The SEC and ESG: The Journey to Prescriptive Disclosure Requirements

Over the last several years, stakeholder demand for environmental, social and governance (ESG) related disclosures from U.S. public companies has exploded. During that time, a multitude of ESG disclosure frameworks, ratings systems, proxy voting policies and investor engagement priorities have been established, each with their own objectives, scopes, definitions and standards.

This generally voluntary and sometimes confusing ESG disclosure universe has frustrated both public companies and their stakeholders. Stakeholders are seeking consistent, comparable and decision-useful data but, in the absence of a unified ESG taxonomy with prescribed disclosure requirements, U.S. public companies and their stakeholders continue to be frustrated.

Current SEC Requirements

The U.S. Securities and Exchange Commission (SEC), as recently as 2020, chose not to address the growing call for standardized and prescribed ESG disclosure requirements instead continuing to rely on its existing principles-based disclosure regime and 2010 climate change guidance.

2010 Climate Change Guidance

In February 2010, the SEC published an interpretive release to provide guidance to public companies about how to apply the SEC’s existing general disclosure requirements to climate change matters specifically. The 2010 guidance recommended that a public company consider disclosure related to the following matters, if material to the company based on its particular facts and circumstances:

• Impact of existing or pending climate change legislation and regulation;
• Indirect consequences of climate change business trends, including increasing demand for new products or services or decreased demand for existing products or services, such as those producing significant greenhouse gas (GHG) emissions; and
• Physical impacts of climate change.

Notably, the 2010 guidance did not establish any specific reporting requirements related to climate change.

2020 Human Capital Disclosure Rules

The 2010 climate change guidance was the SEC’s only official ESG related disclosure pronouncement for almost 10 years. In August 2020, the SEC amended its rules to require a public company to provide disclosure on the following topics, if material to an understanding of its business:

• a description of the company’s human capital resources, including the number of persons employed; 
• any human capital measures that the company uses in managing its business (such as measures that address the development, attraction and retention of personnel).

The 2020 human capital disclosure rules do provide some important topics of focus but are fairly thin and largely principles-based. As a result, in 2021, the breadth and depth of U.S. public company disclosure on human capital varied significantly across companies and industries.

2021: The SEC Jumps into the Fray

In 2021, under President Biden’s administration, the SEC’s approach to ESG and disclosure requirements changed dramatically.

On February 24, 2021, the then acting SEC chair issued a statement directing the SEC’s staff to enhance its focus on climate-related disclosures in public company filings, including reviewing the extent to which public companies were addressing the topics in the 2010 climate change guidance, and to begin working on updating that guidance.

On March 4, 2021, the SEC created the Climate and ESG Task Force in the SEC’s Division of Enforcement. The new task force was charged with reviewing climate risk disclosures, including any material gaps or misstatements under the SEC’s current guidance.

On March 15, 2021, the SEC requested public input from investors, companies and other market participants on climate change disclosure. The request acknowledged that investor demand for climate change disclosures has grown dramatically since the SEC’s 2010 climate change guidance and the need for the SEC’s reporting requirements to include material, decision-useful ESG information. The request for public comment included fifteen questions for consideration, including:

• where and how climate change disclosures should be made (i.e., sustainability reports vs. SEC filings);
• the types of climate risks that can actually be quantified and measured;
• the advantages and disadvantages of establishing different disclosure standard for different industries (e.g., oil and gas vs. financial);
• the advantages and disadvantages of drawing on existing frameworks such as the SASB and TCFD; and
• whether climate related disclosure requirements should be a part of a broader ESG disclosure framework.

It was now apparent that the SEC was moving towards drafting new ESG-related disclosure requirements, with climate-change disclosure as the initial focus. The majority of the public comments received strongly supported the creation of mandatory climate disclosure rules under a standardized disclosure framework.

As part of its effort to draft new climate change disclosure rules, the SEC started sending comment letters to public companies, including non-energy companies, about their current climate change disclosures. In September 2021, the SEC posted a sample comment letter so all companies could see the topics of interest to the SEC staff. The sample comment letter requested information on, among other things:

• why the company provided more expansive disclosure in its sustainability report as compared to its SEC filings;
• climate change “transition” risks (e.g., policy and regulatory changes, market trends, credit risks and technological changes), litigation risks and physical risks;
• the effect of material existing or pending climate change related legislation, regulations and treaties on the company’s business, financial condition and results of operations; and
• purchases and sales of carbon credits or offsets.

In addition to the foregoing, ESG disclosures and related rulemaking considerations were a consistent theme in speeches by the SEC chair and commissioners in 2021. And the SEC’s regulatory agenda announcements in June and December 2021 identified the SEC rulemaking efforts in climate risk, human capital management, board diversity and other related matters as top priorities. In 2021, the SEC completely changed its approach to ESG disclosures and aggressively sought input on how best to construct a new, prescriptive ESG disclosure regime for U.S. public companies.

