In the first post in this series, we overviewed the three main areas addressed in the SEC’s Proposed Rule for climate-related disclosures:

• Governance, strategy, risk and related disclosures outside the financial statements
• Greenhouse gas emission disclosures and attestation requirements
• Financial statement disclosures

As you may have heard and can read about in this Press Release, the comment period for this proposal ended June 17, 2022.

Subsequent posts in this series have addressed proposed disclosures for:

• Governance
• Risks, strategy, business model and outlook
• Risk management processes
• Targets, goals and interactive data
• Scopes 1 and 2 greenhouse gas disclosures
• Scope 3 greenhouse gas disclosures

This post explores the proposed disclosures surrounding greenhouse gas emission intensity and measurement methodology.  As a reminder, these disclosures would be required for all companies in their annual reports on Forms 10-K and 20-F, with updates on Forms 10-Q and 6-K.  Smaller reporting companies would not be subject to the Scope 3 disclosure requirements.  The disclosures about greenhouse gas emissions fall into the following categories:

• Greenhouse gas intensity disclosures
• Methodology
• Liability for scope 3 emissions disclosures

A Starting Note

Much of approach in the proposed rule is based on the Greenhouse Gas Protocol (GHG Protocol).  The GHG Protocol is designed to provide “comprehensive global standardized frameworks to measure and manage greenhouse gas (GHG) emissions from private and public sector operations, value chains and mitigation actions.”  You can learn about the protocol and get information about available tools to build a reliable GHG inventory at the GHG Protocol website.

Greenhouse Gas Intensity Disclosures

Companies would be required to disclose a “GHG Intensity” measure such as metric tons of CO2e per unit of revenue and metric tons of CO2e per unit of production.  This information would be disclosed for Scopes 1 and 2 emissions, and if Scope 3 emissions are disclosed, separately for Scope 3 emissions.

The measures would be disclosed for each fiscal year included in the consolidated financial statements. Disclosure would also include the basis for the production metric used.

If a company does not have revenue or a unit of production measure, it must develop an alternative measure and explain why it is presenting that measure.  Companies may present additional measures, so long as they explain why a measure provides useful information to investors.

Methodology

Companies must disclose the:

• Methodology for estimating emissions;
• Significant inputs; and
• Significant assumptions.

The description of the registrant’s methodology would include information about:

• Organizational boundaries;
• Operational boundaries;
• Calculation approach;
• Calculation tools;
• The determination direct emissions – (Scope 1); and
• The determination of indirect emissions – (Scope 2).

A significant amount of detail would be required in these disclosures about how companies determine boundaries and about consistency in measuring all scopes of emissions.

Companies would be permitted to use reasonable estimates and would disclose reasons for using such estimates and any underlying assumptions.

Companies would be allowed to use estimated data for the fourth quarter of a fiscal year if actual information is not available.  In this case prompt disclosure of the difference between actual and estimated amounts would be required.

Companies could use a range for estimated Scope 3 disclosures.  The reason for disclosing a range and any related assumptions would be disclosed.

Additional disclosures would include, to the extent material:

• Use of third-party data and including the source and process to obtain such data;
• Any changes in methodology;
• Any gaps in data; and
• Any overlaps in the categories for Scope 3 emissions.

Liability for Scope 3 Emissions Disclosures

The proposed rule includes a type of “safe-harbor” for disclosures of scope three emissions.  It states that for “any statement regarding Scope 3 emissions that is disclosed pursuant to §§ 229.1500 through 229.1506 and made in a document filed with the Commission”, such statement

“…is deemed not to be a fraudulent statement (as defined in paragraph (f)(3) of this section), unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.”

Summary

The complexity and related costs, along with the measurement challenges in estimating GHG emissions are likely to be the subject of comments in the SEC’s rulemaking process.  Our next post will explore the proposed S-K Item 1505 about attestation requirements for greenhouse gas emission disclosures.

As always, your thoughts and comments are welcome!

For reference, here is proposed S-K Item 1504:

 

(Item 1504) GHG emissions metrics.

(a) General. Disclose a registrant’s GHG emissions, as defined in § 229.1500(h), for its most recently completed fiscal year, and for the historical fiscal years included in its consolidated financial statements in the filing, to the extent such historical GHG emissions data is reasonably available.

(1) For each required disclosure of a registrant’s Scopes 1, 2, and 3 emissions, disclose the emissions both disaggregated by each constituent greenhouse gas, as specified in § 229.1500(g), and in the aggregate, expressed in terms of CO2e.

