A New Regulatory Environment for Climate and Other ESG Reporting Rules

The Ill-Fated SEC Climate Rule

On March 6, 2024, the SEC adopted final rules “to enhance and standardize climate-related disclosures for investors,” which included, among other things, requirements to disclose material climate-related risks and related governance policies and practices and mitigation and adaptation activities, targets and goals, Scope 1 and 2 emissions reports and financial statement effects of severe weather events and other natural conditions, including related costs and expenditures (the Climate Rule).[1]

Almost immediately upon release of the Climate Rule, multiple lawsuits were filed in federal court objecting to the rule on multiple bases, including that the rule is arbitrary and capricious under the Administrative Procedure Act, the rule exceeds the SEC’s statutory authority and the rule violates the First Amendment by compelling political speech.[2] The U.S. Court of Appeals for the Eighth Circuit was randomly selected as the venue for consolidating the nine filed lawsuits and on April 4, 2024 the SEC voluntarily stayed the rules pending the outcome of the litigation. Briefs have been filed by all parties and the case is currently pending a hearing date.

On December 4, 2024, President-elect Donald Trump announced that Paul Atkins would be his nominee to the SEC as Chairman. Current Chair Gensler and Commissioner Lizárraga both announced their intentions to step down in January 2025 before the inauguration, meaning the SEC will have a majority of Republican Commissioners even before Atkins can be confirmed. The change in administration is expected to bring a deregulatory focus and anticipated reduction in budget and spending for administrative agencies, which, together with the quick turnover at the SEC, is anticipated to mean the end of certain ESG related SEC rulemaking initiatives, including the Climate Rule (along with any new proposed rules on board diversity disclosure and human capital management reporting). Procedurally, the SEC under the new administration could abandon the defense of the rule in court (leading to its vacatur); alternatively, it could take regulatory action to rescind the rule (which would require formal rulemaking, including new notice and comment periods), and, pending a final determination, the SEC could announce that it will not lift the stay or enforce the rule, so that in practice it is never implemented.

While the Climate Rule is assumed to be dead, other climate-related reporting regulations applicable to many U.S. companies will continue to take effect, including the Directive (EU) 2022/2464, as regards corporate sustainability reporting (the CSRD) in Europe and California’s climate reporting laws. Companies will need to consider how to prepare and comply with applicable rules, while at the same time facing divided stakeholders, including those who are increasingly vocal and skeptical of the value of climate and other ESG-related reporting.

The EU and the Corporate Sustainability Reporting Directive

CSRD entered into force on January 5, 2023.[3] The main objective of the CSRD is to harmonize companies’ sustainability reporting and to improve the availability and quality of ESG disclosures. The CSRD requires sustainability reports describing risks, opportunities and impacts, including transition plans material to a company’s business model and strategy relating to a broad range of environmental, social and human rights and governance factors. For example, with respect to environmental factors, the CSRD goes beyond climate and covers general cross-cutting disclosures, as well as pollution, water resources, biodiversity, circular economy, workforce, affected communities, end-users and business conduct. The materiality disclosure threshold is based on a “double materiality” standard, which, unlike the U.S. securities law concept of materiality, requires disclosure both when ESG factors materially impact the financial performance of a company (financial materiality) and when the company’s activities materially impact society and the environment (impact materiality). In-scope companies include not just EU-domiciled and -listed companies but also large EU subsidiaries[4] of companies outside the EU (third-country companies) and third-country companies with significant EU market activity.[5][6]

While additional implementing standards are still forthcoming, on August 7, 2024, the European Commission published a set of Frequently Asked Questions (FAQs)[7] on the CSRD, providing some information for how third-country companies will be required to report:[8]

• For third-country parent reporting, an EU subsidiary or branch of an in-scope third-country group will be required to publish and make accessible group level sustainability information. The content of this sustainability report will be more limited compared to the sustainability statement to be provided by EU companies and large EU subsidiaries.
• A third-country parent will be able to voluntarily publish the group level report ahead of the 2029 reporting date, thereby exempting its large EU subsidiaries,[9] provided that this group level sustainability reporting meets the standards applicable to the EU subsidiaries or equivalent standards.    
• While CSRD reporting for EU companies will be required as part of the consolidated management report, i.e., annual report, a third-country company consolidated sustainability statement can be included in a separate document from the annual report.
• A large EU subsidiary whose parent is a third-country company will be permitted to prepare and publish a consolidated sustainability statement that includes all EU companies that are direct or indirect subsidiaries of the third-country parent through the fiscal year ending on or before January 6, 2030. This “sister company” exemption means that large EU subsidiaries will be permitted to report together rather than on an individual basis through fiscal year 2029 (for December 31 fiscal-year-end companies).
• A third-party assurance opinion will be required on the sustainability report.
• As a Directive, the CSRD needs to be transposed in each Member States to become fully applicable. National transpositions may impose greater requirements on companies, including lower thresholds, and thus applicable national transpositions will need to be reviewed and confirmed. As of this publication, ten Member States, including Germany, Luxembourg and the Netherlands, have not yet transposed the CSRD.

