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California Adopts Sweeping Climate Disclosure Laws

Newsletter Articles

January 8, 2024

Thousands of companies will be required by 2026-27 to disclose their greenhouse gas (“GHG”) emissions and climate-related financial risks under California’s Climate Corporate Data Accountability Act (“Data Act”)[1] and the Climate-Related Financial Risk Act (“Risk Act”).[2] The Data Act requires companies with over $1 billion in annual revenue that operate in California to report their GHG emissions from company-owned sources and consumed energy to the California Air Resources Board (“CARB”) beginning in 2026, and to report GHG emissions from up- and downstream in the supply chain by 2027.[3] The Risk Act requires companies with annual revenue over $500 million that operate in California to biennially report to CARB both climate-related financial risk and measures the companies have adopted to reduce and adapt to that risk.[4]

An estimated 5,400 companies will be subject to the Data Act.[5] An even greater number must comply with the Risk Act. Together, the two laws—dubbed the “Climate Package”—are the most extensive emissions and climate disclosure laws ever enacted in the United States. They go much farther than proposed U.S. Securities and Exchange Commission (“SEC”) reporting rules.[6]

Climate disclosure is not new, but the developing patchwork of state, federal, and international disclosure regulations will pose challenges to business. In this article, we address those challenges and provide suggested approaches to minimizing them.

California’s Climate Reporting Laws

There has been growing pressure on business owners over the past decade to measure and disclose how their operations impact the climate.[7] The requirements vary, but nowhere are they more extensive than in California.

California’s Climate Package grew out of two voluntary disclosure protocols:

  • Greenhouse Gas Protocol (“GHG Protocol”): A globally recognized framework that provides companies with several standards to account for and report GHG emissions,[8] the GHG Protocol establishes comprehensive standardized frameworks and guidelines that serve as a benchmark for businesses and governments to measure and manage GHG emissions. The GHG Protocol’s “Corporate Standard” includes guidance clarifying how companies should measure and account for emissions throughout their value chain. It also supplies tools to assist companies in calculating GHG emissions and measuring the benefits of mitigation projects.[9]
  • Task Force on Climate-Related Financial Disclosures (“TCFD”): As the international benchmark for climate risk disclosure, the TCFD helps companies build frameworks to think about how climate risk manifests as financial risk and how to think about their governance, strategy, risk management, and metrics to address climate-related financial risk. Released in 2017, its Final Report includes 11 recommendations for disclosing clear, comparable, and consistent information about the risks and opportunities presented by climate change. The recommendations focus on four core elements: governance, strategy, risk management, and climate-related metrics and targets. More than 4,000 companies have declared support for the recommendations.[10]

Building on these two voluntary protocols, California adopted mandatory climate disclosure requirements in 2023.

Senate Bill 253 – Climate Corporate Data Accountability Act

SB 253 requires all “reporting entities” generating over $1 billon in gross annual revenue to disclose direct and indirect GHG emissions to the state of California on an annual basis, as well as obtain third-party assurances of said disclosures.

    a. Who is covered?

SB 253 applies to “reporting entities,” which the Act defines as public and private business entities with a total annual revenue in excess of $1 billion that do business in California.[11] “Doing business” in California extends to any company actively engaging in any transaction for the purpose of financial or pecuniary gain or profit within California, regardless of whether the company is domiciled in the state.[12] The $1 billion threshold is measured by the reporting entity’s revenue for the prior fiscal year.

    b. What is required?

SB 253 focuses on disclosure of GHG emissions. The bill requires that reporting entities publicly disclose their Scope 1, Scope 2, and Scope 3 emissions. Scope 1 emissions are all direct GHG emissions that stem from sources the reporting entity owns or directly controls. Scope 2 emissions are indirect GHG emissions from consumed energy of the reporting entity. And Scope 3 emissions are indirect upstream and downstream GHG emissions, other than Scope 2, from sources the reporting entity does not own or directly control. GHG emissions will be published on a digital platform, allowing consumers, investors, and other stakeholders to view the data in a variety of ways over the long term. SB 253 also requires reporting entities to obtain independent third-party assurance of their disclosures, with tiered levels of assurance based on the Scope.[13] An “assurance engagement” is required to determine a company’s GHG emissions, effectively identify the source of the emissions, and develop means to reduce emissions. The assurance provider must have significant experience measuring, analyzing, and reporting GHG emissions and will issue reports independent of the reporting entity.

    c. What reporting framework should companies utilize for disclosure?

