Proposed changes to Regulation S-X
Under the Proposed Rules, a new Article 14 to Regulation S-X (“Reg S-X Article 14”) would require a registrant to disclose in a note to its financial statements certain disaggregated climate-related financial statement metrics which are principally derived from existing financial statement line items. These new financial statement metrics would be required in filings that (i) are subject to a proposed new Subpart 1500 of Regulation S-K (“S-K Item 1500”) and (ii) also require audited financial statements. Generally, this would require inclusion in registration statements and Form 10-K filings, but not in Form 10-Q filings.
The new financial metric disclosures under Reg S-X Article 14 would fall into three categories: (i) financial impact metrics; (ii) expenditure metrics; and (iii) financial estimates and assumptions. Within these three categories, registrants are required to make disclosures in respect of three sub-categories: (i) severe weather events and other natural conditions; (ii) transition activities; and (iii) climate-related risks identified by the registrant.
These financial metrics must be presented on an aggregated line-by-line basis for all negative impacts and, separately, at a minimum, on an aggregated line-by-line basis for all positive impacts. In addition, registrants must provide contextual information, describing how each specified metric was derived, including a description of significant inputs and assumptions used, and, if applicable, policy decisions made by the registrant to calculate the specified metrics.
Notably, the Proposed Rules indicate that if the impact in respect of a certain item is less than 1%, the impact may be omitted. For purposes of determining whether such disclosure threshold has been met, a registrant would be required to aggregate the value of the positive and negative impacts on a line-by-line basis.
Financial impact metrics
| Severe weather events and other natural conditions |
Registrants must disclose the financial impacts of severe weather events and other natural conditions (e.g., flooding, drought, wildfires, extreme temperatures and sea level rise).
Examples of financial impacts form these events include:
- changes to revenues or costs from disruptions to business operations or supply chains;
- impairment charges and changes to the carrying amount of assets (such as inventory, intangibles, and property, plant and equipment) due to the assets being exposed to severe weather, flooding, drought, wildfires, extreme temperatures, and sea level rise;
- changes to loss contingencies or reserves (such as environmental reserves or loan loss allowances) due to impact from severe weather events; and
- changes to total expected insured losses due to flooding or wildfire patterns.
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| Transition activities |
Registrants must disclose the financial impacts of any efforts to reduce greenhouse gas (GHG) emissions or otherwise mitigate exposure to transition risks on any relevant line items in the registrant’s consolidated financial statements.
Examples of financial impacts from these efforts could include:
- changes to revenue or cost due to new emissions pricing or regulations resulting in the loss of a sales contract;
- changes to operating, investing, or financing cash flow from changes in upstream costs, such as transportation of raw materials;
- changes to the carrying amount of assets (such as intangibles and property, plant, and equipment) due to, among other things, a reduction of the asset’s useful life or a change in the asset’s salvage value by being exposed to transition activities; and
- changes to interest expense driven by financing instruments such as climate-linked bonds issued where the interest rate increases if certain climate-related targets are not met.
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| Climate-related risks |
Registrants must include qualitative disclosure regarding the impact of any climate-related risks (separately by physical risks and transition risks) identified by the registrant pursuant to S-K Item 1500 on any of the financial impact metrics disclosed.
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Expenditure metrics
| Severe weather events and other natural conditions |
Registrants must disclose the amount of expenditures and capitalized costs incurred to mitigate the risks from severe weather events and other natural conditions (e.g., flooding, drought, wildfires, extreme temperatures and sea level rise).
Examples of expenses or capitalized costs include amounts to:
- increase the resilience of assets or operations;
- retire or shorten the estimated useful lives of impacted assets
- relocate assets or operations at risk; or
- otherwise reduce the future impact of severe weather events and other natural conditions on business operations.
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| Transition activities |
Registrants must disclose the amount of expenditures and capitalized costs incurred to reduce GHG emissions or otherwise mitigate exposure to transition risks.