(2) When disclosing a registrant’s Scopes 1, 2, and 3 emissions, exclude the impact of any purchased or generated offsets.

(b) Scopes 1 and 2 emissions.

(1) Disclose the registrant’s total Scope 1 emissions and total Scope 2 emissions separately after calculating them from all sources that are included in the registrant’s organizational and operational boundaries.

(2) When calculating emissions pursuant to paragraph (b)(1) of this section, a registrant may exclude emissions from investments that are not consolidated, are not proportionately consolidated, or that do not qualify for the equity method of accounting in the registrant’s consolidated financial statements.

(c) Scope 3 emissions.

(1) Disclose the registrant’s total Scope 3 emissions if material. A registrant must also disclose its Scope 3 emissions if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions. Disclosure of a registrant’s Scope 3 emissions must be separate from disclosure of its Scopes 1 and 2 emissions. If required to disclose Scope 3 emissions, identify the categories of upstream or downstream activities that have been included in the calculation of the Scope 3 emissions. If any category of Scope 3 emissions is significant to the registrant, identify all such categories and provide Scope 3 emissions data separately for them, together with the registrant’s total Scope 3 emissions.

(2) If required to disclose Scope 3 emissions, describe the data sources used to calculate the registrant’s Scope 3 emissions, including the use of any of the following:

(i) Emissions reported by parties in the registrant’s value chain, and whether such reports were verified by the registrant or a third party, or unverified;

(ii) Data concerning specific activities, as reported by parties in the registrant’s value chain; and

(iii) Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a registrant’s value chain, including industry averages of emissions, activities, or economic data.

(3) A smaller reporting company, as defined by §§ 229.10(f)(1), 230.405, and 240.12b-2 of this chapter, is exempt from, and need not comply with, the disclosure requirements of this paragraph (c).

(d) GHG intensity.

(1) Using the sum of Scope 1 and 2 emissions, disclose GHG intensity in terms of metric tons of CO2e per unit of total revenue (using the registrant’s reporting currency) and per unit of production relevant to the registrant’s industry for each fiscal year included in the consolidated financial statements. Disclose the basis for the unit of production used.

(2) If Scope 3 emissions are otherwise disclosed, separately disclose GHG intensity using Scope 3 emissions only.

(3) If a registrant has no revenue or unit of production for a fiscal year, it must disclose another financial measure of GHG intensity or another measure of GHG intensity per unit of economic output, as applicable, with an explanation of why the particular measure was used.

(4) A registrant may also disclose other measures of GHG intensity, in addition to metric tons of CO2e per unit of total revenue (using the registrant’s reporting currency) and per unit of production, if it includes an explanation of why a particular measure was used and why the registrant believes such measure provides useful information to investors.

(e) Methodology and related instructions.

(1) A registrant must describe the methodology, significant inputs, and significant assumptions used to calculate its GHG emissions. The description of the registrant’s methodology must include the registrant’s organizational boundaries, operational boundaries (including any approach to categorization of emissions and emissions sources), calculation approach (including any emission factors used and the source of the emission factors), and any calculation tools used to calculate the GHG emissions. A registrant’s description of its approach to categorization of emissions and emissions sources should explain how it determined the emissions to include as direct emissions, for the purpose of calculating its Scope 1 emissions, and indirect emissions, for the purpose of calculating its Scope 2 emissions.

(2) The organizational boundary and any determination of whether a registrant owns or controls a particular source for GHG emissions must be consistent with the scope of entities, operations, assets, and other holdings within its business organization as those included in, and based upon the same set of accounting principles applicable to, the registrant’s consolidated financial statements.

(3) A registrant must use the same organizational boundaries when calculating its Scope 1 emissions and Scope 2 emissions. If required to disclose Scope 3 emissions, a registrant must also apply the same organizational boundaries used when determining its Scopes 1 and 2 emissions as an initial step in identifying the sources of indirect emissions from activities in its value chain over which it lacks ownership and control and which must be included in the calculation of its Scope 3 emissions. Once a registrant has determined its organizational and operational boundaries, a registrant must be consistent in its use of those boundaries when calculating its GHG emissions.

(4) A registrant may use reasonable estimates when disclosing its GHG emissions as long as it also describes the assumptions underlying, and its reasons for using, the estimates.