SB 253 requires a reporting entity to disclose the specified information in a manner consistent with the GHG Protocol standard and guidance.[14] Disclosures must also account for any acquisitions, divestments, mergers, and other structural changes that can affect the GHG emissions reporting.

    d. Timeline of reporting

SB 253 requires reporting entities publicly disclose their Scope 1 and Scope 2 emissions annually starting in 2026, and disclose their Scope 3 emissions annually beginning in 2027.[15] Unlike the SEC’s proposed rules on climate disclosures, there is no phase-in of the requirements based on the size of the reporting entity.

    e. Penalties

The Act authorizes CARB to seek administrative penalties up to $500,000 in a reporting year for violations. Between 2027 and 2030, penalties related to Scope 3 emissions reporting may only occur for non-filing.[16]

Senate Bill 261 – Climate-Related Financial Risk Act

While SB 253 concerns a company’s effect on climate change, SB 261 concerns the effect of climate change on a company. The motivation behind SB 261 is to improve businesses’ understanding of the internal financial risks created by a changing climate and transition to a low-carbon economy, as well as encourage businesses to adapt to said risks.

    a. Who is covered?

The Act applies to “covered entities,” defined as partnerships, corporations, limited liability companies, or other business entities formed under the laws of California, another state, or the District of Columbia, or under an act of Congress, with total annual revenue above $500 million and doing business in California.[17]

The Act does not include foreign entities that conduct business in California. However, the disclosure requirements will likely apply to foreign companies with legal entities organized in the United States that collectively meet the revenue thresholds under the Act and do business in California. As with SB 253, a covered entity’s revenue for the prior fiscal year serves as the basis for determining whether the entity has met the Act’s $500 million annual revenue threshold.

The Act also does not apply to business entities subject to regulation by the California Department of Insurance or in the business of insurance in any other state. The National Association of Insurance Commissioners has adopted a new standard for insurance companies to report their climate-related risks in alignment with the TCFD. Accordingly, California legislators chose not to require California insurance companies to prepare duplicative reports.

    b. What is required?

Covered entities are required to prepare a climate-related financial risk report disclosing 1) the entity’s climate-related financial risk and 2) measures the entity has adopted to reduce and adapt to said risk.[18] The Act defines “climate-related financial risk” as material risk of harm to immediate and long-term financial outcomes due to physical and transition risks.[19]

SB 261 allows a covered entity, if it does not complete the report consistent with all required disclosures, to provide recommended disclosures to the best of its ability, provide a detailed explanation for any reporting gaps, and describe steps it will take to prepare complete disclosures. The Act also provides covered entities with the option to prepare climate-related financial risk reports at the parent company level; a subsidiary is not required to prepare a separate climate-related financial risk report if the reports are consolidated. All reports must be made public on the entity’s corporate website. 

    c. What reporting framework should companies utilize for disclosure?

SB 261 requires that entities disclose climate-related financial risk in accordance with the recommended framework and disclosures contained in the Final Report of Recommendations of the TCFD, or any subsequent publication.[20]

    d. Timeline for reporting

Under SB 261, covered entities must begin disclosing climate-related financial risk starting January 1, 2026 and biannually thereafter. CARB may adopt implementation regulations by January 1, 2025. As with SB 253, there is no phase-in of the requirements based on the size of the covered entity. It is expected in the early months of 2024, the California legislature will propose cleanup legislation that will extend the deadlines.

    e. Penalties

The Act authorizes CARB to adopt regulations for imposing administrative penalties up to $50,000 per reporting year for violations.

SEC and EU Climate Disclosure Efforts

California is the first state to adopt mandatory climate disclosure laws. The federal government has tried, but not with great success.

In March 2022, the SEC proposed a rule requiring climate-related information in registration statements and annual reports, meant to enhance and standardize climate-related disclosures to address investor demands for information consistency and comparability.[21] The proposed rule would require that publicly-traded companies disclose 1) GHG emissions, 2) climate-related impacts on strategy, along with the company’s governance and risk management frameworks for managing climate-related risks, and 3) how said climate-related risks quantitatively impact the line items of the company’s annual consolidated financial statements.[22] The rule has attracted significant opposition and likely will face legal challenges.[23]

Outside the United States, Europe has implemented regulations relating to emissions reporting, which stem from the European Green Deal. The most recent initiatives include the proposal for a Green Claims Directive, which introduces obligations on how companies substantiate, verify, and communicate environmental claims,[24] and the proposal for a Corporate Sustainability Due Diligence Directive, which requires large companies to take measures to identify adverse human rights or environmental impacts of their operations anywhere in the world and to adopt a transition plan to ensure their business model is compatible with the goal of slowing global warming.[25]

The EU also recently adopted the Corporate Sustainability Reporting Directive (“CSRD”), which requires companies to report relevant information about their impact on people and the environment and risks relating to environmental, social, and governance issues.[26] The CSRD has a separate threshold from California’s recent legislation; it applies to companies with an average of more than 250 employees, a balance sheet of more than 20 million euros, and a net turnover of 40 million euros.[27] Additionally, the CSRD applies to non-EU companies having annual EU-generated revenues in excess of 150 million euros and either a large or listed EU subsidiary or a significant EU branch. The CSRD requires companies to disclose information necessary to understand the impact of the company’s activity on sustainability matters as well as how those matters affect the company’s development, performance, and position. Specifically, companies must comply with detailed EU-side European Sustainability Reporting Standards (ESRS). A first set of ESRS was adopted on July 31, 2023. The CSRD must be transposed into national law by member states by July 6, 2024, with the first report issued in 2025.

