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Thompson Hine LLP, a full-service business law firm with approximately 400 lawyers in 8 offices, was ranked number 1 in the category “Most innovative North American law firms: New working models” by The Financial Times and was 1 of 7 firms shortlisted for The American Lawyer’s inaugural Legal Services Innovation Award. The firm has been recognized by the National Law Journal as a Legal Technology Trailblazer and featured by Bloomberg for its innovative service delivery models, which drive accuracy and predictability. The firm’s commitment to innovation is embodied in Thompson Hine SmartPaTHTM – a smarter way to work – predictable, efficient and aligned with client goals. For more information, please visit ThompsonHine.com and ThompsonHine.com/SmartPaTH.

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On March 21, 2022, the SEC released its long-awaited <a href="https://www.sec.gov/rules/proposed/2022/33-11042.pdf">climate disclosure proposal</a>, which is modeled, in part, on the Task Force on Climate-related Financial Disclosures (TCFD) framework. Among other things, the proposed rules would require a company to disclose in its annual report on Form 10-K information regarding:

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Notably, larger companies would also be required to provide a third-party attestation report from an independent attestation service.

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The climate-related disclosures would need to be included in a company’s annual report on Form 10-K (with material changes to such disclosures included in quarterly reports on Form 10-Q) and in registration statements and tagged in inline XBRL. Most of the required disclosures would be provided for in a new Item 1500 in Regulation S-K. The forward-looking statement safe harbors would apply to portions of the proposed disclosures.

The proposed rules also include proposed phase-in periods for disclosure and some exemptions for smaller reporting companies.

What Do These Proposed Rules Mean for Companies?

The proposal is an expansive rulemaking, requiring, among other things, companies to collect, verify, and report their GHG emissions. While reporting of Scope 3 emissions is qualified by a materiality standard for companies that do not include Scope 3 in their public GHG reduction commitments, the release includes a soft mention of 40% as a threshold that could potentially be material. For many companies, Scope 3 emissions would exceed that threshold.&nbsp;Then there is, of course, a question of determining materiality, which, in itself, requires companies to collect data to measure the significance of Scope 3 emissions to the company, supplier challenges, expenses, and the likely need for additional internal or external resources.

The requirement to include these disclosures in annual reports accelerates timelines for many of the companies that currently include these disclosures in ESG reports or standalone TCFD reports, during a time that is already very busy for financial professionals in finalizing audits and annual report disclosures. Third-party verification requirements impose a further constraint on the timing. And that is only discussing GHG emissions, let alone the proposed financial statement disclosures and other disclosures.

A substantial number of comment letters, litigation and other challenges to the proposed rules, are likely. Regardless, compliance with the final rules is expected to be a significant undertaking.

For those companies that have been waiting to see the SEC’s proposed rulemaking before implementing ESG programs and governance structures, the time to act is now. Companies that already have an ESG program should assess such program, with the goal of aligning the program with the SEC’s proposed requirements, as well as the company’s investor and other stakeholder expectations, which could be a lengthy task.

If you intend to comment, comments are due on or before June 17, 2022. The proposal is likely to generate a substantial number of comment letters.

Disclosure of Climate-Related Risks and Their Impact

The new rules would require disclosures regarding climate-related risks that are reasonably likely to have a material impact on a company, including its business or financial statements. Companies would need to describe their assessment of the materiality of such risks over the short-, medium- and long-term, as well as how they define such time horizons, including how they account for or reassess the expected useful life of assets and the time horizons for their climate-related planning processes and goals.&nbsp;

“Climate-related risks” would mean the actual or potential negative impacts of climate-related conditions and events on a company’s consolidated financial statements, business operations, or value chains (the upstream and downstream activities related to a company’s operations), as a whole. Both physical and transition risks would need to be identified as such and disclosed.

A company would need to describe the nature of the physical risk, whether it is acute or chronic, and, if the risk has had, or is likely to have, a material impact on the company’s business or financial statements, the location (i.e., zip code or similar postal zone) of properties, processes, or operations subject to the risk. Companies subject to material risks relating to flooding or high water stress would be required to disclose additional information relating to those risks.

