Under the Microscope – Navigating Climate Accountability and Building Resilient Programs

Environmental Claims Under Scrutiny from All Directions

Companies making carbon- and climate-related claims have to navigate a complex landscape. On the one hand, regulators, consumers, and investors are demanding more information from companies about how climate change will impact their business, what they are doing to reduce harmful emissions, and whether they can back up their public statements. On the other hand, companies face a growing anti-ESG (Environmental, Social, and Governance) backlash. The movement, led by conservative state regulators, legislators, and activist investors, calls into question whether environmental considerations are material to a company’s operations and its financial performance.

The scrutiny from different directions has created a complex regulatory landscape. It also has left companies more vulnerable than ever to litigation.

Trends and Developments

The SEC’s Climate Disclosure Rules – Now Voluntarily Stayed

In a highly anticipated regulatory development, the U.S. Securities and Exchange Commission (SEC) adopted its final climate-change disclosure rules in March 2024, two years after releasing its original proposal. Under the new regulations, public companies are required to include a “Climate-Related Disclosure” section in their annual reports, addressing governance and risk management, the material impact of climate-related risks in both the short and long term, and climate-related targets or goals that materially affect the business. Additionally, companies must add separate notes to their financial statements detailing the impact of climate-related risks and weather-related events.

By many assessments, the rules are less extensive than expected. Notably, the SEC does not require disclosures on Scope 3 emissions, which cover the carbon impacts from upstream and downstream activities, including everything in a supply chain that directly or indirectly touches business activity. Instead, they only require disclosures of Scopes 1 and 2 greenhouse gas emissions. Scope 1 covers carbon emissions from the assets a company controls, like vehicles, boilers, furnaces, and production plants. Scope 2 covers carbon emissions from the electricity a company purchases.

On April 4, 2024, the SEC issued an order voluntarily staying the rules pending judicial review of consolidated challenges to the rules now before the Eighth Circuit Court of Appeals. In announcing the stay, the SEC said it wished to avoid “potential regulatory uncertainty” but vowed to “continue vigorously defending the Final Rules’ validity in court.”

California’s Climate Accountability Package – Postponed?

While the SEC rules have been stayed pending litigation, other regulators and standard-setting organizations are moving ahead more aggressively. At the state level, for example, California passed legislation requiring applicable companies to disclose Scope 1, 2, and 3 emissions.

The California Climate Accountability Package applies to public and private companies that do business in California and produce annual gross revenue of over $500 million and $1 billion. In-scope companies will be required to prepare a risk report biennially that publicly discloses their GHG emissions, climate-related financial risks, and the measures they adopt to mitigate such risks. Governor Newsom has recently proposed a rider to the California budget that postpones the Climate Accountability Package by two years, meaning the rules will not come into effect until 2028. The Legislature will take up that bill when it returns from summer recess in August. The California Chamber of Commerce and other trade associations have also filed a First Amendment challenge to these laws in federal court, which is set for hearing in early September.

California’s AB 1305

The Voluntary Carbon Market Disclosures Business Regulation Act (VCMDA) applies to a range of entities operating in California that market or sell voluntary carbon offsets or make claims regarding the achievement of net zero emissions, carbon neutral status, or significant carbon emissions reductions. The VCMDA requires annual disclosures on covered companies’ websites to verify the accuracy of carbon claims from carbon offsets. Disclosures include information documenting how a “carbon neutral,” “net zero emission,” or other similar claim was determined to be accurate or accomplished, and how interim progress toward that goal is being measured, the name of the offset seller, the offset project type and site location, specific protocol used to estimate emissions reductions or removal benefits, any information about project reversals or modifications to quantities or start dates, and the type and location of the project, among others.

