On October 7, 2023, California Governor Gavin Newsom signed into law the Climate Accountability Package, comprising the Climate Corporate Data Accountability Act (SB 253) and the Climate-Related Financial Risk Act (SB 261). The Climate Accountability Package imposes disclosure requirements on entities that are active in the state with a total annual revenue above $1 billion (“Reporting Entities”). For the listed entities, these new laws are broader than the Enhancement and Standardization of Climate-Related Disclosures for Investors rules (“SEC Proposed Rules”) proposed by the U.S. Securities and Exchange Commission (“SEC”) in March 2022. However, the SEC Proposed Rules have not yet been finalized and are still under discussion. Below, the Climate Accountability Package is discussed in contrast with the SEC Proposed Rules in relation to (i) the annual disclosure requirements and (ii) the regular assessment of climate-related financial risk.
The Climate Accountability Package requires the Reporting Entities to, starting in 2026, disclose all direct greenhouse gas (“GHG”) emissions that stem from the Reporting Entities themselves, including, but not limited to, fuel combustion activities (Scope 1), and GHG emissions from purchased or acquired electricity, steam, and heating by the Reporting Entities (Scope 2). Further, it requires Reporting Entities to, starting in 2027, disclose all GHG emissions from entities that form a part of the supply chain that may not be owned or controlled by the Reporting Entities (Scope 3). The Reporting Entities are required to follow the Greenhouse Gas Protocol, an accounting and reporting standard formulated by the World Resources Institute and the World Business Council for Sustainable Development set to take effect in 2024.
The SEC Proposed Rules, which apply to only publicly listed companies, proposed that the Scope 3 disclosure be made by listed companies only if they consider them material or if combating Scope 3 GHG emissions is a target or goal of the listed company. Further, although the goal is to provide consistent and comparable data, the SEC Proposed Rules do not link the compliance standards to any framework any global standards. On the contrary, the California laws not only mandate both public and private entities to disclose Scope 3 emissions but also link the requirement to the Greenhouse Gas Protocol.
However, the California laws have underestimated the cost of compliance to businesses in general. They fail to consider that the small-scale entities forming a part of the supply chain of the Reporting Entities may also have to comply with the exhaustive accounting and reporting standards of the Greenhouse Gas Protocol. If these small-scale entities fail to provide the information, they may lose business and see a negative impact on their revenues and financial position. While the Climate Accountability Package does provide a safe harbor from any penalty for failing to assess and calculate Scope 3 emissions from 2027 to 2030, it mandates an annual filing and does not provide a good faith carve out, contrary to the SEC Proposed Rules. To avoid penalties as high as $500,000 annually under the Climate Accountability Packages, the Reporting Entities and those forming their supply chain will have to engage carbon accounting professionals and streamline internal processes to comply with the prescribed standards, possibly incurring huge capital expenses.
The SEC Enhancement and Standardization of Climate-Related Disclosures for Investors rules remain under discussion and have not been finalized. If the finalized rules continue to provide companies the discretion to disclose Scope 3 emissions only if they consider them material, it will be hard for a Reporting Entity to argue that the Scope 3 emissions are immaterial in its registration statements or periodic SEC filings. Further, to be consistent with the California laws, the SEC may also consider linking GHG emissions disclosures to global standards like the Greenhouse Gas Protocol in its finalized rules. However, it is still to be seen if the California laws actually “change the baseline” on which the SEC formulates its emissions disclosure policies.
Another aspect of the Climate Accountability Package is the requirement to assess climate-related financial risks, a layer missing in the SEC Proposed Rules. The Climate-Related Financial Risk Act requires that all entities doing business in California with total annual revenues above $500 million in the previous fiscal year (except insurance companies) to evaluate their climate-related financial risks following the standards set by the Task Force on Climate-Related Financial Disclosures (“TCFD”). The entities are required to submit a report every two years disclosing the risks that they have identified and outlining the measures they have already adopted or propose to adopt to reduce these risks. To comply, the boards of these entities would need to take measures and establish independent committees with outside carbon accounting professionals and set costly internal processes in place.
While the disclosure of Scopes 1, 2, and 3 emissions may not be a matrix for solving climate change, the assessment of climate-related financial risks may be a step in the right direction. Understanding and disclosing the impact of their business operations may force businesses to make more sustainable choices in the future. In the meantime, however, compliance costs could heavily burden the businesses. While California Governor Gavin Newsom showed his concerns by instructing the California Air Resources Board to monitor the cost impact, the bulk of the finances these disclosures may sit on will have to be seen in practice.