(i) When disclosing its GHG emissions for its most recently completed fiscal year, if actual reported data is not reasonably available, a registrant may use a reasonable estimate of its GHG emissions for its fourth fiscal quarter, together with actual, determined GHG emissions data for the first three fiscal quarters, as long as the registrant promptly discloses in a subsequent filing any material difference between the estimate used and the actual, determined GHG emissions data for the fourth fiscal quarter.

(ii) In addition to the use of reasonable estimates, a registrant may present its estimated Scope 3 emissions in terms of a range as long as it discloses its reasons for using the range and the underlying assumptions.

(5) A registrant must disclose, to the extent material and as applicable, any use of third-party data when calculating its GHG emissions, regardless of the particular scope of emissions. When disclosing the use of third-party data, it must identify the source of such data and the process the registrant undertook to obtain and assess such data.

(6) A registrant must disclose any material change to the methodology or assumptions underlying its GHG emissions disclosure from the previous fiscal year.

(7) A registrant must disclose, to the extent material and as applicable, any gaps in the data required to calculate its GHG emissions. A registrant’s GHG emissions disclosure should provide investors with a reasonably complete understanding of the registrant’s GHG emissions in each scope of emissions. If a registrant discloses any data gaps encountered when calculating its GHG emissions, it must also discuss whether it used proxy data or another method to address such gaps, and how its accounting for any data gaps has affected the accuracy or completeness of its GHG emissions disclosure.

(8) When determining whether its Scope 3 emissions are material, and when disclosing those emissions, in addition to emissions from activities in its value chain, a registrant must include GHG emissions from outsourced activities that it previously conducted as part of its own operations, as reflected in the financial statements for the periods covered in the filing.

(9) If required to disclose Scope 3 emissions, when calculating those emissions, if there was any significant overlap in the categories of activities producing the Scope 3 emissions, a registrant must describe the overlap, how it accounted for the overlap, and the effect on its disclosed total Scope 3 emissions.

(f) Liability for Scope 3 emissions disclosures.

(1) A statement within the coverage of paragraph (f)(2) of this section that is made by or on behalf of a registrant is deemed not to be a fraudulent statement (as defined in paragraph (f)(3) of this section), unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.

(2) This paragraph (f) applies to any statement regarding Scope 3 emissions that is disclosed pursuant to §§ 229.1500 through 229.1506 and made in a document filed with the Commission.

(3) For the purpose of this paragraph (f), the term fraudulent statement shall mean a statement that is an untrue statement of material fact, a statement false or misleading with respect to any material fact, an omission to state a material fact necessary to make a statement not misleading, or that constitutes the employment of a manipulative, deceptive, or fraudulent device, contrivance, scheme, transaction, act, practice, course of business, or an artifice to defraud as those terms are used in the Securities Act of 1933 or the Securities Exchange Act of 1934 or the rules or regulations promulgated thereunder.

In the first post in this series, we overviewed the three main areas addressed in the SEC’s Proposed Rule for climate-related disclosures:

• Governance, strategy, risk and related disclosures outside the financial statements
• Greenhouse gas emission disclosures and attestation requirements
• Financial statement disclosures

As you may have heard and can read about in this Press Release, the comment period for this proposal ended June 17, 2022.

Subsequent posts in this series have addressed proposed disclosures for:

• Governance
• Risks, strategy, business model and outlook
• Risk management processes
• Targets, goals and interactive data
• Scopes 1 and 2 greenhouse gas disclosures

This post explores proposed disclosures for Scope 3 greenhouse gas emissions.  The next post will focus on greenhouse gas intensity and methodology disclosures.  As a reminder, these disclosures would be required for all companies in their annual reports on Forms 10-K and 20-F, with updates on Forms 10-Q and 6-K.  Smaller reporting companies would not be subject to the Scope 3 disclosure requirements.

A Starting Note

Much of approach in the proposed rule is based on the Greenhouse Gas Protocol (GHG Protocol).  The GHG Protocol is designed to provide “comprehensive global standardized frameworks to measure and manage greenhouse gas (GHG) emissions from private and public sector operations, value chains and mitigation actions.”  You can learn about the protocol and get information about available tools to build a reliable GHG inventory at the GHG Protocol website.

General Disclosure Requirements

As a reminder from our last post, the overall disclosure requirement specifies what must be disclosed and for which periods.   The proposed rule would require that companies disclose their GHG emissions, as defined in proposed S-K Item 1500(h).

