SEC climate disclosure rule is still in play: What financial firms need to know

The Securities and Exchange Commission's landmark rule on climate-related disclosures for publicly traded U.S. companies was finalized in March — only to be stayed by the regulator in April amid an onslaught of litigation. Then in June, 38 members of Congress wrote a letter to Gary Gensler asking the SEC chair to "vigorously defend" the rule as it heads to the Eighth Circuit Court of Appeals.

The upshot is that the embattled rule is still in play and may yet be enacted. And if it is, financial firms will need to be prepared for what will follow.

Breaking down the final rule

The SEC's final rule takes concepts from both the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol to assess firms on climate matters. Firms must provide certain climate-related information in their registration statements and annual reports.

Specified disclosures required per the new rule include Scope 1 and 2 greenhouse gas emissions (if deemed material by the company), climate-related risks that have, or are expected to, materially impact the business and disclosures related to severe weather events and other natural phenomena. Also required per the rule is the disclosure of the firm's compliance processes to manage material climate risk and disclosures related to board oversight of material climate risks.

READ MORE: SEC climate rule has wide implications

Further requirements outlined in the rules include disclosure of any transition plans, scenario analysis or internal carbon pricing used to manage climate related risk. Transition plan disclosure would largely impact the world's largest financial firms, many of whom have made commitments to transition to net zero. 

Finally, emissions disclosures will be required to have a certain level of third-party assurance, depending on the firm's filing status.

Major changes from the initial proposed rules include dropping disclosure of Scope 3 emissions and scaling back Scope 1 and 2 emissions disclosures to only apply to accelerated filers and large accelerated filers (LAFs), when deemed material. The SEC also extended the reasonable assurance phase for LAFs and is only requiring limited assurance for accelerated filers.

Following the global leaders

The SEC is the latest regulator/supervisor to issue disclosure requirements as part of what amounts to a complicated global jigsaw puzzle. Several other jurisdictions have already set requirements for such reporting — most notably the European Union and the California legislature. Likewise, firms that have made net zero commitments or voluntarily report via TCFD standards are already providing similar data to that sought by the SEC.

While the new SEC rules therefore do not present extensive new requirements beyond those which were already upcoming, firms will still have significant work to do to meet them: Just 34% of U.S. financial firms voluntarily made Scope 1 and 2 disclosures as of 2022, and even fewer have any third-party assurance of their numbers.

Likewise, for firms without a presence in California or the EU (e.g. many publicly traded U.S. regional banks), the SEC rules may mark the first mandatory reporting obligation. Additionally, firms that are — or soon will be — reporting emissions and risks in other jurisdictions may have incremental reporting obligations found in the SEC requirements, for example costs related to severe weather events.

READ MORE: 24 new rules and proposals to watch from the SEC and other regulators

How can financial firms respond?

For those firms starting from scratch, key questions to help guide implementation planning should include:

• What are our significant near- and long-term climate risks?
• How are we prioritizing investments to transform our business?
• How do we quickly mature our collection of data and use of technology?
• How do we build a "fit for purpose" governance model and system of controls for non-financial reporting?

To respond effectively to the SEC's regulation, firms will need to develop several components of climate infrastructure. They will need clear accountability for climate reporting, which will likely require the creation of cross-functional teams within finance, legal and other units for comprehensive reporting. Many firms are hiring specialized ESG controllers to manage this process with roles similar to financial controllers but specifically designed for ESG-reporting integrity.
Given that the SEC's rules are partially based on the TCFD framework, firms already reporting via TCFD should be well-positioned, as they will have in place governance and risk management frameworks similar to those required by the SEC rules. Since the release of the TCFD, many firms have already updated their governance structures to embed climate-related oversight.

However, it has been noted that firms have had difficulty with quantitative disclosure of scenario analysis. Given that firms have had much more time to comply with TCFD regulations, it stands to reason that some of this ambiguity will transfer to the world of SEC rules.

READ MORE: Road test ESG practices in your own RIA to better understand sustainable investments

The SEC rules also require board oversight, so these cross-functional teams will be essential in communicating with management. Firms will need to report their transition plans and climate goals, which will require alignment from executives, and a cohesive opinion on their future strategy. Collaboration between the board and interdisciplinary teams will allow for integration between financial goals and sustainability at compliant firms.

Currently, very few firms have ESG data accessible at the level required to satisfy disclosure requirements. They will have to refine their data collection processes, as well as maintain their data inventories for accurate reporting. Firms will have to build internal systems for climate reporting and the related data governance and disclosure controls.

Once these systems are in place, the next steps will be for these teams to do materiality current state analysis, which will help with mandatory reporting and to identify gaps in their systems. Scenario analyses used to mitigate climate-related risks will need to be a component of the current state assessment as well. Firms will also have to build a framework for incident management for when issues arise. Lastly, companies must partner with third-party assessors for the limited assurance requirement.

The climate-related disclosures bring complexities that will require both short- and long-term action by financial institutions, with the first reporting potentially beginning for the 2025 fiscal year.

READ MORE: 5 ways to guide clients on ESG and impact investing

While financial firms have a very clear process for financial reporting, there are not yet standard best practices for how to approach climate reporting, and there are a lot of "what ifs" involved with scenario analyses. 

Firms will have to be comprehensive in their analyses to appropriately identify and manage climate-related risk and remain compliant. Given the nature of ESG data, reporting processes will change over time, and best practices for addressing the new SEC rules will likewise continue to evolve.