What are the key differences between the SEC’s proposal and the TCFD, and how can affected businesses prepare?
The U.S. Securities and Exchange Commission (the “SEC”) has recently published its climate disclosure proposal (the “SEC Proposal”), on which see our blog post here, our client briefing here and a recording of our webinar here.
The SEC Proposal is based in part on the recommendations (the “TCFD Recommendations”) of the Task Force on Climate-related Disclosures (the “TCFD”). The TCFD Recommendations have gained widespread acceptance as a global standard for climate-related disclosures and, as a result, a number of jurisdictions (including Canada, Hong Kong, Japan, New Zealand, Singapore and Switzerland) have either mandated TCFD-aligned reporting in domestic regulation, or are in the process of doing so.
The SEC Proposal covers the same four “pillars” of disclosure as the TCFD framework: governance; strategy; risk management; and metrics and targets. The requirements within each pillar in the SEC Proposal are also broadly aligned with the TCFD’s 11 recommended disclosures. However, as discussed below, in certain instances the SEC’s Proposal goes further and requires disclosures that are not required under the TCFD Recommendations. This is consistent with the approach being taken by the IFRS’s International Sustainability Standards Board (“ISSB”) and the disclosure standards being developed by the EU in conjunction with its proposed Corporate Sustainability Reporting Directive (the “CSRD”), which both use the TCFD Recommendations as the foundational basis of a more extensive and prescriptive disclosure regime.
In this note, we consider key differences between the SEC Proposal and the TCFD Recommendations, and how affected businesses can get ready for the proposed SEC rule change.
The changing landscape of climate-related disclosure
The SEC Proposal has come at a time of significant change in the landscape of climate-related disclosure regimes more broadly.
- The ISSB (which was established by the International Financial Reporting Standards Foundation Trustees in November 2021) intends to deliver a comprehensive global baseline of sustainability-related disclosure standards to provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities to help them make informed investment decisions. The ISSB’s aim is to develop comprehensive global disclosure standards, for both climate and other sustainability-related information. In March 2022 it published draft standards for climate-related disclosures which build upon the TCFD Recommendations as well as industry-based disclosure requirements from the Sustainability Accounting Standards Board. These are out for consultation until 29 July 2022.
- The EU is in the process of replacing its current non-financial reporting regime with the proposed CSRD which will require large businesses (including certain businesses from outside the EU) to include sustainability disclosures in their annual reports. The CSRD proposal itself is under intense negotiation. Draft disclosure standards published by the European Financial Reporting Advisory Group are open for consultation until 8 August 2022. Delegated Acts mandating use of the standards are proposed to be adopted by 30 April 2023 (previously 31 October 2022) and 31 January 2024 (instead of October 2023).
- The UK already mandates climate-related disclosures for certain businesses and increasing numbers of jurisdictions are doing the same. For example, the UK Listing Rules require certain listed companies to make climate-related financial disclosures consistent with the TCFD Recommendations. While compliance with these reporting obligations is on a “comply or explain” basis, the relevant rules clarify that the circumstances in which non-compliance can be explained are limited. Requirements to make climate disclosures are now being extended to other businesses in the UK. The reporting landscape continues to develop, with the UK government proposing to require reporting against the ISSB sustainability disclosure standards.
These disclosure frameworks have similarities, in particular in relation to climate reporting. However, different approaches are being taken in relation to scope (both the ISSB and the EU regime will cover sustainability more broadly, rather than focusing on climate) and materiality (the EU regime incorporates the concept of “double materiality”, i.e. considering both whether the impact on the business is material, and whether the business’s impact on the external environment is material, incorporating detailed due diligence requirements to support this).
The ISSB has formed a working group looking at enhancing compatibility between different sustainability disclosure initiatives. This includes representatives from the Chinese Ministry of Finance, the European Commission, the European Financial Reporting Advisory Group, the Japanese Financial Services Authority, the Sustainability Standards Board of Japan Preparation Committee, the UK Financial Conduct Authority and the U.S. SEC. The proposed CSRD contemplates recognition of equivalent regimes, but which regimes might qualify is likely to remain uncertain for some time.
It remains to be seen what final form the various proposals will take, and the extent to which they will ultimately be aligned, but what is clear is that sustainability and climate-related reporting is here to stay.
Who needs to consider the differences between the SEC Proposal and the TCFD Recommendations?
The SEC Proposal applies to both U.S. domestic and foreign private issuers who are SEC-reporting or are filing a registration statement with the SEC (though “smaller reporting companies” are exempt from certain of the requirements).
The interaction between the SEC Proposal and the TCFD Recommendations will be of most interest to:
- U.S. domestic and foreign private issuer registrants who currently issue TCFD-aligned reporting on a voluntary basis, who need to consider how their disclosure will need to change if the SEC Proposal is enacted; and
- registrants who are required to prepare TCFD-aligned reporting on a mandatory basis in another jurisdiction (for example, the UK), who need to consider whether they can and should report the same information globally, or if disclosures need to be tailored to the requirements of each specific regime.
