The SEC’s Proposed Climate-Related Disclosures: Post Ten – Financial Statement Disclosures

ESG, Reporting

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:

This post explores the proposed financial statement disclosures.  All companies would be required to make these disclosures.  In addition, they would be subject to the requirements of internal control over financial reporting.  The financial statement disclosure requirements fall into the following categories:

  • Climate-related disclosure instructions
  • Contextual information
  • Disclosure thresholds
  • Financial impacts of severe weather events and other natural conditions
  • Financial impacts related to transition activities
  • Expenditure to mitigate risks of severe weather events and other natural conditions
  • Expenditure related to transition activities
  • Financial estimates and assumptions impacted by severe weather events and other natural conditions
  • Financial estimates and assumptions impacted by transition activities
  • Impact of identified climate-related risks
  • Impact of identified climate-related opportunities

Climate-Related Disclosure Instructions

The general instructions for the proposed financial statement disclosures specify that they must be included in any filing that is required to include the disclosures proposed by Regulation S-K Subpart 1500 and also includes audited financial statements.  These would essentially be annual reports on Forms 10-K and 20-F and registration statements.  These disclosures would be included in a note to the financial statements and would be required for each period for which the company includes financial statements in its filing.

Contextual Information

 Disclosure would include:

  • How each metric was derived;
  • Descriptions of significant inputs and assumptions; and
  • Any related policy decisions.

Disclosure Thresholds

The proposed rule would require disclosure if the amounts described below are over 1% of the relevant financial statement line item or expenditure or capitalized cost category.   This test would be based on the sum of the absolute value of all related impacts.  This threshold would apply to all the following financial statement disclosures.

Financial Impacts of Severe Weather Events and Other Natural Conditions

Companies would be required to disclose the impact of severe “weather events and other natural conditions, such as flooding, drought, wildfires, extreme temperatures, and sea level rise.”  This disclosure would be for each affected line item in the financial statements.  In addition, separate disclosure would be required for negative and positive impacts.

The proposed rule provides these example disclosures:

“(1) Changes to revenues or costs from disruptions to business operations or supply chains;

(2) Impairment charges and changes to the carrying amount of assets (such as inventory, intangibles, and property, plant and equipment) due to the assets being exposed to severe weather, flooding, drought, wildfires, extreme temperatures, and sea level rise;

(3) Changes to loss contingencies or reserves (such as environmental reserves or loan loss allowances) due to impact from severe weather events; and

(4) Changes to total expected insured losses due to flooding or wildfire patterns.”

Financial Impacts Related to Transition Activities

Companies would disclose the impact of any efforts to reduce GHG emissions or otherwise mitigate exposure to transition risks.  Separate disclosure would be required for negative and positive impacts.

Expenditure to Mitigate Risks of Severe Weather Events and Other Natural Conditions and Expenditure Related to Transition Activities

Companies would separately disclose the aggregate amount of expenditure and the aggregate amount of capitalized costs incurred during the fiscal years presented to mitigate the risks from severe weather events and to reduce GHG emissions or otherwise mitigate exposure to transition risks.

Financial Estimates and Assumptions Impacted by Severe Weather Events and Other Natural Conditions and Financial Estimates and Assumptions Impacted by Transition Activities

Disclosure would be required concerning whether the estimates and assumptions used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with, or known impacts from, severe weather events and other natural conditions or by risks and uncertainties associated with, or known impacts from, a potential transition to a lower carbon economy or any climate-related targets disclosed by the company.

Impact of Identified Climate-Related Risks and Impact of Identified Climate-Related Opportunities

Companies would be required to disclose the impact of any climate-related risks, as defined in proposed regulation S-K Item 1502(a).  This information would be presented separately for physical risks and transition risks.  Companies could voluntarily disclose similar information for climate-related opportunities.

Summary

The complexity and related costs of measuring the amounts described above along with the challenges of the proposed measurement threshold have been the subject of comments in the SEC’s rulemaking process.

As always, your thoughts and comments are welcome!

For reference, here is proposed Regulation S-X Article 14:

Article 14 – Climate-related disclosure

  • 210.14-01 Climate-related disclosure instructions.

(a) General. A registrant must include disclosure pursuant to § 210.14-02 in any filing that is required to include disclosure pursuant to subpart 229.1500 of this chapter and that also requires the registrant to include its audited financial statements. The disclosure pursuant to § 210.14-02 must be included in a note to the financial statements included in such filing.

(b) Definitions. The definitions in § 229.1500 (Item 1500 of Regulation S-K) apply to this Article 14 of Regulation S-X.

(c) Basis of calculation. When calculating the metrics in this Article 14, except where otherwise indicated, a registrant must:

(1) Use financial information that is consistent with the scope of the rest of its consolidated financial statements included in the filing; and

(2) Whenever applicable, apply the same accounting principles that it is required to apply in preparation of the rest of its consolidated financial statements included in the filing.

(d) Historical periods. Disclosure must be provided for the registrant’s most recently completed fiscal year, and for the historical fiscal year(s) included in the consolidated financial statements in the filing (e.g., a registrant that is required to include balance sheets as of the end of its two most recent fiscal years and income statements and cash flow statements as of the end of its three most recent fiscal years would be required to disclose two years of the climate-related metrics that correspond to balance sheet line items and three years of the climate-related metrics that correspond to income statement or cash flow statement line items).

  • 210.14-02 Climate-related metrics.

(a) Contextual information. Provide contextual information, describing how each specified metric was derived, including a description of significant inputs and assumptions used, and, if applicable, policy decisions made by the registrant to calculate the specified metrics.

