Canada: The SEC's Final Rules On Climate Related Disclosure And What They May Mean For Canadian Issuers
Capital Markets and Mergers & Acquisitions Bulletin

After several delays, 24,000 comment letters and litigation threats from various actors, the US Securities and Exchange Commission (SEC) released its final rules regarding mandatory climate disclosure risk on March 6, 2024 (the Final Rules).

The Final Rules are a significant development for Canada, as our regulators prepare to issue a new set of climate-related disclosure rules in the context of requirements adopted in the US and internationally.

The SEC's Final Rules are a more narrowly focused version of the draft rules published by the SEC in 2022. Notably, listed companies in the US will not be required to disclose indirect greenhouse gas emissions from their value chain (Scope 3 emissions), and the disclosure of direct emissions (Scope 1 emissions) and emissions related to purchased energy (Scope 2 emissions) will only be imposed on certain larger issuers.

We briefly review the requirements of the Final Rules, how they impact Canadian issuers, and what they may mean for climate-related disclosure in Canada and internationally going forward.

The Key Features Of The SEC's Final Rules

The goal of the Final Rules, as stated by the SEC, is to enhance and standardize climate-related disclosure by public companies and in public offerings. They require disclosure in annual financial statements and registration statements of material climate-related risks which materially impact, or could reasonably be expected to materially impact, an issuer's business strategy, operations, or financial condition, including for example, the financial impact of severe weather events and, for certain issuers, Greenhouse gases (GHG) disclosure metrics.

The Final Rules address numerous issues, including:

• The oversight of climate-related risks by the issuer's board of directors.
• The role of management in assessing and managing material climate-related risks.
• The issuers' initiatives, if any, to mitigate or adapt to a material climate-related risk, including the use, if any, of transition plans, scenario analysis, or internal carbon prices.
• The financial impacts of severe weather events and carbon offsets and renewable energy credits, if used as a material component of the issuer's plans to achieve its disclosed targets or goals.

Notably, however, the Final Rules scale back several of the requirements of the SEC's 2022 draft rules. For example:

• Disclosure regarding board members' climate expertise is no longer required.
• Safe harbours have been provided for forward-looking disclosures related to transition planning, scenario analysis, internal carbon price, and targets and goals.
• Required notes in the issuer's audited financial statements have been limited to two issues, being the capitalized costs, expenditures expensed, charges, and losses:
  • incurred as a result of severe weather events and other natural conditions; and
  • related to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of a company's plans to achieve its disclosed climate-related targets or goals.

Scope 1, 2 and 3 Emissions Under The SEC's Final Rules

Perhaps the most divisive issue regarding climate-related disclosure is the scope of emissions to be subject to mandatory disclosure. On this front the Final Rules provide as follows:

Scope 3 – In response to concerns that information regarding emissions occurring across an issuer's value chain (Scope 3) is difficult to collect and calculate, the Final Rules abandoned the mandatory disclosure of Scope 3 emissions previously included in the SEC's 2022 draft rules. An SEC commissioner also indicated in public comments on March 6 that the SEC's decision was in part influenced by investor feedback that Scope 3 emissions disclosure is of less value than information regarding Scope 1 and 2 emissions. By contrast, the standards issued by the International Sustainability Standard Board (ISSB), the EU's Corporate Sustainability Reporting Directive and the new California legislation mandate Scope 3 disclosure.

Scope 1 & 2 – The Final Rules require certain LAFs and Non-Exempt AFs (each as defined below) to disclose direct GHG emissions (Scope 1) and emissions related to purchased energy (Scope 2), if such emissions are material. Scope 1 and 2 disclosure has generally been less divisive given that such emissions are easier for an issuer to calculate and control. Scope 1 and 2 disclosure is also mandatory under the ISSB standards, the EU directive and the new California legislation.