Proposed S-K Item 1500(h) provides this definition of GHG emissions:

GHG emissions means direct and indirect emissions of greenhouse gases expressed in metric tons of carbon dioxide equivalent (CO2e), of which: (1) Direct emissions are GHG emissions from sources that are owned or controlled by a registrant. (2) Indirect emissions are GHG emissions that result from the activities of the registrant, but occur at sources not owned or controlled by the registrant.

Direct and indirect GHG emissions would be disclosed using the definitions of Scopes 1, 2, and 3 emissions which are included in S-K 1500 and are based on the definitions in the GHG Protocol.  The disclosures would also be required to be disaggregated by type of greenhouse gas and in the aggregate in terms of CO2e.  (Our previous post discusses the requirement for Scopes 1 and 2 emissions.)

The various types of greenhouse gases are specified in proposed S-K Item 1500(g):

Greenhouse gases (“GHG”) means carbon dioxide (CO2), methane (“CH4”), nitrous oxide (“N2O”), nitrogen trifluoride (“NF3”), hydrofluorocarbons (“HFCs”), perfluorocarbons (“PFCs”), and sulfur hexafluoride (“SF6”)

In addition, disclosures of Scopes 1, 2, and 3 emissions would exclude the impact of any purchased or generated offsets. 

The periods specified in the proposed rule are the most recently completed fiscal year, and “to the extent such historical GHG emissions data is reasonably available,” for earlier years included in its consolidated financial statements.

 

Scope 3 Emissions 

The Proposed Rule would require companies to disclose total Scope 3 emissions if they are material or if the company has set “a GHG emissions reduction target or goal that includes its Scope 3 emissions.”  This amount would be disclosed separately from Scopes 1 and 2 emissions.

Disclosure would include categories of upstream or downstream activities.  Additionally, if any categories of Scope 3 emissions are significant, Scope 3 emissions data would be presented separately for such categories.

Proposed S-K Item 1500 includes this definition of Scope 3 emissions:

 Scope 3 emissions are 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.

(1) Upstream activities in which Scope 3 emissions might occur include:

(i) A registrant’s purchased goods and services;

(ii) A registrant’s capital goods;

(iii) A registrant’s fuel and energy related activities not included in Scope 1 or Scope 2 emissions;

(iv) Transportation and distribution of purchased goods, raw materials, and other inputs;

(v) Waste generated in a registrant’s operations;

(vi) Business travel by a registrant’s employees;

(vii) Employee commuting by a registrant’s employees; and

(viii) A registrant’s leased assets related principally to purchased or acquired goods or services.

(2) Downstream activities in which Scope 3 emissions might occur include:

(i) Transportation and distribution of a registrant’s sold products, goods or other outputs;

(ii) Processing by a third party of a registrant’s sold products;

(iii) Use by a third party of a registrant’s sold products;

(iv) End-of-life treatment by a third party of a registrant’s sold products;

(v) A registrant’s leased assets related principally to the sale or disposition of goods or services;

(vi) A registrant’s franchises; and

(vii) Investments by a registrant.

Disclosure would also include the data sources used to calculate the registrant’s Scope 3 emissions, including the use of any of the following:

Emissions reported by entities in the company’s “value chain” and whether such information is verified or unverified;

Information about specific activities reported by entities in the company’s value chain; and

Information “derived from economic studies, published databases, government statistics, industry associations, or other third-party sources.”

Smaller reporting companies would not be required to disclose Scope 3 emissions.

Summary

The complexity and related costs of identifying and estimating Scope 3 emissions have been the subject of comments in the SEC’s rulemaking process.  Our next post will explore the proposed intensity and methodology disclosures for greenhouse gas emission.

As always, your thoughts and comments are welcome!

_________________________________________________________________________

For reference, here is proposed S-K Item 1504:

(Item 1504) GHG emissions metrics.

(a) General. Disclose a registrant’s GHG emissions, as defined in § 229.1500(h), for its most recently completed fiscal year, and for the historical fiscal years included in its consolidated financial statements in the filing, to the extent such historical GHG emissions data is reasonably available.

(1) For each required disclosure of a registrant’s Scopes 1, 2, and 3 emissions, disclose the emissions both disaggregated by each constituent greenhouse gas, as specified in § 229.1500(g), and in the aggregate, expressed in terms of CO2e.

(2) When disclosing a registrant’s Scopes 1, 2, and 3 emissions, exclude the impact of any purchased or generated offsets.

(b) Scopes 1 and 2 emissions.

