The Status of Two Pending Rules That Would Require Disclosure of Climate Risks

By Jeffrey Karp, Senior Counsel, and Edward Mahaffey, Legal Research and Writing Attorney

We discuss the status of two pending federal regulations that would require the disclosure of information concerning greenhouse gas (GHG) emissions and climate-related risks: one proposed by several agencies that would apply to federal contractors, and the other by the Securities and Exchange Commission (SEC) that would apply to public companies.

The Proposed Rule for Federal Contractors

On November 14, 2022, Defense Department, General Services Administration, and National Aeronautics and Space Administration (Agencies) published a proposed rule, “Federal Acquisition Regulation: Disclosure of Greenhouse Gas Emissions and Climate-Related Financial Risk.”^[1] According to the agencies’ summary of the proposal in the Federal Register, it would “amend the Federal Acquisition Regulation (FAR) to implement a requirement to ensure certain Federal contractors disclose their greenhouse gas emissions and climate-related financial risk and set science-based targets to reduce their greenhouse gas emissions.”^[2]

The Agencies acknowledge that some similarities exist between the content of the disclosures required in the proposed FAR and SEC rules but note that the FAR rule requires contractors with significant Federal contracts “to provide their disclosures using the CDP Climate Change Questionnaire to maximize the consistency, comparability, and accessibility of disclosure data for use in managing Federal procurements and supply chains.”^[3] (CDP, formerly the Carbon Disclosure Project, is a nonprofit organization that runs a global environmental disclosure system.)

The proposed rule would separate ‘major Federal suppliers’ into two categories: major contractors and significant contractors.[4] Suppliers in both categories would be required to disclose annual Scope 1 and Scope 2 GHG emissions.[5] But only major contractors must provide an annual climate disclosure that includes Scope 3 GHG emissions and science-based target requirements.^[6]

The rule would define Scope 1 emissions as direct GHG emissions from sources that are owned or controlled by the reporting entity;^[7] Scope 2 emissions as indirect GHG emissions derived from the generation of electricity, heating and cooling, or steam by third party sources and purchased or acquired for the reporting entity's own consumption;^[8] and Scope 3 emissions as GHG emissions, other than Scope 2 emissions, that are generated by third party sources as a consequence of the reporting entity’s operations.^[9]

Under the proposed rule, a science-based target is “a target for reducing greenhouse gas emissions that is in line with reductions that the latest climate science deems necessary to meet the goals of the Paris Agreement to limit global warming to well below 2°C above pre-industrial levels and pursue efforts to limit warming to 1.5°C.”^[10] Major contractors would be required to develop science-based targets, and have them validated every five years by the Science Based Targets initiative (SBTi),^[11] a partnership between CDP, the United Nations Global Compact, World Resources Institute, and the World Wide Fund for Nature.^[12]

The comment period for the proposal ends January 13, 2023.^[13]

Enforcing the Federal Supplier Rule

It is anticipated that difficulties may occur in accurately measuring Scope 2 and 3 GHG emissions, and in evaluating science-based targets. In an effort to address these concerns and strengthen compliance, the rule relies on third parties for GHG measurement and science-based methodologies. For example, evaluation of science-based targets is to be conducted by the SBTi.

Nevertheless, validation of the targets is not the same as tracking companies’ progress towards achieving these targets, something for which the SBTi acknowledges it presently is developing a process.[14] The SBTi states that, during the coming year, it will issue more specific guidance on what companies must report annually on a public basis to facilitate this process.^[15] However, in the meantime, consistent with the Agencies’ proposed rule, the SBTi suggests disclosure through CDP’s annual questionnaire as one of several ways for companies to “publicly disclose their emissions inventory and progress against their targets.”^[16]

Nonetheless, questions remain whether the Agencies will promulgate a final rule as strict as the proposed rule, and whether the federal courts will uphold the final rule’s legality. Interestingly, a review of the comments submitted to date indicate that, while there have been some objections to aspects of the proposed rule from organizations representing federal contractors, those comments generally have been rather muted.^[17] The White House’s announcement of the proposed rule pointed out that more than half of major Federal contractors are already disclosing climate related information,^[18] which, perhaps, may account for the absence of rancor.