A company would need to disclose the nature of the transition risk, including whether the risk relates to regulatory, technological, market (including changing consumer, business counterparty, and investor preferences), liability, reputational, or other transition-related factors, and how such factors impact the company. For example, transitions risks could include increased costs attributable to climate-related changes in law or policy, reduced market demand for carbon-intensive products leading to decreased sales, prices, or profits for such products, the devaluation or abandonment of assets, risk of legal liability and litigation defense costs, competitive pressures associated with the adoption of new technologies, reputational impacts that might trigger changes to market behavior, changes in consumer preferences or behavior, or changes in a company’s behavior.

Impacts of Such Risks and Related Disclosures

In addition to describing climate-related risks, companies would need to describe each of the following in the short-, medium- and long-term (using the same time horizons as for the climate-related risk disclosures):

Companies would be required to describe their risk governance, including the board’s oversight of climate-related risk and management’s role in assessing and managing such risks, as well as whether and how climate-related risks are integrated into their overall risk management system or processes (for instance, how a board or management committee responsible for assessing and managing climate-related risks interacts with the board or management committee governing risks). Although some companies currently include this type of information in their proxy statements or in reports using the TCFD framework, the proposed disclosure requirements are quite expansive, including proposed disclosures regarding individual directors’ qualifications and management’s internal organization in assessing and managing climate-related risks.

Companies would need to disclose, among other things: (i) any board members or committees responsible for the oversight of climate-related risks; (ii) whether any directors have expertise in climate-related risks (and, if so, how they obtained such expertise); (iii) how management provides the board with information regarding climate-related risks; (iv) how frequently the board or relevant committee considers climate-related risks; (v) if and how the board or committee considers climate-related risks as part of its business strategy, risk management, and financial oversight (for example, in relation to the review and oversight of business strategy, risk management policies, performance objectives, budgets, and major purchases, sales, and expenditures); and (vi) if and how the board sets climate-related targets and goals and oversees progress against those targets or goals, including any interim targets or goals.

Companies would also be required to disclose (i) whether certain management positions or committees are responsible for assessing and managing climate-related risks, and identifying any such positions or committees; (ii) the relevant expertise of such individuals; (iii) how such managers or committees are informed about, and monitor, climate-related risks (such as whether specific positions or committees are responsible for monitoring and assessing specific climate-related risks and the extent to which management relies on in-house staff and/or third-party consultants to evaluate climate-related risks and implement related plans of action); and (iv) if and how often the responsible positions or committees report to the board or relevant board committee on climate-related risks.

In addition, companies would need to include information regarding their processes for identifying, assessing, and managing climate-related risks and how such processes are integrated in their overall risk management system or processes.

With respect to processes for identifying and assessing such risks, required disclosures would include: (i) how the relative significance of climate-related risks compared to other risks is determined; (ii) how existing or likely regulatory requirements or policies, such as GHG emissions limits, are considered when identifying climate-related risks; (iii) how shifts in customer or counterparty preferences, technological changes, or changes in market prices are considered in assessing potential transition risks; and (iv) how the materiality of climate-related risks is determined, including how the potential size and scope of any identified climate-related risk is assessed.

With respect to processes for managing such risks, companies would need to describe how they decide whether to mitigate, accept, or adapt to a particular risk, prioritize addressing climate-related risks, determine how to mitigate a high priority risk, and, to the extent material, use any insurance or other financial products to manage exposure to climate-related risks.

Companies would be required to describe any transition plan (a strategy and implementation plan to reduce climate-related risks) they may have in place, which could include a plan to reduce GHG emissions in line with their commitments or commitments of jurisdictions in which they have significant operations. Such description should include the relevant metrics and targets used to identify and manage physical and transition risks, plans to mitigate or adapt to any identified physical risks (such as moving operations vulnerable to rising sea levels) or transition risks (including, among other things, laws, regulations, or policies restricting GHG emissions or products with high GHG footprints and changing demands or preferences of consumers, investors, employees, and business counterparties), and steps taken during the prior fiscal year to achieve the transition plan’s targets or goals.