(1) Disclose the registrant’s total Scope 1 emissions and total Scope 2 emissions separately after calculating them from all sources that are included in the registrant’s organizational and operational boundaries.

(2) When calculating emissions pursuant to paragraph (b)(1) of this section, a registrant may exclude emissions from investments that are not consolidated, are not proportionately consolidated, or that do not qualify for the equity method of accounting in the registrant’s consolidated financial statements.

(c) Scope 3 emissions.

(1) Disclose the registrant’s total Scope 3 emissions if material. A registrant must also disclose its Scope 3 emissions if it has set a GHG emissions reduction target or goal that includes its Scope 3 emissions. Disclosure of a registrant’s Scope 3 emissions must be separate from disclosure of its Scopes 1 and 2 emissions. If required to disclose Scope 3 emissions, identify the categories of upstream or downstream activities that have been included in the calculation of the Scope 3 emissions. If any category of Scope 3 emissions is significant to the registrant, identify all such categories and provide Scope 3 emissions data separately for them, together with the registrant’s total Scope 3 emissions.

(2) If required to disclose Scope 3 emissions, describe the data sources used to calculate the registrant’s Scope 3 emissions, including the use of any of the following:

(i) Emissions reported by parties in the registrant’s value chain, and whether such reports were verified by the registrant or a third party, or unverified;

(ii) Data concerning specific activities, as reported by parties in the registrant’s value chain; and

(iii) Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a registrant’s value chain, including industry averages of emissions, activities, or economic data.

(3) A smaller reporting company, as defined by §§ 229.10(f)(1), 230.405, and 240.12b-2 of this chapter, is exempt from, and need not comply with, the disclosure requirements of this paragraph (c).

(d) GHG intensity.

(1) Using the sum of Scope 1 and 2 emissions, disclose GHG intensity in terms of metric tons of CO2e per unit of total revenue (using the registrant’s reporting currency) and per unit of production relevant to the registrant’s industry for each fiscal year included in the consolidated financial statements. Disclose the basis for the unit of production used.

(2) If Scope 3 emissions are otherwise disclosed, separately disclose GHG intensity using Scope 3 emissions only.

(3) If a registrant has no revenue or unit of production for a fiscal year, it must disclose another financial measure of GHG intensity or another measure of GHG intensity per unit of economic output, as applicable, with an explanation of why the particular measure was used.

(4) A registrant may also disclose other measures of GHG intensity, in addition to metric tons of CO2e per unit of total revenue (using the registrant’s reporting currency) and per unit of production, if it includes an explanation of why a particular measure was used and why the registrant believes such measure provides useful information to investors.

(e) Methodology and related instructions.

(1) A registrant must describe the methodology, significant inputs, and significant assumptions used to calculate its GHG emissions. The description of the registrant’s methodology must include the registrant’s organizational boundaries, operational boundaries (including any approach to categorization of emissions and emissions sources), calculation approach (including any emission factors used and the source of the emission factors), and any calculation tools used to calculate the GHG emissions. A registrant’s description of its approach to categorization of emissions and emissions sources should explain how it determined the emissions to include as direct emissions, for the purpose of calculating its Scope 1 emissions, and indirect emissions, for the purpose of calculating its Scope 2 emissions.

(2) The organizational boundary and any determination of whether a registrant owns or controls a particular source for GHG emissions must be consistent with the scope of entities, operations, assets, and other holdings within its business organization as those included in, and based upon the same set of accounting principles applicable to, the registrant’s consolidated financial statements.

(3) A registrant must use the same organizational boundaries when calculating its Scope 1 emissions and Scope 2 emissions. If required to disclose Scope 3 emissions, a registrant must also apply the same organizational boundaries used when determining its Scopes 1 and 2 emissions as an initial step in identifying the sources of indirect emissions from activities in its value chain over which it lacks ownership and control and which must be included in the calculation of its Scope 3 emissions. Once a registrant has determined its organizational and operational boundaries, a registrant must be consistent in its use of those boundaries when calculating its GHG emissions.

(4) A registrant may use reasonable estimates when disclosing its GHG emissions as long as it also describes the assumptions underlying, and its reasons for using, the estimates.

(i) When disclosing its GHG emissions for its most recently completed fiscal year, if actual reported data is not reasonably available, a registrant may use a reasonable estimate of its GHG emissions for its fourth fiscal quarter, together with actual, determined GHG emissions data for the first three fiscal quarters, as long as the registrant promptly discloses in a subsequent filing any material difference between the estimate used and the actual, determined GHG emissions data for the fourth fiscal quarter.