2022: The SEC’s Year of Rulemaking

Climate Change

On March 21, 2022, the SEC published its long-awaited proposed rules to enhance and standardize climate-related disclosures in public company registration statements and periodic reports. The proposed disclosures are similar to those that many public companies already provide relying on broadly accepted disclosure frameworks, including TCFD and the Greenhouse Gas Protocol.

Required Disclosures

The proposed rules would require a public company to disclose information regarding:
Board and management oversight and governance of climate-related risks;

• The impact of climate-related risks on the company’s business and consolidated financial statements, over the short-, medium-, or long-term;
• The effect of climate-related risks on the company’s strategy, business model, and outlook;
• The company’s processes for identifying, assessing, and managing climate-related risks and the integration of such processes into the company overall risk management;
• A description of any transition plan that is part of the company’s climate-related risk management strategy, including the relevant metrics and targets used to identify and manage any physical and transition risks;
• A description of any scenario analysis used by the company to assess its resilience to climate-related risks, including any assumptions and projected principal financial impacts;
• Information about any internal carbon price the company uses and how it is set;
• The impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a company’s consolidated financial statements;
• The company’s direct GHG emissions (Scope 1) and indirect GHG emissions from purchased electricity and other forms of energy (Scope 2), separately disclosed, expressed both by disaggregated constituent greenhouse gases and in the aggregate, and in absolute terms, not including offsets, and in terms of intensity;
• The company’s indirect GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions, in absolute terms, not including offsets, and in terms of intensity; and
• If the company has publicly set climate-related targets or goals:

1. The scope of activities and emissions included in the target, the time horizon by
2. which the target is to be achieved, and any interim targets;
3. How the company intends to meet its targets or goals;
4. Relevant data that indicates whether the company is making progress and how such progress has been achieved, with yearly updates; and
5. If carbon offsets or credits have been used to achieve the targets or goals, information about the offsets or credits including the amount of carbon reduction they represent.

Presentation, Attestation, Accommodations and Phase-In Periods

The proposed rules would require a public company to provide the required disclosures in its registration statements and Form 10-K. The various disclosures would be made in a separate, appropriately captioned section of the registration statement or report, with the financial statement metric disclosures made in a note to the company’s consolidated financial statements.

If the public company is an accelerated or large accelerated filer, the company must obtain an attestation report from an independent auditor covering, at a minimum, the Scope 1 and Scope 2 GHG emissions disclosure.

The Scope 3 emissions disclosure is not required for smaller reporting companies. If disclosed, the Scope 3 emissions information is covered by a safe harbor from liability. All disclosures are also covered by the existing forward-looking statement safe harbor to the extent any disclosures including forward-looking statements.

The proposed rules include a phase-in period for all registrants depending on filer status, with an incremental phase-in period for Scope 3 emissions disclosure. The proposed rules also include an additional phase-in period for the assurance requirement for GHG emissions disclosure.

The Path and Timing to a Final Rule

The SEC is targeting adopting final rules by December 2022, such that the largest public companies would begin complying with the new rules in 2024 (for fiscal years ended 2023).

However, the SEC will have to digest an overwhelming number of comments to the proposed rules, both in support and opposition, before drafting its final version. And the proposed rules will certainly be subject to litigation challenges, much like the conflicts mineral rule several years ago. So, the December 2022 target date seems ambitious, but political and investor pressures may be sufficient to get some version of a final rule in place in that timeframe.

Human Capital Management and Board Diversity

The SEC is also planning to issue proposed rules on human capital management (likely mandating disclosures about workforce diversity, turnover, training and compensation) and corporate board diversity likely mandating enhanced disclosures about the diversity of current board members and board nominees.

About the authors:

Mike Blankenship is the managing partner with Winston & Strawn’s Houston office. He focuses his practice on corporate finance, M&A, private equity, special purpose acquisition company (SPAC) offerings and securities law. He regularly counsels public companies on strategic transactions, capital markets offerings, and general corporate and securities law matters. Blankenship represents both issuers and underwriters in U.S. and international capital markets transactions, including IPOs and SPAC IPOs, and he advises on corporate governance and securities market regulation. In addition, he has advised numerous clients on many ESG matters, including ESG due diligence and developing and implementing long-term ESG strategies.

Eric Johnson is a corporate partner with Winston & Strawn’s Houston office. For more than 20 years, he has focused his practice on energy industry M&A, capital markets transactions, including SPACs, and public company governance matters, including ESG and energy transition issues. He is co-chair of Winston’s worldwide ESG advisory team.