The Proposed SEC Rule

While the comment period on the FAR climate disclosure rule is ongoing, SEC’s proposed climate-related disclosure rule, issued in March 2022, remains in limbo. The proposed rule’s purpose is to protect investors by providing them with consistent and comparable information regarding climate-related risks affecting the public companies in which they may invest.[19] Specifically, public companies must report their Scope 1 and 2, and also in some cases Scope 3, GHG emissions;[20] explain line items in required financial statements that involve climate-related impacts and expenditures; detail the manner in which climate change is affecting or is likely to impact business operations; and provide information regarding any publicly announced climate-related targets or goals, and the manner in which its plans will be implemented. Such disclosures must be made in SEC filings, such as registration statements, annual 10-K forms, and financial reports.

Comments on the SEC Proposal

More than 4,000 comments were submitted during the comment period, which ended in June 2022.[21] Many commenters strongly expressed support for the proposed rule.[22] However, there were some previously ardent supporters of an enhanced climate disclosure regime, such as Blackrock, who submitted detailed comments suggesting revisions to provisions in the proposed rule that were identified as overly burdensome to issuers or of questionable materiality[23] to investors.

For example, Blackrock sought to distinguish between requiring the disclosure of Scope 1&2, and Scope 3 emissions:

. . . We support quantitative disclosure aligned with the Greenhouse Gas Protocol (“GHG Protocol”). As investors, we use GHG emissions estimates to size an issuer’s climate-related exposure. Specifically, we look to companies to provide Scope 1 and 2 GHG emissions disclosures, and meaningful short-, medium-, and long-term science-based reductions targets, where available for their sectors.

As investors, we use Scope 3 emissions as a proxy metric (among others) for the degree of exposure companies have to carbon-intensive business models and technologies. However, we do not believe the purpose of Scope 3 disclosure requirements should be to push publicly traded companies into the role of enforcing emission reduction targets outside of their control. Given methodological complexity for Scope 3 emissions and the lack of direct control by companies over the requisite data, our investors believe the usefulness of this disclosure various significantly right now across industries and Scope 3 emission categories. . .[24]

Accordingly, Blackrock stated that it is “generally supportive of the Commission’s proposal to require disclosure of Scope 1 and Scope 2 emissions,” but disagrees “with the Commission’s approach to requiring disclosure of Scope 3 emissions in SEC filings.”[25]

Similarly, commenters who oppose the proposed rule challenged the materiality of Scope 3 metrics,[26] as well as other disclosures that would be required in SEC filings,[27] such as the inclusion of three types of climate-related information in footnotes to a company’s audited financial statements (financial impact metrics; expenditure metrics; and financial estimates and assumptions).[28]

Also, commenters who raised materiality concerns have noted that the climate-related disclosures that the SEC is seeking to impose, such as greenhouse gas emissions data and the business risks stemming from physical impacts (e.g., severe weather events) and the transition to a decarbonized economy, are distinctly different than the financial information that the Agency traditionally required to protect investors and enable them to make informed decisions.[29]

Although the proposed rule is focused on information disclosure, the breadth of the required disclosures seems likely to place additional pressure on both public companies and companies in their respective supply chains to intensify their GHG emission reduction activities. Thus, some opponents have contended the SEC’s rulemaking proposal exceeds the Commission’s authority under the Securities Act of 1933 and the Securities Exchange Act of 1934,[30] and that promulgation of a rule requiring climate-related disclosures is to influence U.S. climate policy,[31] rather than protecting investors’ financial interests.[32]