IFRS Sustainability and Climate-Related Disclosure Standards

Last year, the International Sustainability Standards Board (ISSB), established by the IFRS Foundation (IFRS), issued a baseline of disclosure standards (IFRS S1 and IFRS S2) to facilitate consistent and comparable disclosures on risks and opportunities related to sustainability and climate. Although the standards are voluntary, several jurisdictions, such as China and Canada, have signaled that they will adopt rules that are tailored to the IFRS S2 standards for climate-related risk disclosures.

The Anti-ESG Legislation Floodgates

Just as they have been preparing to meet new environmental regulations, companies also have been confronting a mounting anti-ESG backlash. Last year, 240 anti-ESG bills were introduced, a staggering increase of more than six times the amount in 2021 and 2022 combined.

To be sure, much of the legislation has not become law. Of the 240 bills, 95 have failed as of December 2023. But the activity is worth tracking.

The bills seek to impose various limitations. States such as Arizona, Indiana, Missouri, New Hampshire, Ohio, and Texas have proposed legislation that seeks to prohibit investment professionals, agents, and state fiduciaries from considering ESG matters when making investments on behalf of their state.

Other states, including Alabama, Arkansas, Iowa, Minnesota, and Oklahoma, as well as Arizona, Missouri, and Texas, have proposed prohibiting contracts with companies that boycott or negatively screen certain industries such as fossil fuel, firearms, agriculture, and mining, among others. Meanwhile, bills proposed in Kentucky, Arkansas, Maine, and Minnesota would require state governmental entities to divest from financial companies engaged in energy company boycotts.

Litigation Threats from Both Sides

The scrutiny of environmental disclosures, claims, and decision-making coming from both sides has created a volatile litigation landscape. On the one side, investors, consumers, and state AGs have filed lawsuits against companies alleging greenwashing of climate disclosures. For example, Delta Airlines is facing a class action lawsuit challenging Delta’s claim that it is “the world’s first carbon-neutral airline.” The plaintiffs allege that Delta’s claim made it seem like Delta did not release additional carbon into the atmosphere, when in fact the claim is based on carbon offsetting investments and activities. Delta’s motion to dismiss is currently pending.

At the same time, the anti-ESG backlash has also resulted in litigation. For example, late last year, the Tennessee attorney general sued the asset management firm BlackRock, alleging it made false or misleading representations to current and potential Tennessee consumers regarding the extent to which ESG considerations influence its investment strategies. The case remains ongoing.

Building Resilience – Scaffolding for Carbon and Climate Initiatives

Monitor Regulations and Involve Legal Counsel

In this environment, national and global businesses must continue to monitor regulatory developments in the jurisdictions where they operate and to involve legal counsel in statements and disclosures made about their environmental goals and impact.

Communications Scoping and Vetting

Claims must be properly scoped, substantiated, and easily understood by anyone relying on them. Data accuracy and substantiation should be the bedrock of any ESG program. Companies should develop the right processes and policies to ensure that they only make claims that are substantiated by quality data.

Update Disclosures Regularly

Corporate climate data is dynamic and evolves as the company, its environment, and its value chain evolve. Companies must develop both programs that recognize this dynamism and policies and processes that ensure their data is accurate. Because generating “real time” climate data can be impractical, companies should include appropriate disclaimers on current representations and forward-looking statements. Qualification gives companies the needed scaffolding to mitigate liability risk while they continue to work towards data integrity and accuracy.

Less Is More

In light of mounting pressure on companies to make climate and carbon disclosures, it is critical to scrutinize all disclosures to confirm that they can be substantiated with quality data. Companies should carefully consider whether to respond to each data request. As regulations proliferate, it is prudent to carefully consider what disclosures are required and to consult with legal counsel early and often.

Gap Analysis

Before regulations were introduced, companies made voluntary disclosures that now heighten their risks as assurance levels intensify and regulatory risks grow. Consider conducting a gap analysis on disclosures to understand differences between existing disclosures and new required disclosures. Where there are gaps, leverage existing processes to update what is required or pare back extraneous disclosures. Where you find discrepancies, consult with legal counsel for guidance on how to rectify discrepancies and chart a way forward.