(ii) In addition to the use of reasonable estimates, a registrant may present its estimated Scope 3 emissions in terms of a range as long as it discloses its reasons for using the range and the underlying assumptions.

(5) A registrant must disclose, to the extent material and as applicable, any use of third-party data when calculating its GHG emissions, regardless of the particular scope of emissions. When disclosing the use of third-party data, it must identify the source of such data and the process the registrant undertook to obtain and assess such data.

(6) A registrant must disclose any material change to the methodology or assumptions underlying its GHG emissions disclosure from the previous fiscal year.

(7) A registrant must disclose, to the extent material and as applicable, any gaps in the data required to calculate its GHG emissions. A registrant’s GHG emissions disclosure should provide investors with a reasonably complete understanding of the registrant’s GHG emissions in each scope of emissions. If a registrant discloses any data gaps encountered when calculating its GHG emissions, it must also discuss whether it used proxy data or another method to address such gaps, and how its accounting for any data gaps has affected the accuracy or completeness of its GHG emissions disclosure.

(8) When determining whether its Scope 3 emissions are material, and when disclosing those emissions, in addition to emissions from activities in its value chain, a registrant must include GHG emissions from outsourced activities that it previously conducted as part of its own operations, as reflected in the financial statements for the periods covered in the filing.

(9) If required to disclose Scope 3 emissions, when calculating those emissions, if there was any significant overlap in the categories of activities producing the Scope 3 emissions, a registrant must describe the overlap, how it accounted for the overlap, and the effect on its disclosed total Scope 3 emissions.

(f) Liability for Scope 3 emissions disclosures.

(1) A statement within the coverage of paragraph (f)(2) of this section that is made by or on behalf of a registrant is deemed not to be a fraudulent statement (as defined in paragraph (f)(3) of this section), unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.

(2) This paragraph (f) applies to any statement regarding Scope 3 emissions that is disclosed pursuant to §§ 229.1500 through 229.1506 and made in a document filed with the Commission.

(3) For the purpose of this paragraph (f), the term fraudulent statement shall mean a statement that is an untrue statement of material fact, a statement false or misleading with respect to any material fact, an omission to state a material fact necessary to make a statement not misleading, or that constitutes the employment of a manipulative, deceptive, or fraudulent device, contrivance, scheme, transaction, act, practice, course of business, or an artifice to defraud as those terms are used in the Securities Act of 1933 or the Securities Exchange Act of 1934 or the rules or regulations promulgated thereunder.

In the first post in this series, we overviewed the three main areas addressed in the SEC’s Proposed Rule for climate-related disclosures:

• Governance, strategy, risk and related disclosures outside the financial statements
• Greenhouse gas emission disclosures and attestation requirements
• Financial statement disclosures

As you may have heard and can read about in this Press Release, on May 9, 2022, the SEC extended the comment period for this proposal to June 17, 2022.

The second post in this series explored proposed governance disclosures.  This third post focuses on more disclosures outside the financial statements, proposed S-K Item 1502’s disclosures about risks, strategy, business model and outlook. This information would be required for all companies in their annual reports on Forms 10-K and 20-F, with updates on Forms 10-Q and 6-K. These disclosures fall into the following categories:

• Climate-related risks reasonably likely to have a material impact on the company;
• Actual and potential impacts of identified climate-related risks on strategy, business model, and outlook;
• How any actual and potential impacts of identified climate-related risks are considered as part of business strategy, financial planning, and capital allocation;
• Whether and how any climate-related risks disclosed have affected or are reasonably likely to affect the consolidated financial statements;
• Whether a company maintains an internal carbon price, and if so, how it uses such a price; and
• The resilience of the company’s business strategy to potential future changes in climate-related risks.

Description of Climate-Related Risks

This part of proposed S-K Item 1502 requires companies to describe any climate-related risks that are “reasonably likely” to have a material impact on a company, including a material impact on its consolidated financial statements.

As a reminder, here is the definition of “climate-related risk” in proposed S-K Item 1500:

Climate-related risks means the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole. Climate-related risks include the following:

(1) Physical risks include both acute risks and chronic risks to the registrant’s business operations or the operations of those with whom it does business.

(2) Acute risks are event-driven and may relate to shorter term extreme weather events, such as hurricanes, floods, and tornadoes, among other events.