The S-K Regulations and Climate Disclosure

Others questioned the need for a separate climate-related disclosure rule since there already are detailed SEC rules requiring disclosure of liabilities and risks that would encompass the disclosure of material climate change information.[33] With regard to disclosure of climate-related risks, the SEC issued a guidance document in 2010 that provides examples of material information, but there are no specific rules requiring such disclosures.[34] Although the SEC required that registrants more broadly disclose environmental liabilities[35] when amending its S-K Regulations in 2020,[36] the Commission declined to specifically mandate the disclosure of climate-related risks because a majority of the Commissioners at the time found such directives inconsistent with the Agency’s “principles-based” approach to revising the regulations.[37] Thus, affected companies must decide on a case-by-case basis whether any of the climate change business risks and impacts they face are sufficiently material to require disclosure under the environmental-related regulations.

The Commission in the Biden Administration has taken a proactive position in enforcing these S-K regulations. In March 2021, the SEC formed an Enforcement Division Task Force to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.[38] Moreover, in September 2021 the Division of Corporate Finance staff posted a sample letter highlighting the types of comments or questions it planned to send to issuers inquiring about the climate-related risk disclosures made in recent filings. Subsequently, the staff sent several rounds of letters to a number of companies seeking to button down responses to their tailored questions and comments.

The Anticipated Final SEC Rule

Since the Agency’s expected Fall 2022 time frame for issuing a final rule has passed, speculation has arisen regarding whether the Commission is considering dropping some of the more contentious requirements or aggressive compliance timetables in the proposed rule. While changes before issuance of a final rule certainly are plausible, it is not surprising that additional time is needed to complete the rulemaking package given that the Agency staff must review and consider over 4,000 comments and prepare a responsiveness summary for the Commission’s consideration.

Nonetheless, it does not appear that support has lessened for the proposed rule among the majority of Commissioners. Since the rule was proposed in March 2022, Commissioner Lee, a rule champion, has left the SEC, but her replacement, Jaime Lizarraga, also appears to strongly support its issuance:

Investors rely extensively on financial statement disclosures to make informed investment decisions. These quantitative metrics are essential for investors to understand the operations and performance of a company, and the same can be said for climate-related metrics.[39]

Regardless of its scope, the SEC’s final climate risk disclosure rule is expected to be challenged in court by a variety of parties, including a group of “red state” attorneys general. Since the proposal first was published, the Supreme Court has issued a decision in West Virginia v. EPA in which it applied the “major questions doctrine”[40] to reject the Environmental Protection Agency’s Clean Power Plan, thus limiting the EPA’s authority to address climate change.[41] The Court rooted its major questions doctrine analysis in “both separation of powers principles and a practical understanding of legislative intent.”[42] In the “extraordinary cases” in which the doctrine applies, “something more than a merely plausible textual basis for the agency action is necessary. The agency instead must point to “clear congressional authorization” for the power it claims.”[43]

The “major question doctrine” already has been raised in comments challenging the SEC’s authority to require that public companies make the sweeping range of disclosures included in the proposed climate risk disclosure rule. Also, it can be expected that the doctrine and arguments that the agency has exceeded its authority granted by Congress will appear prominently in the D.C. Circuit briefs challenging the final rule’s validity. However, the Commission has an advantage of long being recognized as having broad authority to determine the disclosure of information that is necessary to protect investors and enable them to make informed decisions. Thus, the SEC may be taking additional time to evaluate the rulemaking record and strategize regarding the appropriate scope of the final rule, and to wordsmith the accompanying statement of basis and purpose for the rule.

[1] 87 Fed. Reg. 68312.

[2] Id.

[3] Id. at 68312-13.

[4] Major contractors received more than $50 million in total Federal contract obligations (as defined in OMB Circular A-11) in the prior Federal fiscal year, and significant contractors received at least $7.5 million but no more than $50 million. Id. at 68313.

[5] Id. at 68313.

[6] Id.

[7] Id. at 68329.

[8] Id.

[9] Id.

[10] Id.

[11] Id. at 68315.

[12] https://sciencebasedtargets.org/about-us/partners.

[13] 87 Fed. Reg. 68312.

[14] Id.

