---

by Peter Cherpack, Ardmore EVP of Credit Technology and Board Member

New SEC Climate Disclosure Rule – Materiality Issues and Scopes

After two years of review and public comment, the U.S. Securities and Exchange Commission approved a new climate disclosure rule on March 6, 2024 (the “Rule”). What follows is a brief review of the contents of the Rule and how it may impact U.S. banks. While some industry groups have already announced pending litigation to postpone the Rule’s implementation, it is important for all public companies to understand what the Rule requires regardless of the timing of its actual implementation. (Even private companies can consider the likelihood that this rule will be template for those that will follow).

Main Content of the Rule

Essentially, the Rule will require all public companies to disclose information about their climate-related governance, strategy, risks, targets, and alignment with established climate reporting frameworks. It includes a requirement to disclose a company’s scope 1 and 2 emissions, as well as transition plans, and use of scenario analysis. (Scope 1 are direct emissions that are owned or controlled by a company, such as their trucks and cars. Scope 2 are emissions that are caused indirectly from where the energy the company purchases and used is produced. For example, the emissions caused when generating the electricity used in office buildings.)

Notably, scope 3 emission tracking and disclosure is not addressed by the Rule. (Scope 3 are emissions not produced by the company itself but by those that are indirectly responsible in its value chain. An example of this for banks would be borrowers they lend to.) Tracking these scope 3 emissions create complex challenges today, and while their tracking requirements are already in place in Europe, the SEC chose to not address them in this Rule.

A key concept that drives much of the disclosure content in the Rule is the idea of “materiality”. Each company is told to address items considered to be material to them and their business. Materiality is not just based on financial impact or thresholds, it is information that’s considered to be significantly relevant to the company’s ability to create value over the short and longer term. Needless to say, a “climate related materiality assessment” is a process the industry will have to learn about as these requirements are refined.

Timing and Who Is Impacted

As is typical of SEC rules, the implementation is phased in over time based on a company’s SEC filing status. Large Accelerated Filers (“LAF”) will have to start some of the disclosure activities in 2025, with other filers – except the Small Reporting Companies (“SRC”) will start in 2026. There are different disclosure schedule requirements phased in over time – which are outlined in the SEC’s fact sheet for the climate disclosure rule – accessible via this link. If you are not sure of your institution’s SEC Filing status, your finance manager can confirm this for you.

What Does This Mean to Community and Regional Banks in 2024?

A best practice of credit risk management is to always look ahead and be proactive about managing emerging risks. Eventually, all public banks will have to provide quantitative data on how climate change affects their financial performance including both physical and transitional risks, as well as any risk mitigation plans they have.

Now that the Rule is published, it would be prudent for bank credit risk managers – at banks of all sizes – to start to understand how climate-related risk could impact their lending and profitability. Simple early steps can involve identifying concentrations of physical climate risk (potential losses due to acute climate events like hurricanes, wildfires and floods). Other evolving early activities could include scenario testing and sensitivity tests.

Managing climate-related credit risk is in its infancy for most smaller financial institutions, but it is clearly an emerging risk to be dealt with. While there is currently no other U.S. regulation requiring smaller bank compliance with climate-related disclosure, the Rule is a good indication of future requirements that may “trickle down”. Depending on the state your institution does business in, you may have more detailed disclosure requirements coming your way even sooner. As more information is distributed about this important Rule, the credit risk professionals at Ardmore will keep you updated.

---