GHG Emissions Disclosures and Attestation Report

Companies would also be required to provide information regarding their GHG emissions.  

Definitions of GHG and Direct and Indirect Emissions

The definitions of GHG and the scope of emissions would be generally consistent with the definitions under the GHG Protocol standards.

Because the foregoing definitions match those used by the U.S. Environmental Protection Agency in its GHG emissions reporting program, companies that provide GHG emissions data under the program would be able to use such information in providing required disclosures under the proposed rules.

Disclosure Requirements - Scope of Emissions

Notably, if Scope 3 emissions are not material, or a company determines that only certain categories are material, the proposed rules suggest that companies consider disclosing the basis for such determinations.

The proposed rules would include a safe harbor for Scope 3 emissions from certain forms of liability under the securities laws. In addition, smaller reporting companies would be exempt from the Scope 3 emissions disclosure requirements.

Determining Materiality of Scope 3 Emissions

The SEC noted that, “given their relative magnitude,” for many companies, Scope 3 emissions could be material “to help investors assess the [companies’] exposure to climate-related risks, particularly transition risks, and whether they have developed a strategy to reduce their carbon footprint in the face of regulatory, policy, and market constraints.” In assessing whether Scope 3 emissions are material, companies should consider the following: &nbsp;

These materiality determinations will not be easy. In addition, as noted above, if Scope 3 emissions are not material, or a company determines that only certain categories are material, the proposed rules suggest that companies consider disclosing the basis for such determinations.

Disclosure Requirements - Information to be Provided

For each type of emissions data required to be disclosed (as described above), companies would need to include certain additional information for the most recently completed fiscal year and for the historical fiscal years included in their financial statements, to the extent such information is reasonably available.

Significantly, the proposed rules would require larger companies (accelerated filers and large accelerated filers) to provide an attestation report meeting certain minimum standards from an independent attestation service provider, covering the disclosure of their Scope 1 and Scope 2 emissions. These companies would also be required to provide certain related information about the service provider, who would be required to meet certain minimum qualification and independence requirements. The proposed rules would not require a third-party assurance over Scope 3 emissions.

The SEC did not prescribe a particular framework to be used for the report; instead, the report would be required to be provided pursuant to standards publicly available at no cost, established by a body or group that followed due process procedures, including the broad distribution of the framework for public comment. The SEC indicated that the attestation standards of the PCAOB, American Institute of Certified Public Accountants (AICPA), and International Auditing and Assurance Standards Board (IAASB) would meet the due process requirement.

Such reports would initially be required at the “limited assurance” level, which would phase in to the “reasonable assurance” level. The service provider would be required to provide their consent, which would be filed as an exhibit.

Companies that are not otherwise subject to the attestation report requirements and that obtain third-party attestation or verification of their GHG emissions disclosures will be required to provide certain information regarding such assurance or verification.

The proposed rules do not include any requirement to obtain an attestation report covering the effectiveness of internal control over GHG emissions disclosure; however, the SEC indicated the current proposals were “appropriate first steps,” leaving open the possibility that such requirement could someday be mandated.

Climate-Related Metrics in Financial Statements – Financial Impact Metrics, Expenditure Metrics and Estimates and Assumptions

The proposed rules would add a new Article 14 – Climate Related Disclosure to Regulation S-X, requiring disclosure of certain climate-related metrics in the notes to the financial statements in Form 10-K filings. Such metrics would generally be disclosed for each year included in the financial statements. These disclosures would be subject to audit and within the scope of a company’s internal control over financial reporting.

For each type of financial statement metric, companies would be required to disclose how the metric was derived, including significant inputs and assumptions used, and, if applicable, policy decisions made to calculate the specified metrics, as well as the impact of any identified climate-related risks, including physical risks and transition risks, on any of the metrics.

Companies could also optionally disclose the impact of any climate-related opportunities on such financial statement metrics, subject to certain disclosure requirements.