(3) Chronic risks relate to longer term weather patterns and related effects, such as sustained higher temperatures, sea level rise, drought, and increased wildfires, as well as related effects such as decreased arability of farmland, decreased habitability of land, and decreased availability of fresh water.

(4) Transition risks are the actual or potential negative impacts on a registrant’s consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks, such as increased costs attributable to changes in law or policy, reduced market demand for carbon-intensive products leading to decreased 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 (including those stemming from a registrant’s customers or business counterparties) that might trigger changes to market behavior, consumer preferences or behavior, and registrant behavior.

The definition of “reasonably likely” would be essentially the same as the definition used in MD&A, as described in Financial Release 36 (Release 33-6835), which you can review here.  (Check out Section III.B.)  As a reminder, this can be a low level of probability, perhaps even less than 50%.

These risks should be described over the short-, medium-, and long-term.  The proposed rule does not define these terms but does require that a company disclose how it defines all three time horizons.  In addition, the proposed rule specifically requires disclosure about how a company “takes into account or reassesses the expected useful life of the registrant’s assets and the time horizons for the registrant’s climate-related planning processes and goals.”

The risks required to be disclosed may include physical risks and/or transition risks.  Disclosures about physical risks would include the nature of the risk and whether it is an “acute or chronic risk.”  Other details such as the location and nature of the properties, processes, or operations subject to the physical risk would be disclosed.  The proposed rule would require several very specific disclosures about flooding and water stress risks.

Description of transition risks would include the nature of the risk, including whether it relates to regulatory (including GHG emission regulations), technological, market, liability, reputational, or other factors, and how those factors impact the company.

Description of Actual and Potential Impacts of Climate-Related Risks on Strategy, Business Model, and Outlook

This part of the proposal would require disclosure about how the risks identified above impact on a company’s:

• Business operations, including the types and locations of its operations;
• Products or services;
• Suppliers and other parties in its value chain;
• Activities to mitigate or adapt to climate-related risks, including adoption of new technologies or processes;
• Expenditure for research and development; and
• Any other significant changes or impacts.

Each area would also be analyzed by short-, medium-, and long-term time horizons

Discussion of Impacts of Climate-Related Risks on Business Strategy, Financial Planning and Capital Allocation 

In this section of the proposed disclosure a company would discuss how the risks identified above affect its:

• Business strategy
• Financial planning
• Capital allocation

The discussion would include current and forward-looking disclosures to help a reader understand “whether the implications of the identified climate-related risks have been integrated into the registrant’s business model or strategy, including how any resources are being used to mitigate climate-related risks.”

This discussion would have to include any financial metrics that a company discloses pursuant to the proposed new rules in Regulation S-X (more details about these in later posts), as well the role of carbon offsets or renewable energy credits (RECs) in these areas.

Discussion of Impact of Climate-Related Risks on Consolidated Financial Statements

Disclosure here would include information about any climate-related risks described above that have or are “reasonably likely” to affect the company’s financial statements, including any of the climate related metrics disclosed pursuant to the proposed Regulation S-X rules.

Disclosures About Internal Carbon Prices

Companies that maintain an internal carbon price would be required to disclose how they use such a price along with other disclosures, including:

• The price in units of the registrant’s reporting currency per metric ton of CO2e;
• The total price, including how the total price is estimated to change over time, if applicable;
• The boundaries for measurement of overall CO2e on which the total price is based if different from the GHG emission organizational boundary required for the related Regulation S-X disclosures; and
• The rationale for selecting the internal carbon price.

If a company maintains more than one internal carbon price, these disclosures would be required for each price.

Resilience Disclosures

This section of the proposed rule would require companies to discuss the “resilience” of their business strategy “in light of potential future changes in climate-related risks.”  Discussion would include any analytical tools, such as scenario analysis, used by the company, including, if applicable, several details about how scenario analysis is used.

Summary

The comprehensive list of areas to be addressed and granular detail of specific disclosures within each area of proposed S-K Item 1502 present several disclosure challenges.  Many are likely to be the subject of comments in the SEC’s rulemaking process.  Our next post will explore the follow-on disclosures in proposed S-K Item 1503 about risk management processes.

As always, your thoughts and comments are welcome!

For reference, here is proposed S-K Item 1502:

Item 1502 – Strategy, business model, and outlook.

