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SEC climate-related disclosure attestation requirements

The Securities and Exchange Commission (SEC) proposed rule changes in March that would require public companies to make climate-related disclosures and add new attestation requirements for accelerated and large accelerated filers.

Under the umbrella of environmental, social, and governance (ESG) reporting, the SEC's goal in issuing the nearly 500-page proposal is to provide "consistent, comparable, and decision-useful information" for investors about climate-related risks.

Under new Regulation S-K Items 1504 and 1505, qualitative and quantitative disclosures would be required both inside and outside of financial statements, and new sections of annual reports and registration statements would be required.

"This is a big deal because we knew it was coming but not what it would look like," Damon Busse, a partner at accounting firm Baker Tilly stated.  "Now, a lot of analysis needs to be done."

"Because not all of the new disclosures will be subject to attestation, it will be important for registrants and their providers to structure disclosures appropriately to be clear as to what is and is not subject to attestation."

According to Ruth Tang, audit partner and ESG reporting and assurance leader at KPMG, new financial statement disclosures would be subject to audit and internal controls over financial reporting.

Financial statements would include a note containing climate-related metrics, such as the amounts of negative and positive impacts for each line of the financial statements, as well as disclosure of amounts by physical risks and transition risks, as well as the expenditures expensed and capitalized for each.

When the total dollar amount of the impact exceeds 1% of the related financial statement line item, proposed disclosure is required. Furthermore, climate-related risks and uncertainties related to estimates and assumptions would have to be disclosed.

"The biggest surprise for me was the required disclosures inside the financial statements, particularly the 1 percent bright line threshold for line-by-line financial statement impact," Busse said. He pointed out that the SEC rarely provides clear materiality thresholds that differ from how management and auditors think about materiality.

Other proposed disclosures include a discussion of risk oversight by management and the board of directors; the process for risk identification, assessment, and management; whether risks have had (or are likely to have) a material impact on the company's strategy and business model; and a description of any risk mitigation transition plan.

There are also proposed metrics and methodology for Scope 1 (direct), Scope 2 (indirect produced by purchased energy), and Scope 3 (supply chain/vendors) greenhouse gas (GHG) emissions, as well as information about the company's climate-related targets, such as the scope, timeline, and data used to measure progress and update the plan each year.

Depending on when the proposed rules are adopted by the SEC, the disclosures would be phased in over different effective dates. If the rules are finalized by December 2022, calendar year-end filers will be required to make the following disclosures:

- For large accelerated filers, fiscal year 2023 (FY2024 for Scope 3 disclosures, if material);

- For accelerated and nonaccelerated filers, FY2024 (FY2025 for Scope 3 disclosures, if material); and

- For smaller reporting companies, FY2025 (exempt from Scope 3 disclosures).

For accelerated and large accelerated filers, Attestation Assurance is required for Scope 1 and 2 GHG emissions disclosures outside of the financial statements. Scope 3 disclosures, which are also subject to a safe harbor provision for affected registrants, do not require attestation.

The proposed attestation requirements are based on the AICPA's model, which divides attestation engagements into two categories:

- Limited assurance (state whether the provider is aware of any material modifications that should be made to the subject matter for the disclosure to be in accordance with, or based on, the requirements in S-K Item 1504 or for the assertion about the subject matter to be fairly stated), or

- Reasonable assurance (provide an opinion about whether the subject matter is in accordance with, or based on, the requirements in S-K Item 1504 in all material respects or that the assertion about the subject matter is fairly stated in all material respects).

"Limited assurance is a negative statement, akin to a review of financial statements in Form 10-Q," Busse explained, "while reasonable assurance is an affirmative opinion about fair presentation, like an audit of financial statements or internal control over financial reporting."

"LLimited assurance … focuses on whether there are inconsistencies with the framework and there is very limited substantive testing," Tang explained, "while reasonable assurance will be at the examination level without evaluation of internal controls over financial reporting."

A proposed phase-in period for attestation of disclosures has been proposed. The effective dates have yet to be determined, but the proposal includes examples if the rules are finalized by December 2022.

Limited assurance attestation would be required for large accelerated filers for FY2024 and 2025, with reasonable assurance required for FY2026 and beyond for calendar year-end filers. Limited assurance would be required for accelerated filers in FY2025 and 2026, with reasonable assurance required in FY2027 and beyond. Other filers are not required to provide assurance.

The proposal does not require the attestation provider to be a CPA firm or to follow any specific professional standard framework, but it does include eligibility criteria such as relevant knowledge and expertise about greenhouse gas emissions, a quality control system, and independence.

"he provider can be, but is not required to be, the same as the financial statement auditor," Busse said. "The SEC wanted an open marketplace for these services."

"There are many other types of firms, like engineers, that have been in business for years and help companies calculate and verify these metrics, but it’s important for companies to think about who is in the best position to provide assurance," Tang said.

Many auditors of accelerated and large accelerated filers, according to Busse and Tang, will likely provide climate-related attestation because they have institutional knowledge and familiarity with the company and its processes and controls, as well as a system of quality control.

Non-CPA firms, according to Busse, may opt out of attestation and instead provide advisory services in this area. "Assurance providers have to go through the client acceptance process and be comfortable that management and the board can be prepared and take responsibility for the information being reported," he said. "They also need to meet the independence standards in Regulation S-X Rule 2-01, so they can’t help management and also provide assurance."

"“Companies need to put processes and policies in place to identify and monitor the required metrics and a system of quality control to make sure the disclosures are complete and accurate. Most companies are not doing this today. Companies will find it difficult to get assurance without first having a diagnostic assessing the current state of their related processes and controls and their reporting readiness for these type of metrics. " Tang said. 

One of the difficulties with the proposed disclosures and attestations is board oversight and the requirements of S-K Item 1501 for disclosures about the board's expertise and how it oversees climate-related risks.

"There is a learning curve, and this is an area where there may be additional work to do even for companies making some climate disclosures today," Busse said. "There may be a talent constraint challenge. This is a relatively new space, and the current board may not have the expertise to oversee the new disclosures, so there may be a need to augment the current board. "

"Companies already reporting ESG information should make sure the ESG team within the organization is beginning to collaborate with the financial reporting and accounting team because the information will reside in the 10-K," Tang explained.

The proposed rules' public comment period has been extended until June 17, and the SEC will vote on issuing a final rule after reviewing the comments. "Registrants’ management and their boards should not wait for the final rule but should take the time to begin to understand how the SEC is thinking about all of this," Busse advised.

 "This is the first proposed set of rules out there. Companies must understand where regulation is headed, as regulators around the world are seeking similar types of disclosures," Tang agreed.


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