Subject to a threshold requirement (described below), companies would be required to disclose the financial impacts of severe weather events and other natural conditions (such as flooding, drought, wildfires, extreme temperatures, and rising sea levels) and transition activities on any relevant line items in their financial statements, as well as the financial impact of any identified climate-related risks. (Identified physical risks are referred to together with severe weather events and other natural conditions as “climate-related events”.) Positive impacts and negative impacts relating to climate-related events or transition activities would each need to be disclosed separately on an aggregated, line-by-line basis. The SEC provided the following chart as an example and noted that additional disclosures could include the company’s decision to include the impact from opportunities, the specific events that were aggregated, and, if applicable, the estimation methodology used to disaggregate the amount of impact on the cost of revenue among the climate-related events, transition activities, and other factors:

Total Negative Impact from Climate-related Events

Total Positive Impact from Climate-related Events

Total Negative Impact from Climate-related Transition Activities

Total Positive Impact from Climate-related Transition Activities and Climate-Related Opportunities

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Financial impacts relating to severe weather events and other natural conditions could include changes to revenues or costs from disruptions to business operations or supply chains; impairment charges and changes to the carrying amount of assets due to assets being exposed to severe weather and other natural conditions; or changes to loss contingencies or reserves, or to total expected insured losses, due to severe weather events, flooding, or wildfire patterns.

Financial impacts related to transition activities could include changes to revenue or cost due to new emissions pricing or regulations resulting in the loss of a sales contract; changes to operating, investing, or financing cash flows from changes in upstream costs, such as transportation of raw materials; changes to the carrying amount of assets due to a reduction of an asset’s useful life or a change in an asset’s salvage value by being exposed to transition activities; and changes to interest expense driven by financing instruments, such as climate-linked bonds issued where the interest rate increases if certain climate-related targets are not met.

Such disclosures would not be required for a particular line item if the aggregated impact of the severe weather events and other natural conditions, transition activities, and identified climate-related risks is less than 1% of the total line item for the relevant fiscal year. In determining whether this threshold is met, companies would need to aggregate the absolute value of the positive and negative impacts on a line-by-line basis. The SEC provided the following example:

For purposes of determining whether such impacts would trigger the disclosure threshold requirements, the company would perform the following analysis:

F/S Balance (From Consolidated Financial Statements)

Because the absolute value of the aggregate impacts of the climate-related events and transition activities exceeded 1% of the cost of revenue, the company would be required to include disclosure for such line item. 

Companies would need to separately disclose the aggregate amounts of both expenditures expensed and capitalized costs incurred toward (i) positive and negative impacts associated with the climate-related events (i.e., severe weather events and other natural conditions and identified physical risks) and (ii) transition activities (specifically, to reduce GHG emissions or otherwise mitigate exposure to transition risks, including identified transition risks).

The SEC provided the following table as an example for potential disclosure and noted that additional disclosure could include the specific climate-related events and transition activities that were aggregated for purposes of determining the impacts on the capitalized or expensed expenditure amounts and, if applicable, policy decisions made in determining the amount of climate-related events or transition activities categorized as expenditure capitalized versus expenditure expensed or whether impacts from pursuing any climate-related opportunities are included in the analysis, as well as the composition of the total expenditure expensed and total expenditure capitalized used to calculate whether the disclosure threshold was met and, if applicable, a discussion of the estimation methodology used to disaggregate the amount of impact between the climate-related events, transition activities, and other factors, including if an event or an activity impacted both capitalized and expensed cost:

Expenditure Incurred for Climate-related Events

Expenditure Incurred for Climate-related Transition Activities

The expenditure metrics would be subject to the same disclosure threshold as the financial impact metrics; in determining whether the threshold is met, companies may separately determine the amount of expenditure expensed and the amount of expenditure capitalized, but would be required to aggregate expenditure related to climate-related events and transition activities within each such category.

