Overview of the SEC Climate Disclosure Rule
The Securities and Exchange Commission’s (SEC) Climate Disclosure Rule released on March 6, 2024 has two main goals: (1) require companies to calculate the financial impact from climate risk and (2) standardize the environmental reporting landscape to ensure that investors are equipped with the necessary information to make informed investment decisions. Understanding how a company is financially impacted by a changing climate is a new concept for many and requires a lot of new data in order to comply. In this article, we dive into what is in the SEC’s new rule and how companies can start to prepare.
Three Key Sections:
Climate Strategy in the Boardroom
The new rule lays climate responsibility on the shoulders of the board of directors and the C-suite leadership. The board and management must demonstrate how material climate-related risks are incorporated into their broader risk-management processes, outline their plans to mitigate these risks and address the impact of climate change. A top down approach to climate mitigation makes sure that environmental awareness permeates company culture, signifying a strong commitment to climate stewardship. To comply with this section of the rule, companies must describe (1) who at the company is responsible for climate risk oversight; (2) what processes are in place for assessing and mitigating risks; and (3) whether and how any transition or mitigation strategies are put in place.
Scope 1 and 2 Emissions Disclosure, Leaving Out Scope 3
A key change from the SEC’s proposed rule is that Scope 3 emissions (those indirect greenhouse gas emissions from sources like supply chain, employee commutes, and vendor products) are no longer required. In addition, Scope 1 emissions (direct emissions that arise from sources owned or under the control of the reporting entity) and Scope 2 emissions (indirect emissions from sources such as electricity use) are required only for Large-Accelerated Filers and non-exempt Accelerated Filers and only if those emissions are deemed material to the company. Therefore a quantitative assessment of Scope 1 and 2 emissions must be made for those companies and they must also receive a limited assurance report from an independent assurance provider.
Financial Statements - Climate Risks are Financial Risk
The SEC rule necessitates companies to incorporate a narrative note in their financial statements detailing the potential impact of material climate-related risks on the company’s financial position, performance, and cash flows. This encompasses capitalized costs, expenditures, and losses arising from severe weather events like flooding, fires, sea level rise, and storms. It also encompasses risks linked to the physical ramifications of climate change on a company’s assets, supply chain, and operations. Furthermore, the SEC requires “reasonable assurance” to the completeness of a company’s climate-related financial disclosures, which necessitates the implementation of rigorous verification processes and internal controls to ensure that the disclosed information is supported by data and aligns with established methodologies.