materiality assessment of the scope 1 and scope 2 emissions of the targets carbon offsets or renewable energy certificates, scenario analysis climate transition plan. We need to understand the current state of climate disclosures and to perform an inventory of climate related information that the company has already gathered or disclosed. And to have a clear understanding of the data, the processes, and control over this information. The next step, which also needs to happen rather sooner than later, is to identify the disclosure and control gaps when it comes to missing data or controls, including both in and outside the financial statement.
Another important takeaway is to review disclosures that are made or statements that are made on the website or in any materials of the company against the requirement of the SEC rules. Finding a suitable attestation provider and considering the exposure to the severe weather events or natural conditions if it is a significant contributor factor to the costs or expenses that the company may incur. And also, we think that the companies needs to start preparing right now.
We have to note that these rules are still subject to significant litigation challenges. The decision made by most federal administrative agencies are subject to review by a court. We need to keep watching the litigation developments, but at the same time, to continue preparing for when the SEC rules come into effect and the disclosure requirements will start apply to the company.
Dave Dalton:
A continually evolving and developing situation, as you said, Olga. And we will keep an eye on it. Amy, Olga, this is great. First program and a series of podcasts addressing this topic. And we're looking forward to hearing from you both again very soon. So thanks so much for your time today.
Amy Pandit:
Thank you.
Olga Gidalevitz:
Thank you.
Dave Dalton:
You can find complete bios and contact information for Amy and Olga at Jonesday.com. Please reach out to them with any questions about today's subject matter. As we sign off, please remember, this is the first in a series of podcasts on the new SEC Rules on climate disclosure. Look for those programs in the coming weeks, or even better, subscribe to Jones Day Talks at Apple Podcasts or wherever you find your favorite podcast programming to make sure you don't miss anything. Jones Day Talks is produced by Tom Kondilas. As always, we thank you for spending some time with us and hope you enjoyed the content. I'm Dave Dalton. We'll talk to you next time.
Speaker 4:
Thank you for listening to Jones Day Talks. Comments heard on Jones Day Talks should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on Jones Day Talks are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit Jonesday.com.
