FEATURE: Climate risk disclosure is becoming the norm around the world

21 Mar 2024

Quantum Commodity Intelligence – The US Securities and Exchange Commission (SEC) earlier this month approved proposals for more extensive disclosure by companies on climate change. More details on that debate and on the court challenges can be found here.

The SEC regulations cover the US, but they are far from the only such climate reporting structures in place or planned around the world. Here Quantum outlines what the SEC regulations will entail, together with some of the main other approaches being taken at the national, supra-national and global levels.

SEC

SEC’s final rules on “The Enhancement and Standardization of Climate-Related Disclosures for Investors” were backed by three votes to two along political lines (Democratic/Republican) on March 6 and come into effect 60 days after publication in the US Federal Register, although an appeals court has temporarily paused new rules.

They would compel companies, referred to in the text as registrants, to report “climate-related risks that have materially impacted, or are reasonably likely to have a material impact on, its business strategy, results of operations, or financial condition”.

There are also requirements that “certain disclosures related to severe weather events and other natural conditions will be required in a registrant’s audited financial statements” in the rules.

SEC's final set of proposals dropped a requirement for companies to disclose value-chain, or indirect scope 3 emissions, which for many companies accounts for the majority of their carbon footprint. Requiring only reporting on scope 1 (direct) and scope 2 (energy consumption emissions) will be phased in gradually depending on company size starting in the calendar year ending 2025.

In relation to carbon credits, information is required on the “capitalised costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of a registrant’s plans to achieve its disclosed climate-related targets or goals” in the notes of financial statements.

Information will need to be disclosed on the: volume of credits used to achieve company carbon reduction; source, location and cost of the credits; registries that issued the credits; and types or credits, whether they are avoidance, reduction or removals.

The rules also include a ‘safe harbor’ clause from “private liability for climate-related disclosures (excluding historical facts) pertaining to transition plans, scenario analysis, the use of an internal carbon price, and targets and goals”.

EU

In the 27 member state EU, large and listed companies will have to disclose information on environmental, social and governance (ESG) under the Corporate Sustainability Reporting Directive (CSRD), which entered into force on January, 2023. Companies subject to the CSRD will have to report disclosures in line with the European Sustainability Reporting Standards (ESRS).

The ESRS are “tailored to EU policies, while building on and contributing to international standardisation initiatives”, according to the European Commission. The first companies will have to apply the new rules for the first time in the 2024 financial year, for reports published in 2025.

Unlike the SEC ruling, ESRS E1 covers scope 1, 2 and 3 emissions. It also requires disclosure on a “transition plan for climate change mitigation” that includes carbon reduction targets and an explanation of how the goals are compatible with the limiting of global warming to 1.5° Celsius above pre-industrial levels in line with the Paris Agreement on climate change.

In addition, greenhouse gas (GHG) goals “shall be gross targets, meaning that the undertaking shall not include GHG removals, carbon credits or avoided emissions as a means of achieving the GHG emission reduction targets”, ESRS E1 states. GHG removals and storage from projects it may have developed in a company’s own operations, or contributed to in the upstream and downstream value chain, need to be reported.

Further information on carbon credits includes the “amount of GHG emission reductions or removals from climate change mitigation projects outside its value chain it has financed or intends to finance through any purchase of carbon credits”. There should also be an “understanding of the extent and quality” of these carbon credits, whether they are to be retired and are they based on existing contracts.

Where a company has made a claim about carbon neutrality using offsets it must explain how the reliance on credits will “neither impede nor reduce the achievement of its GHG emission reduction targets or, if applicable, its net zero target”, as well as give information on carbon standards.

Specific information on credits to be reported includes project types, whether removals are from biogenic or technological storage, percentage of projects in the EU, if any qualify as a corresponding adjustment under Article 6 of the Paris Agreement, and the volume cancelled in the reporting year.

ISSB

The International Sustainability Standards Board (ISSB), which sets standards for corporate reporting on climate targets, published last June sustainability disclosure standards that aim to harmonise how companies across the world measure their progress and the information they give on the types of carbon credits used.

The standards have also been one of the motivations for financial exchanges worldwide to introduce much tougher requirements for companies to avoid 'greenwash', requiring detailed information from customers and investors on their climate targets and use of carbon credits.

The two sustainability disclosure standards, known as IFRS S1 and IFRS S2, became effective at the start of this year. Their release followed a consultation from the financial sector and other interested parties, as well as calls from the G20 bloc of major economies, the Financial Stability Board (FSB), the International Organisation of Securities Commissions and industry leaders.

Under IFRS S1, companies are required to provide disclosure to give investors clear sight of sustainability-related risks and opportunities in the short-term, medium-term and long-term timescales. IFRS S2 relates to requirements involving climate-related disclosures, including information on carbon credits.

"Any information about the planned use of carbon credits shall clearly demonstrate the extent to which these carbon credits are relied on to achieve the net greenhouse gas emissions targets," IFRS S2 states.

In addition, as part of these disclosures, entities should include information about carbon credits it has already purchased that the entity is planning to use to meet its net GHG emissions target. Companies also have to disclose which third-party schemes would verify or certify the offsets, and provide information on the type of carbon credit.