• "LAFs" generally means issuers, in addition to meeting other conditions, with a public float of at least US$700 million.
• "Non-Exempt AFs" generally means issuers, in addition to meeting other conditions and which are neither smaller reporting companies nor emerging growth companies (as defined by the Final Rules), with a public float of between US$75 million and US$700 million.

Reasonable assurance – The Final Rules extend the phase-in periods for assurance of GHG emissions. Issuers are initially required to provide limited assurance related to Scope 1 and Scope 2 emissions. As a second step, reasonable assurance (similar to the assurance provided by auditors for financial statements) will also be required, but only for LAFs, following a phase-in period. The EU directive adopts a similar two-step approach while the ISSB standards rely on the adoption of assurance requirements by jurisdictions and regulators.

How Do The SEC's Final Rules Impact Canadian Issuers?

The Final Rules apply to foreign private issuers (FPIs), being non-governmental issuers who do business in the US but are incorporated elsewhere. Similar to US domestic issuers, the Final Rules subject FPIs to various disclosure and reporting requirements. However, FPIs are eligible for relief from certain of these requirements which US domestic issuers are not similarly eligible for.

Under the Final Rules, FPIs are required, similar to US domestic issuers, to file their GHG emissions metrics as part of their annual report filings on Form 20-F, but will be permitted to do so on a delayed basis. That said, Canadian registrants who use the multijurisdictional disclosure system (MJDS) and file their annual reports on Form 40-F are exempt from the Final Rules.

How Might The SEC's Final Rules Influence Canadian Regulators?

The SEC's Final Rules are a significant development that will undoubtedly be closely considered by the Canadian Securities Administrators (CSA) in finalizing its approach to climate-related disclosure requirements in Canada.

However, we do not necessarily expect total alignment. For example, in its 2021 proposal regarding climate disclosure rules (Proposed National Instrument 51-107 Disclosure of Climate-related Matters (NI 51-107)) (the CSA's Proposed Rules), the CSA proposed a comply-or-explain approach for all GHG emissions metrics, meaning that a company could elect not to disclose its emissions provided it explains why. In contrast to the SEC's 2022 draft rules, the CSA's Proposed Rules appeared more lenient as, unlike the SEC's draft rules, they did not impose obligations regarding scenario analysis, transition plans, internal carbon pricing, emission offsets or financial reporting.

It remains to be seen how Scope 3 emissions will be treated under the CSA's revised instrument. Given that Scope 3 disclosure was not initially included in the CSA's Proposed Rules, and that the SEC has abandoned Scope 3 disclosure in the Final Rules, mandatory Scope 3 disclosure may be less likely.

On the other hand, after the release of the ISSB standards in June 2023, the CSA indicated their willingness to integrate such standards into Canadian reporting requirements, with modifications as appropriate in the Canadian context. Under the ISSB standards, Scope 3 disclosure is mandatory.

As a next step, we understand that the Canadian Sustainability Standards Board (CSSB), the Canadian branch of the ISSB, is set to issue its draft version of the ISSB standards later this month (March 2024). We also expect these to be closely considered by the CSA.

Could We Ever See International Consensus Regarding Climate-Related Disclosure?

Whether material alignment regarding sustainability disclosure reporting on a global level is achievable is uncertain. With the SEC's abandonment of mandatory Scope 3 emissions disclosure, the Final Rules break from the ISSB standards as well as from certain standards adopted or proposed in several other prominent international jurisdictions. For example, the European Union, California, Brazil, Singapore, and three of China's major stock markets have either published, or given effect to, reporting rules that include Scope 3 emissions disclosure. The UK, Australia and Hong Kong have also proposed rules for doing so. Moreover, notwithstanding the SEC's efforts, within hours of their adoption, ten US states announced they would challenge the Final Rule for exceeding the SEC's statutory authority.

For the foreseeable future, the regulatory landscape looks likely to remain fragmented at the international level and with the result that multinational companies subject to reporting requirements in multiple jurisdictions will need to navigate a complex regulatory landscape.

Special thanks to Nivi Srinivasan for her research assistance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.