What are the key differences between the SEC Proposal and the TCFD Recommendations?
The SEC Proposal requires organisations to disclose: (i) whether any member of the board has expertise in climate-related risks (to be described if so); and (ii) if members of management or board committees are responsible for assessing and managing climate-related risks, the climate-related expertise of the relevant individuals. Climate expertise is not defined, and many individuals will have concerns about holding themselves out as experts in such a highly technical area in which stakeholder expectations are shifting rapidly.
The TCFD Recommendations do not have an equivalent requirement. Although TCFD guidance suggests businesses should consider a discussion of whether climate-related responsibilities have been assigned to management-level positions or committees, this stops short of disclosure of relevant expertise.
That said, in practice, many large listed companies include a matrix of board-level expertise in their annual reports, and are already starting to indicate where board members have climate, ESG or sustainability-related knowledge. This is often supplemented with information on how the board accesses expert advisory support and engages with training on sustainability-related matters. This voluntary disclosure is an effort by companies to respond to stakeholder expectations that boards will actively engage with this area as a priority matter.
The SEC Proposal requires disclosure of transition plans if the entity has adopted one as part of its climate-related risk management strategy. The TCFD Recommendations do not expressly require transition plan disclosure, but the TCFD has subsequently published specific guidance clarifying that it believes the existing recommendations “implicitly cover the key aspects of transition plans”, and that entities which have made greenhouse gas (“GHG”) emissions reduction commitments, operate in jurisdictions that have done so, or have agreed to meet investor expectations regarding reductions, should disclose certain information relating to their transition plans.
Disclosure of transition plans will be inherently forward-looking, and therefore should be positioned and caveated appropriately.
Impact on financial statements
The SEC Proposal requires organisations to include disclosure of specific climate-related metrics (such as financial impacts of severe weather events which have occurred and the impact of efforts to reduce emissions or mitigate exposure to transition risks) in notes to their audited financial statements (subject to the one per cent. materiality threshold discussed below). By contrast, the TCFD is not prescriptive as to the format of disclosure of impact of climate-related issues on organisations’ financial performance and financial position and permits organisations to describe such impacts in qualitative, quantitative, or a combination of both qualitative and quantitative terms. Some businesses may find this level of specificity challenging, and those with a more mature approach to assessing climate-related risks may find that the disclosure requirements fall short of more advanced methodologies adopted in-house.
In general, in relation to the SEC Proposal, a matter is “material” if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote. However, the SEC Proposal does provide a specific threshold for certain items – a registrant is required to disclose financial impacts on a line item in its consolidated financial statements where the sum of the absolute values of all the impacts represents one per cent. or more of the total line item for the relevant financial year. This materiality threshold is significantly lower than registrants would typically use for other disclosures.
Under the TCFD Recommendations, materiality is to be determined in a manner consistent with the approach to materiality taken for other information included in annual financial filings. This means it is also a “single materiality” reporting framework (and not a “double materiality” one). In contrast to the SEC Proposal, however, no numerical materiality thresholds are specified.
Under both regimes, organisations will need to carry out an exercise of identifying material information for disclosure.
The TCFD Recommendations require an organisation’s resilience to be considered through climate-related scenario analysis.
The SEC Proposal does not require disclosure of scenario analysis unless it has been used. This means that registrants using scenario analysis because they are required to do so by the rules of another jurisdiction or for voluntary TCFD alignment would have to disclose in the U.S. the scenarios considered, including parameters, assumptions, and analytical choices, and the projected principal financial impacts (both in qualitative and quantitative terms) on the registrant’s business strategy under each scenario.
Scenario analysis requires forward-looking consideration. To the extent the outcomes of scenario analysis are disclosed, organisations will want to make clear the methodology used and areas of uncertainty or potential change and include appropriate caveats and disclaimers.
The SEC Proposal mandates disclosure of specific emissions-related items, which are not always required by the TCFD Recommendations.
- Scope 3 emissions: Disclosure is required under the SEC Proposal if the emissions are material, or if an issuer has set an emissions target which includes Scope 3. There is, however, a safe harbour provision which provides a defence to liability where Scope 3 emissions data is calculated in good faith. The TCFD Recommendations strongly encourage all organisations to consider disclosing Scope 3 emissions, though do not mandate it. In considering whether to disclose, organisations should “consider whether such emissions are a significant portion” of their total GHG emissions. The TCFD Recommendations make reference to the 40 per cent. threshold used by the Science Based Targets initiative. Many organisations already disclose their Scope 3 emissions in their existing TCFD-aligned reporting (and in the UK, the Streamlined Energy and Carbon Reporting regime does require some businesses to report a very limited portion of their Scope 3 emissions, such as emissions from business travel).