Even though voluntary reporting by third-country company groups is permitted in lieu of large EU subsidiary reporting, since reporting standards for third-country companies have not yet been published, many non-EU groups are considering whether to report on behalf of the large EU subsidiaries in the first instance. Any decision on when to move to consolidated group reporting should take into consideration company structure, including the number of large EU subsidiaries, the ability to utilize “sister company” reporting and the difficulty in preparing data for reporting for EU subsidiaries or the consolidated group. It will also depend on the content of future sustainability reporting standards for third-country groups and the extent to which they differ from the standards applicable to EU companies.

Recent announcements from the European Commission suggest ongoing work to prepare an “omnibus” directive aimed at consolidating and rationalizing the broader EU ESG reporting framework (including the CSRD, the Corporate Due Diligence Directive (CSDDD) and the Taxonomy Regulation).

California Climate Reporting Mandates

In 2023, California adopted three laws related to climate reporting (the CA Climate Rules). The first two, SB-253 (the Climate Corporate Data Accountability Act) and SB-261 (the Climate-Related Financial Risk Act), apply to all public and private companies that “do business in California” (CA Covered Entities).

SB-253 requires CA Covered Entities with total annual revenues in excess of $1 billion to publicly disclose Scope 1 and 2 emissions starting in 2026 and Scope 3 emissions starting in 2027, and to obtain assurance on such data from an independent third-party. On December 5, 2024, the California Air Resources Board (CARB) published an Enforcement Notice that allows companies to use existing reporting systems and data collected for Scope 1 and 2 emissions disclosures for the first reporting cycle, and assured that “CARB will not take enforcement action for incomplete reporting against entities, as long as the companies make a good faith effort to retain all data relevant to emissions reporting for the entity’s prior fiscal year.”[10] Additional specific requirements and guidance will be published by CARB in due course. SB-261 requires CA Covered Entities with total annual revenues in excess of $500 million to prepare biennial reports beginning on or before January 1, 2026 disclosing the company’s climate-related financial risk and the measures the company has adopted to reduce and adapt to such climate-related financial risk.

Like the SEC Climate Rule, SB-253 and SB-261 are subject to legal challenge. Chamber of Commerce of the United States of America et al. v. California Air Resources Board et al. challenges the laws on the basis that they are unconstitutional for violating the First Amendment. On November 5, 2024, the U.S. District Court for the Central District of California deferred a plaintiff motion for summary judgment and allowed the challenge to move into discovery. Given an expected lengthy time for discovery and any further motions or trial, in scope companies should continue to prepare for compliance on the current timeline.

The third law, AB 1305 (the Voluntary Carbon Market Disclosures), requires disclosure of voluntary carbon markets, sales and purchases in or from California and website disclosure of the use of offsets to achieve net-zero and GHG reduction plans starting January 1, 2025. More widely applicable, AB 1305 also requires website disclosure relating to certain claims regarding the achievement of net zero emissions, “carbon neutral” products and other similar climate claims, as well as other information on progress toward disclosed goals.

Reporting in a Multi-Jurisdiction Environment–Takeaways

In 2025, companies will face multiple new reporting mandates, heightened litigation and related risks and divergent attitudes and views toward disclosure, climate action and ESG initiatives.  Companies should consider following key takeaways as they navigate the new environment on climate and ESG rules and risk:

• Ongoing disclosure requirements: companies still need to prepare for and begin reporting. Many U.S. and other multinational companies will be subject to CSRD or the CA Climate Rules, regardless of any eventual repeal or invalidation of the Climate Rule. While some of the detailed financial reporting in the Climate Rule will not be required, for many companies climate risk related disclosure and Scope 1, 2 and in some cases, Scope 3, emissions reports, assured by a third-party, will still be required starting in 2026. A main difference is that, at least with respect to CSRD and the CA Climate Rules, U.S. companies will be able to continue to file climate and sustainability information in a separate report and avoid the heightened liability regime of U.S. reporting. However, regardless of the Climate Rule, the general SEC mandate that companies must disclose all material information still applies — including climate change and social matters material to companies’ existing business, strategy and goals, and the material financial impacts of company actions and responses to such matters. 