(b) Disclosure thresholds.

(1) Disclosure of the financial impact on a line item in the registrant’s consolidated financial statements pursuant to paragraphs (c) and (d) of this section (including any impacts included pursuant to paragraphs (i) and (j) of this section) is not required if the sum of the absolute values of all the impacts on the line item is less than one percent of the total line item for the relevant fiscal year.

(2) Disclosure of the aggregate amount of expenditure expensed or the aggregate amount of capitalized costs incurred pursuant to paragraphs (e) and (f) of this section (including any impacts included pursuant to paragraphs (i) and (j) of this section) is not required if such amount is less than one percent of the total expenditure expensed or total capitalized costs incurred, respectively, for the relevant fiscal year.

(c) Financial impacts of severe weather events and other natural conditions. Disclose the impact of severe weather events and other natural conditions, such as flooding, drought, wildfires, extreme temperatures, and sea level rise on any relevant line items in the registrant’s consolidated financial statements during the fiscal years presented. Disclosure must be presented, at a minimum, on an aggregated line-by-line basis for all negative impacts and, separately, at a minimum, on an aggregated line-by-line basis for all positive impacts. Impacts may include, for example:

(1) Changes to revenues or costs from disruptions to business operations or supply chains;

(2) Impairment charges and changes to the carrying amount of assets (such as inventory, intangibles, and property, plant and equipment) due to the assets being exposed to severe weather, flooding, drought, wildfires, extreme temperatures, and sea level rise;

(3) Changes to loss contingencies or reserves (such as environmental reserves or loan loss allowances) due to impact from severe weather events; and

(4) Changes to total expected insured losses due to flooding or wildfire patterns.

(d) Financial impacts related to transition activities. Disclose the impact of any efforts to reduce GHG emissions or otherwise mitigate exposure to transition risks on any relevant line items in the registrant’s consolidated financial statements during the fiscal years presented. Disclosure must be presented, at a minimum, on an aggregated line-by-line basis for all negative impacts and, separately, at a minimum, on an aggregated line-by-line basis for all positive impacts. Impacts may include, for example:

(1) Changes to revenue or cost due to new emissions pricing or regulations resulting in the loss of a sales contract;

(2) Changes to operating, investing, or financing cash flow from changes in upstream costs, such as transportation of raw materials;

(3) Changes to the carrying amount of assets (such as intangibles and property, plant, and equipment) due to, among other things, a reduction of the asset’s useful life or a change in the asset’s salvage value by being exposed to transition activities; and

(4) 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.

(e) Expenditure to mitigate risks of severe weather events and other natural conditions. Disclose separately the aggregate amount of expenditure expensed and the aggregate amount of capitalized costs incurred during the fiscal years presented to mitigate the risks from severe weather events and other natural conditions, such as flooding, drought, wildfires, extreme temperatures, and sea level rise. For example, a registrant may be required to disclose the amount of expense or capitalized costs, as applicable, to increase the resilience of assets or operations, retire or shorten the estimated useful lives of impacted assets, relocate assets or operations at risk, or otherwise reduce the future impact of severe weather events and other natural conditions on business operations.

(f) Expenditure related to transition activities. Disclose separately the aggregate amount of expenditure expensed and the aggregate amount of capitalized costs incurred during the fiscal years presented to reduce GHG emissions or otherwise mitigate exposure to transition risks. For example, a registrant may be required to disclose the amount of expense or capitalized costs, as applicable, related to research and development of new technologies, purchase of assets, infrastructure, or products that are intended to reduce GHG emissions, increase energy efficiency, offset emissions (purchase of energy credits), or improve other resource efficiency. A registrant that has disclosed GHG emissions reduction targets or other climate-related commitments must disclose the expenditures and costs related to meeting its targets, commitments, and goals, if any, in the fiscal years presented.

(g) Financial estimates and assumptions impacted by severe weather events and other natural conditions. Disclose whether the estimates and assumptions the registrant used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with, or known impacts from, severe weather events and other natural conditions, such as flooding, drought, wildfires, extreme temperatures, and sea level rise. If yes, provide a qualitative description of how the development of such estimates and assumptions were impacted by such events.

(h) Financial estimates and assumptions impacted by transition activities. Disclose whether the estimates and assumptions the registrant used to produce the consolidated financial statements were impacted by risks and uncertainties associated with, or known impacts from, a potential transition to a lower carbon economy or any climate-related targets disclosed by the registrant. If yes, provide a qualitative description of how the development of such estimates and assumptions were impacted by such a potential transition or the registrant’s disclosed climate- related targets.

(i) Impact of identified climate-related risks. A registrant must also include the impact of any climate-related risks (separately by physical risks and transition risks, as defined in
§ 229.1500(c) of this chapter), identified by the registrant pursuant to § 229.1502(a) of this chapter, on any of the financial statement metrics disclosed pursuant to paragraphs (c) through (h) of this section.

(j) Impact of climate-related opportunities. A registrant may also include the impact of any opportunities arising from severe weather events and other natural conditions, any impact of efforts to pursue climate-related opportunities associated with transition activities, and the impact of any other climate-related opportunities, including those identified by the registrant pursuant to § 229.1502(a) of this chapter, on any of the financial statement metrics disclosed pursuant to paragraphs (c) through (h) of this section. If a registrant makes a policy decision to disclose the impact of an opportunity, it must do so consistently for the fiscal years presented, including for each financial statement line item and all relevant opportunities identified by the registrant.

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