[15] https://sciencebasedtargets.org/faqs.

[16] Id.

[17] https://www.govexec.com/management/2022/11/heres-what-contracting-community-thinks-new-proposed-rule-climate-reporting/379761/.

[18] https://www.whitehouse.gov/briefing-room/statements-releases/2022/11/10/fact-sheet-biden-harris-administration-proposes-plan-to-protect-federal-supply-chain-from-climate-related-risks/.

[19] The Enhancement and Standardization of Climate-related Disclosures for Investors, Release Nos. 33-11042; 34-94478 (March 21, 2022).

[20] The proposed SEC rule would define these terms similarly, but not identically, to the definitions in the proposed rule for federal suppliers. Scope 1 emissions, according to the SEC proposal, are “direct GHG emissions from operations that are owned or controlled by a registrant.” Scope 2 emissions would be defined as “indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant.” Scope 3 emissions would consist of “all indirect GHG emissions not otherwise included in a registrant's Scope 2 emissions, which occur in the upstream and downstream activities of a registrant's value chain.” 87 Fed. Reg. 21334 at 21466.

[21] In October 2022, the SEC reopened the public comment period for a number of its rulemaking proceedings, including the climate disclosure rule, for an additional 60 days upon discover of an internet snafu that excluded some number of comments.

[22] See, e.g., comments of Schneider Electric, June 17, 2022; Allstate Insurance Company, June 17, 2022; Democratic members of Congressional Committee on Oversight & Reform, July 7, 2022; Consumer Federation of America, June 17, 2022.

[23] See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976) (holding that a fact is material “if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision” or if it “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” to the shareholder.)

[24] Comment of Blackrock, June 17, 2022, pg. 3.

[25] Id. at pg. 8.

[26] See, e.g., comment of American Chemistry Council, June 17, 2022, pg. 15.

[27] See comment of Marathon Oil, 17 June 2022, pp. 4-5; see also comment of CohnResnick, June 22, 2022, pp.1-2.

[28] See comment of American Petroleum Institute, June 17, 2022, pg. 2.

[29] See comment of American Bankers Association, June 17, 2022, pg. 1; see also comment of Richard C. Breeden and several former SEC Chairmen and Commissioners, June 17, 2022, pg. 1.

[30] See, e.g., comment of Mandy Gunasekara, former US EPA Chief of Staff, June 16, 2022, pg. 3.

[31] See correspondence of Republican members of Senate Banking Committee to SEC Chairman Gary Gensler, June 15, 2022, pg.1; see also comment of John McCuskey and Michael Watson, elected state officials, June 14, 2022, pg. 1.

[32] See correspondence of Republican members of Senate Banking Committee to SEC Chairman Gary Gensler, June 15, 2022, pg.1.

[33] See comment of Maryland State Bar, June 17, 2022, pg. 2

[34] See Commission Guidance Regarding Disclosure Related to Climate Change (Climate Guidance), 17 C.F.R. pts. 211, 231, 242.

[35] In particular, Items 101, 103, 105, and 303 affect environmental disclosure, 17 C.F.R. pt. 229.

[36] Regulation S-K contains the uniform disclosure rules. It sets forth instructions for preparing the required narrative or nonfinancial statement portions of registration statements, as well as annual reports, proxy statements, and other filings required of publicly traded companies.

[37] See https://www.sec.gov/rules/final/2020/33-10825.pdf, pp.42-43.

[38] See https://www.sec.gov/news/press-release/2021-42.

[39] Speech at Future of ESG Data in London, October 17, 2022, available at https://www.sec.gov/news/speech/lizarraga-speech-meeting-investor-demand-high-quality-esg-data.

[40] The major questions doctrine holds that courts should not defer to agency statutory interpretations that concern questions of vast economic or political significance where the legislature has not clearly given the agency authority to make that type of interpretation.

[41] West Virginia v. EPA, 142 S. Ct. 2587, 2616 (2022).

[42] Id. at 2609.

[43] Id.