Examples of expenses or capitalized costs include amounts related to:
- research and development of new technologies; and
- the purchase of assets, infrastructure, or products that are intended to reduce GHG emissions, increase energy efficiency, offset emissions (purchase of energy credits), or improve other resource efficiency.
A registrant that has disclosed GHG emissions reduction targets or other climate-related commitments must disclose the expenditures and costs related to meeting its targets, commitments, and goals, if any.
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| Climate-related risks |
Registrants must disclose the impact of any climate-related risks (separately by physical risks and transition risks) identified by the registrant pursuant to S-K Item 1500 on any of the expenditure metrics disclosed.
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Financial estimates and assumptions
| Severe weather events and other natural conditions |
Registrants must disclose whether the estimates and assumptions used to produce the consolidated financial statements were impacted by exposures to risks and uncertainties associated with, or known impacts from, severe weather events and other natural conditions (e.g., flooding, drought, wildfires, extreme temperatures, and sea level rise).
Registrants must provide qualitative descriptions of how the development of such estimates and assumptions were impacted by such events.
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| Transition activities |
Registrants must disclose whether the estimates and assumptions the registrant used to produce the consolidated financial statements were impacted by risks and uncertainties associated with, or known impacts from, a potential transition to a lower carbon economy or any climate-related targets disclosed by the registrant.
Registrants must provide a qualitative description of how the development of such estimates and assumptions were impacted by such a potential transition or the registrant’s disclosed climate related targets.
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| Climate-related risks |
Registrants must disclose the impact of any climate-related risks (separately by physical risks and transition risks) identified by the registrant pursuant to S-K Item 1500 on any of the financial estimates and assumptions used to produce the consolidated financial statements.
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Climate-related opportunities
In addition to the above financial statement metrics, under the proposed Reg S-X Article 14, registrants are permitted to include the impact on any of the above metrics of any:
- opportunities arising from severe weather events and other natural conditions;
- efforts to pursue climate-related opportunities associated with transition activities; and
- other climate-related opportunities, including those identified by the registrant pursuant to S-K Item 1500.
If a registrant determines to disclose the impact of an opportunity, it must do so consistently for the fiscal years presented, including for each financial statement line item and all relevant opportunities identified by the registrant.
What should registrants do to prepare?
While a registrant's climate-risk profile will be largely dependent on the nature of the registrant's business and industry, the Proposed Rules provide a framework for registrants to assess their financial statement presentation and reporting methodologies.
- Adjustments in Scope of Financial Statement Audits: The proposed Article 14 will require registrants to make significant adjustments to their processes and system of internal controls over financial reporting particularly given the granularity required to report the financial statement metrics and the impact of climate-related events or transition initiatives. For certain registrants whose industries are particularly susceptible to climate-related risks, these processes and changes in reporting infrastructure may prove both costly and challenging to effectively implement with precision. Registrants would be well advised to assess their monitoring, accounting, planning, and governance practices and begin to develop internal controls in collaboration with their auditors well in advance before compliance is required.
- Assess Financial Reporting Systems and Infrastructure: Given that certain climate-related events will have an impact on revenue, cost of revenue, reserves and litigation exposure, registrants should assess their existing financial reporting systems and related controls and procedures to determine whether they will effectively be able to capture the required data and determine the impact that climate-related events on each financial statement line item. Registrants should carefully assess the scope and any related gaps in climate related information they presently disclose both in respect of their SEC filings or sustainability reports and determine what adjustments would be required under the Proposed Rules, once adopted.
- Engagement of Advisors: As noted above, a registrant's climate-related disclosure would be the subject of audit and require attestation. Boards and management will need to become acclimated, if they have not done so already, with climate related concepts. Given that this will require a significant amount of time, expertise and resources, registrants should begin to evaluate the role of their auditors and other service providers. Given the scope of disclosure under the Proposed Rules, registrants may need to engage additional expertise to support the operational, legal and managerial implications required to ensure compliance. Registrants should also evaluate the costs associated as a result of the additional engagement required with their external advisers.
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