(a) Describe any climate-related risks reasonably likely to have a material impact on the registrant, including on its business or consolidated financial statements, which may manifest over the short, medium, and long term. If applicable, a registrant may also disclose the actual and potential impacts of any climate-related opportunities when responding to any of the provisions in this section.

 (1) Discuss such climate-related risks, specifying whether they are physical or transition risks and the nature of the risks presented.

(i) For physical risks, describe the nature of the risk, including if it may be categorized as an acute or chronic risk, and the location and nature of the properties, processes, or operations subject to the physical risk.

(A) If a risk concerns the flooding of buildings, plants, or properties located in flood hazard areas, disclose the percentage of those assets (square meters or acres) that are located in flood hazard areas in addition to their location.

(B) If a risk concerns the location of assets in regions of high or extremely high water stress, disclose the amount of assets (e.g., book value and as a percentage of total assets) located in those regions in addition to their location. Also disclose the percentage of the registrant’s total water usage from water withdrawn in those regions.

(ii) For transition risks, describe the nature of the risk, including whether it relates to regulatory, technological, market (including changing consumer, business counterparty, and investor preferences), liability, reputational, or other transition-related factors, and how those factors impact the registrant. A registrant that has significant operations in a jurisdiction that has made a GHG emissions reduction commitment may be exposed to transition risks related to the implementation of the commitment.

(2) Describe how the registrant defines short-, medium-, and long-term time horizons, including how it takes into account or reassesses the expected useful life of the registrant’s assets and the time horizons for the registrant’s climate-related planning processes and goals.

(b) Describe the actual and potential impacts of any climate-related risks identified in response to paragraph (a) of this section on the registrant’s strategy, business model, and outlook.

 (1) Include impacts on the registrant’s:

(i) Business operations, including the types and locations of its operations;

(ii) Products or services;

(iii) Suppliers and other parties in its value chain;

(iv) Activities to mitigate or adapt to climate-related risks, including adoption of new technologies or processes;

(v) Expenditure for research and development; and

(vi) Any other significant changes or impacts.

(2) Include the time horizon for each described impact (i.e., in the short, medium, or long term, as defined in response to paragraph (a) of this section).

(c) Discuss whether and how any impacts described in response to paragraph (b) of this section are considered as part of the registrant’s business strategy, financial planning, and capital allocation. Provide both current and forward-looking disclosures that facilitate an understanding of whether the implications of the identified climate-related risks have been integrated into the registrant’s business model or strategy, including how any resources are being used to mitigate climate-related risks. Include in this discussion how any of the metrics referenced in § 210.14- 02 of this chapter and § 229.1504 or any of the targets referenced in § 229.1506 relate to the registrant’s business model or business strategy. If applicable, include in this discussion the role that carbon offsets or RECs play in the registrant’s climate-related business strategy.

(d) Provide a narrative discussion of whether and how any climate-related risks described in response to paragraph (a) of this section have affected or are reasonably likely to affect the registrant’s consolidated financial statements. The discussion should include any of the climate related metrics referenced in § 210.14-02 of this chapter that demonstrate that the identified climate-related risks have had a material impact on reported financial condition or operations.

(e)(1) If a registrant maintains an internal carbon price, disclose:

(i) The price in units of the registrant’s reporting currency per metric ton of CO2e;

(ii) The total price, including how the total price is estimated to change over time, if applicable;

(iii) The boundaries for measurement of overall CO2e on which the total price is based if different from the GHG emission organizational boundary required pursuant to § 229.1504(e)(2); and

(iv) The rationale for selecting the internal carbon price applied.

(2) Describe how the registrant uses any internal carbon price described in response to paragraph (e)(1) of this section to evaluate and manage climate-related risks.

(3) If a registrant uses more than one internal carbon price, it must provide the disclosures required by this section for each internal carbon price and disclose its reasons for using different prices.

(f) Describe the resilience of the registrant’s business strategy in light of potential future changes in climate-related risks. Describe any analytical tools, such as scenario analysis, that the registrant uses to assess the impact of climate-related risks on its business and consolidated financial statements, and to support the resilience of its strategy and business model. If the registrant uses scenario analysis to assess the resilience of its business strategy to climate-related risks, disclose the scenarios considered (e.g., an increase of no greater than 3 ºC, 2 ºC, or 1.5 ºC above pre-industrial levels), including parameters, assumptions, and analytical choices, and the projected principal financial impacts on the registrant’s business strategy under each scenario. The disclosure should include both qualitative and quantitative information.