- GHG intensity: Disclosure is mandatory under the SEC Proposal, whereas under the TCFD Recommendations this is only the case for certain industries with high energy consumption.
- Protocol for reporting GHG emissions: The SEC Proposal does not require registrants to follow a specific external protocol for reporting GHG emissions, instead requiring a registrant to set the organisational boundaries for its GHG emissions disclosure using the same scope of entities, operations, assets, and other holdings as those included in its consolidated financial statements. By contrast, the TCFD recommends using the GHG Protocol, which requires an organisation to base its organisational boundaries on either an equity share approach or a control approach.
- Independent attestation: The SEC Proposal requires accelerated and large accelerated filers to obtain an attestation report carried out by an independent attestation service provider. This requirement is being phased in initially on the basis of “limited assurance” and ultimately on the basis of “reasonable assurance”. The attestation should cover the disclosure of Scope 1 and 2 emissions at a minimum. No such attestation is required under the TCFD Recommendations, though some organisations already voluntarily obtain third-party confirmation of their emissions figures under their current TCFD-aligned reporting.
- Offsets: When disclosing Scope 1, 2 and 3 emissions, the SEC Proposal requires the impact of any offsets to be excluded. The TCFD Recommendations do not contain an equivalent requirement.
Disclosure of climate-related opportunities
The TCFD Recommendations require organisations to consider and report on both climate-related risks and opportunities. Under the SEC Proposal, disclosure of climate-related opportunities is voluntary (and a registrant may describe them “if applicable”). Disclosure of opportunities needs to be carefully considered given the forward-looking nature of that information, and should be appropriately positioned and caveated.
The SEC Proposal applies equally to all registrants regardless of the sector in which they operate, and there are no sector-specific provisions in the SEC Proposal. By contrast, the TCFD has published supplemental recommendations and guidance for the financial sector (banks, insurance companies, asset owners and asset managers) and for four non-financial sectors (energy; transportation; materials and buildings; and agriculture, food and forest products).
It is difficult to predict what form the final SEC rules will take. Comments are due by 17 June 2022, and the SEC has already received numerous comment letters that they will need to take the time to review. Typically, there would be at least a few material changes between the proposed and final versions of SEC regulations, but we expect that many of the key parts of the SEC Proposal – for example, building off of the TCFD Recommendations, mandatory disclosures of Scope 1 and 2 emissions, and some form of an attestation requirement – will remain part of the final rule. However, it is likely that some elements of the final rules will be challenged in the U.S. courts.
However, companies who will need to comply with the rules when they do come into force, whether or not they already report in line with the TCFD Recommendations, can start taking positive actions:
- Ensure you have in place appropriate board-level structures to guide and oversee your climate strategy. This should include considering specific expertise of individual directors, whether you need assistance from external experts, and board-level training if required. Consider what management-level structures are needed to implement the strategy on a day-to-day basis.
- Check that you have functioning internal reporting lines and escalation routes. For these to work effectively, businesses also need to ensure that their climate strategy is integrated across the business and that people across the business are trained and understand the implications of the strategy for their area of the business.
- Put a team in place (if there is not one already) which will be responsible for gathering the required information and reporting (and systems to support them in collating such information). This team needs to have the competency, time and capacity to collate and confirm the information required.
- Ensure that you have the required systems in place to be able to collate the required information and put it in the format required for reporting.
- Be aware of timing; collating this information (especially for the first time) can be time consuming and needs to be completed in time for your reporting cycle. Remember that you will also need to request information from others and build this into your timelines.
- Recognise that your disclosures will develop over time. Businesses should be realistic about preparing their reports and be mindful of trying to achieve too much, too fast and overcommitting themselves, either through their general disclosures or specific metrics and targets, which should be realistic (albeit still ambitious).
- If the final SEC rules require independent attestation, start considering who will be able to offer this service, the information they will require to carry out the attestation, and how long this will take.
- Assess the robustness of the organisation’s transition planning, and whether it is ready for external disclosure, given potential liability considerations.
- Track the SEC developments so that you are aware of timing and potential rule changes. It will be important to track developments, as well as evolving market practice, so you are aware of timing and potential rule changes and able to position yourself in comparison with peers.
- If your organisation is already reporting in alignment with the TCFD Recommendations, note the differences to the SEC Proposals and be prepared to make any changes required to be able to report in line with the SEC (and/or the TCFD Recommendations, depending on your situation).
If you would like to explore this topic further, we have a client webinar taking place at 9am EST / 2pm BST on 8 June 2022. We will continue to monitor developments in these areas and encourage you to contact us if you have any questions.
For further information, please contact:
Yaroslav Alekseyev, Partner, Linklaters
 Meaning the four recommendations and eleven recommended disclosures set out in the report entitled “Recommendations of the Task Force on Climate-related Financial Disclosures” published in June 2017 by the TCFD (Listing Rule 9.8.6.R(8)(a)).