What’s Next for Climate Disclosure and How Businesses Can Prepare

Now that Governor Newsom has signed California’s climate disclosure bills into law, businesses must begin the process of report preparation. It will be a multistep process.

First, companies should determine whether the new law applies to them, creating an obligation to submit climate reports. Next, companies should evaluate the need to update current reports if they have already established the infrastructure for climate disclosure, or begin the process of creating a system for future disclosure. It would be beneficial for companies undertaking this step to seek guidance and assistance from experts in order to ensure accurate and effective compliance. And under the Risk Act, companies must also evaluate internal operations to assess climate risk and the need for changes to mitigate or adapt to climate risk. Again, seeking outside assistance may be warranted.

Companies affected by California’s new legislation should also broaden their scope to assess what other climate disclosure regulations apply to them—domestic or international—and what proposed legislation they might need to adhere to in the future. The process of gathering information related to emissions and climate-related financial risk is also an economic burden that companies must account for in current and future operations. Given the likely future of climate disclosure, businesses should begin preparing systems for documenting and reporting emissions and climate-related risk.

For more information on compliance with the California Data Act and Risk Act, please contact James Pollack or Emma Lautanen, both of whom are attorneys in Marten’s products practice.

 

[1] Sen. Bill 253, 2023-2024, Reg. Sess., ch. 382, 2023 Cal. Stat.

[2] Sen. Bill 261, 2023-2024, Reg. Sess., ch. 383, 2023 Cal. Stat.

[3] Sen. Bill 253, 2023-2024, Reg. Sess., ch. 382, 2023 Cal. Stat.

[4] Sen. Bill 261, 2023-2024, Reg. Sess., ch. 383, 2023 Cal. Stat.

[5] How Will California’s Sustainability Disclosure Laws Influence the SEC Plans: FEI Weekly Podcast, FEI (Nov. 20, 2023), https://www.financialexecutive....

[6] See John B. (Jack) Lyman & Isabel Q. Carey, SEC Climate Rule Would Require Public Disclosures of Carbon Emissions, Marten Law (Mar. 31, 2022).

[7] Michael Copley, Climate rules are coming for corporate America, NPR (Oct. 12, 2023), https://www.npr.org/2023/10/12....

[8] Greenhouse Gas Protocol, About Us, https://ghgprotocol.org/about-....

[9] Id.

[10] See Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017.

[11] Sen. Bill 253, 2023-2024, Reg. Sess., ch. 382, 2023 Cal. Stat.

[12] Id.

[13] Scope 1 and Scope 2 emissions would be at a “limited assurance level” beginning in 2016 and at a “reasonable assurance level” beginning in 2030, while assurance for Scope 3 emissions would be required at a “limited assurance level” beginning in 2030, Id.

[14] Id.

[15] Id.

[16] Id.

[17] Sen. Bill 261, 2023-2024, Reg. Sess., ch. 383, 2023 Cal. Stat.

[18] Id.

[19] Id.

[20] Id.

[21] The Enhancement and Standardization of Climate-Related Disclosures for Investors (proposed March 21, 2022) (to be codified at 17 C.F.R. Parts 210, 229, 232, 239, and 249), available at https://www.sec.gov/rules/prop...;

[22] The Enhancement and Standardization of Climate-Related Disclosures for Investors (proposed March 21, 2022) (to be codified at 17 C.F.R. Parts 210, 229, 232, 239, and 249), available at https://www.sec.gov/rules/prop...;

[23] Jacqueline M. Vallette and Kathryne M. Gray, SEC’s Climate Risk Disclosure Proposal Likely to Face Legal Challenges, Harvard Law School Forum on Corporate Governance (May 10, 2022), https://corpgov.law.harvard.ed....

[24] Green Claims, European Commission, https://environment.ec.europa.....

[25] Just and sustainable economy: Commission lays down rules for companies to respect human rights and environmental in global value chains, European Commission (Feb. 23, 2022), https://ec.europa.eu/commissio....

[26] Corporate sustainability reporting, European Commission, https://finance.ec.europa.eu/c....

[27] Id.

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