The SEC provided the following example: assume a company capitalized $200,000 of expenditure incurred related to Event D; capitalized another $100,000 of expenditure incurred related to Activity E; and expensed $25,000 of expenditure incurred related to Event F (which is an identified transition risk). The company would determine whether the disclosure requirements were triggered based on the proposed thresholds, as shown below:

Captitalized (total expenditure incurred during the year that was capitalized)

Expense (total expenditure incurred during the year that year was expensed)

Current Fiscal Year Balances (From Consolidated Financial Statements)

Because the amount of capitalized costs exceeded 1%, the company would be required to disclose such category of expenditure. No disclosure would be required for the expenditure incurred that was expensed (related to Event F above) because it was below the 1% threshold.

A company would also be required to include a description of how (if at all) the financial estimates and assumptions used to prepare its financial statements were impacted by exposure to risks and uncertainties associated with, or known impacts from, severe weather events and other natural conditions, transition activities, or identified climate-related risks, or a potential transition to a lower carbon economy or any climate-related targets disclosed by the company.

Publicly Disclosed Targets and Goals&nbsp; &nbsp;

A company that has publicly disclosed any climate-related targets or goals would be required to provide certain information regarding such targets or goals, including, among other things, (i) how and when it intends to meet its targets or goals, and the scope of activities and emissions included; (ii) any interim targets or goals; (iii) the defined baseline time period and baseline emissions against which progress will be tracked; and (iv) data demonstrating whether the company is making progress toward achieving the target or goal, and how such progress has been achieved, which disclosures would need to be updated annually.

In addition, to the extent a company has used carbon offsets or RECs as part of its plan to achieve its climate-related target or goals, it would need to discuss certain related information, including the amount of carbon reduction represented by such offsets or amount of generated renewable energy represented by such RECs and the source and cost of such offsets or RECs.

The proposed rules would also permit disclosure of actual or potential impacts of any “climate-related opportunities<ins cite="mailto:Smith,%20Sylvia" datetime="2022-03-22T11:15">,</ins>” or the actual or potential positive impacts of climate-related conditions and events on a company’s consolidated financial statements, business operations, or value chains, as a whole, subject to certain requirements. Such opportunities could include cost savings associated with the increased use of renewable energy, increased resource efficiency, the development of new products, services, and methods, access to new markets caused by the transition to a lower carbon economy, and increased resilience along a company’s supply or distribution network related to potential climate-related regulatory or market constraints. Companies could disclose information about such opportunities when disclosing their climate-related risk governance, strategy, and management.

The climate change-related disclosures would be disclosed under Part II, Item 6. Climate-Related Disclosure of Form 10-K (replacing the current “Reserved” heading). Companies may incorporate the disclosure by reference from another section within the Form 10-K, such as the risk factors or management’s discussion and analysis. Any material changes to such disclosures during the fiscal year would need to be disclosed in new Part II, Item 1B. Climate-Related Disclosure of Form 10-Q. Registration statements on Forms S-1, S-11 and S-4 would also be amended to require the climate-related disclosures, and Form S-3 would also be impacted.

The SEC has included phased-in compliance dates for the proposed rules, which would apply to all companies, with compliance based on filer status, and an additional phase-in period for Scope 3 emissions disclosure. The following table assumes that the proposed rules will be adopted with an effective date in December 2022 and that the filer has a December 31st fiscal year end:

Disclosure Compliance Date of All Proposed Disclosures Including GHG Emissions Metrics; Scope 1, Scope 2, and Associated Intensity Metric, but Excluding Scope 3

Disclosure Compliance Date of GHG Metrics; Scope 3 and associated intensity metric

Financial Statement Metrics Audit Compliance Date

Companies with a different fiscal year-end date that results in their fiscal year 2023 commencing before the effective date of the rules would not be required to comply with the proposed rules until the following fiscal year. (For example, a large&nbsp;accelerated filer with a March 31 fiscal year-end would not be required to comply with the proposed climate disclosure rules until its Form 10-K for fiscal year 2024, filed in June 2024.)

The third-party attestation report would be subject to the following phase-in periods:

SEC Releases Long-Awaited Proposed Climate Disclosure Rules

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