Meanwhile, companies will need to provide information on whether the underlying offset will be nature-based or based on technological carbon removals, and whether the underlying offset is achieved through carbon reduction or removal. In addition, IFRS S2 requires companies to disclose which GHGs are covered by the target and whether Scope 1, 2 or 3 emissions are covered by the target.

Users of general purpose financial reports should be able to understand the credibility and integrity of the carbon credits that entities plan to use, such as assumptions regarding the permanence of the carbon offsets, the IFRS S2 states.

IOSCO

The International Organization of Securities Commissions (IOSCO), a policy forum for global securities regulators, earlier this month closed a 90-day consultation on its report outlining a set of good practices aimed at promoting integrity and orderly functioning of the voluntary carbon market (VCM).

The consultation was an effort to resolve some of the "vulnerabilities" identified by IOSCO and others, such as how carbon credits are traded, their underlying integrity, and how they are used by buyers.

The consultation document stated: “IOSCO’s work is not focused on environmental integrity; instead, the proposed set of good practices … are practices that relevant regulators and other authorities or market participants could consider in addressing vulnerabilities described in the paper.

“While not legally binding, they are intended to support sound market structures and enhance financial integrity in the VCMs such that carbon credits can be traded in an orderly and transparent way.”

A total of 21 ‘good practices’ were covered in the document across four areas – regulatory frameworks, primary market issuance, secondary market trading, and the use and disclosure of use of carbon credits.

It said that disclosure should be “consistent with their respective mandates, relevant regulators and other authorities could consider, consistent with their jurisdiction’s laws and domestic legal requirements, encouraging or requiring disclosures regarding an entity’s use of carbon credits to achieve any net GHG emission targets”.

The US Commodity Futures Trading Commission is finalising its own VCM guidelines, but market sources said they should be seen as working in tandem with principles set out by IOSCO.

California

In October 2023, California Governor Gavin Newsom signed into law two bills – Climate Corporate Data Accountability Act (SB253) and Climate-Related Financial Risk Act (SB 261). SB253 mandates US companies with annual revenues over $1 billion active in the state to report all their GHG emissions across the whole value chain – scopes 1 and 2 by 2026 and scope 3 by 2027. The emissions reports must be verified by an independent third party.

SB261 mandates companies with annual revenues of $500 million doing business in the state to prepare material “climate-related financial risk” biennial reports that include measures to reduce and adapt to the risks, with the first report scheduled for January 1, 2026.

Reports must be in line with recommendations made by the Task Force on Climate-related Financial Disclosures (TCFD) and again need to be verified by an independent third party.

The TCFD is a now disbanded organisation set up by the international body FSB to develop recommendations on the types of information that companies should related to climate change risk.

A new draft bill (SB1036) in California, which had a hearing on March 20, proposes to make it unlawful for company employees in the supply chain to handle offsets if the credits are "unlikely to be quantifiable, real, and additional".

SB1036 was put forward last month by Democratic Party California state senator Monique Limón in a renewed attempt to exert major control over the VCM after Newsom vetoed the lawmaker's sponsorship of similar legislation 'CA SB390 (23R)' in October last year.

SB1036 covers a wide cross-section of participants in the carbon market, including companies that sell credits – either directly as project developers or as intermediaries – as well as registries, standards and verifiers.

The draft legislation says employees in the supply chain would be liable “if the person knows or should know that the greenhouse gas reductions or greenhouse gas removal enhancements of the offset project related to the voluntary carbon offset are unlikely to be quantifiable, real, and additional”.

The bill also covers carbon dioxide removals credits, proposing to make it unlawful “for a person to market, make available or offer for sale, or sell a voluntary carbon offset if the person knows or should know that the durability of the voluntary carbon offset’s greenhouse gas reductions or greenhouse gas removal enhancements is less than the atmospheric lifetime of carbon dioxide emissions, except as provided”.

Other jurisdictions

Elsewhere, the UK has mandatory climate-related financial disclosure for publicly-listed and large companies, as well as so-called limited liability partnerships. The regulations apply to reporting for financial years starting on or after April 6, 2022 and are aligned with the TCFD recommendations.

In Australia, the government is planning to introduce mandatory climate-related disclosure for large companies and financial institutions, releasing a draft bill earlier this year. “These laws would require large businesses to disclose information each year about their climate-related financial risks, opportunities, plans and strategies,” according to the country’s financial regulator the Australian Securities & Investments Commission.

Reporting could start for some entities for the 2024-2025 financial year – which starts on July 1 – for scope 1 and 2 emissions, with information on scope 3 emissions to be reported from the second reporting year. The draft has no reference to carbon credits.

In Canada, the Canadian Securities Administrators, an umbrella organisation of the provincial and territorial securities regulators, came out with a proposed regulation on climate disclosure before SEC in the US.

However, the regulation, 51-107 Disclosure of Climate-related Matters, has yet to be approved and could be amended to drop scope 3 reporting requirements to bring it in line with SEC, as many companies report in both jurisdictions and have called for harmonised rules.

In Japan, listed companies have to report “sustainability-related” information in line with TCFD from the 2023-2024 financial year. The Sustainability Standards Board of Japan, set up in July 2022 after the formation of the ISSB, is expected to come up with further reporting standards for the start of 2025 FY in line with ISSB.

South Korea is to introduce rules on climate disclosure for listed companies over a certain size. The regulations were initially planned for next year but are now expected to start in 2026.