• Companies will increasingly need to manage and watch for competing views on disclosure and litigation around climate and ESG disclosure, and manage internal processes to provide consistent information. Companies face different sentiments toward the value of climate and ESG reporting from investor groups, regulators and other stakeholders around the world.  There is increasingly litigation from groups on both sides of the political aisle, some pushing for more disclosure and action and others critical of ESG policies and concerned about related business risks and expenses. Companies should be mindful of risk and liability concerns and keep in mind that any public disclosures may subject them to future regulatory or legal action. In balancing interests and mitigating risk, companies should consider limiting disclosure to those necessary to comply with regulatory requirements and, to a lesser extent, significant investor consensus. For example, while the Nasdaq diversity disclosure rule was vacated, many institutional investors still request information on gender and racial and ethnic characteristics of board members. In response to requests for information from vendors and other stakeholders, including investors, whether in questionnaires or in sustainability reports or SEC filings, companies should maintain a consistent, disciplined approach, including a widely vetted process that includes internal stakeholders from legal, sustainability and investor relations/marketing or communications groups to help ensure appropriate responses in light of legal mandates and liability risk.

• Companies should continue to monitor other U.S. state and non-U.S. jurisdictions for applicable new disclosure mandates. Over the next few years, we expect Europe and the U.S. will likely further diverge in approach to climate and other ESG mandates, including increased regulation in Europe (including the CSDDD[11]) with a contrasting deregulatory environment in the United States. Other jurisdictions may propose more new standards, creating a panoply of disclosure regimes. For example, the 2023 ISSB Standards, voluntary standards intended to create a global baseline to consolidate disclosure frameworks, are being considered for adoption by several jurisdictions outside of Europe. In light of expectations around the Climate Rule, certain state legislatures and executives may expand efforts, similar to the CA Climate Rules,[12] while other states will continue to enact laws or promulgate regulations deemphasizing climate and ESG disclosure and action, including by limiting investment by public entities in certain climate or ESG-related investments. Given the time and resources needed to comply with these differing requirements, companies will need to continue to understand applicable rules and regulatory developments.

[1] SEC Press Release, “SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors” (March 6, 2024), available here. SEC Final Rule, “The Enhancement and Standardization of Climate-Related Disclosures for Investors” (March 2024), available here.

[2] While eight of the lawsuits followed similar arguments, one filed by environmental groups represented by Earthjustice argued that the SEC’s action was arbitrary and capricious under the Administrative Procedure Act because it did not include all the elements in the proposed rule, including the requirement to disclose Scope 3 emissions, and that the SEC was not mandating disclosure that investors required to make informed investment decisions.

Recently, the Fifth Circuit has vacated multiple SEC and Department of Labor rules related to climate and ESG matters on the basis that they were arbitrary and capricious under the Administrative Procedures Act, most recently, the SEC’s approval of a Nasdaq rule requiring most listed companies to disclose the gender and racial/ethnic makeup of their boards of directors, or disclose why they do not, based on a finding that the SEC failed to justify its determination that Nasdaq’s rule was consistent with the requirements of the Exchange Act.  See Alliance for Fair Board Recruitment; National Center for Public Policy Research v. Securities and Exchange Commission (December 11, 2024), available here.

[3] As a directive, the CSRD must be transposed into national law by Member States, as a result of which there may be slight differences from one Member State to another where the CSRD leaves room for discretion.

[4] In-scope subsidiaries include EU domiciled subsidiaries that meet two of three thresholds including (i) 250 employees over the financial year, (ii) a net turnover of EUR 40 million and (iii) a balance sheet of over EUR 20 million, whether on a solo or a consolidated basis.

[5] In-scope companies include third-country companies with an EU net turnover of more than EUR 150 million and an EU subsidiary, or, in the absence of such a subsidiary, an EU branch with a net turnover of more than EUR 40 million.

[6] For details on CSRD scope and applicability to companies, see our February 2023 alert memo available here.

[7] European Commission, “Frequently asked questions on the implementation of the EU corporate sustainability reporting rules” (August 7, 2024), available here.

[8] European Union, “Commission Notice on the interpretation of certain legal provisions in Directive 2013/34/EU (Accounting Directive), Directive 2006/43/EC (Audit Directive), Regulation (EU) No 537/2014 (Audit Regulation), Directive 2004/109/EC (Transparency Directive), Delegated Regulation (EU) 2023/2772 (first set of European Sustainability Reporting Standards, ‘first ESRS delegated act’), and Regulation (EU) 2019/2088 (Sustainable Finance Disclosures Regulation, ‘SFDR’) as regards sustainability reporting,” available here.

[9] Large EU-listed companies cannot benefit from the parent company exemption.

[10] CARB, “The Climate Corporate Data Accountability Act Enforcement Notice” (December 5, 2024), available here.

[11] For details on the CSDDD, see our March 2022 alert memo available here.

[12] For example, on December 26, 2024, New York enacted a new climate liability law that would require fossil fuel companies to share in payments of $75 billion to address the effects of climate change in the state.  The law follows a similar one in Vermont.  While the New York law is expected to be challenged, these efforts may pave the way for other states to enact far reaching laws relating to emissions.  While the New York law assigns liability based directly on production of fossil fuel, future legislative or regulatory efforts could draw from information provided under existing or new disclosure mandates.