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.