California’s Bold Move on Climate Disclosures
As public companies anticipate the Securities and Exchange Commission’s (“SEC”) final climate disclosure rules, which are expected to be released sometime fourth quarter of 2023, California has beaten the federal government to the punch. On September 12, 2023, the California State Senate passed the Climate Corporate Data Accountability Act (SB 253) (“CCDAA”) which could quickly affect many companies based both in California and elsewhere in the United States, and may also ultimately require more disclosure regarding the carbon emissions of those companies. The passage of the bill is just one of many recent moves that demonstrate California’s aggressive stance on climate issues.1
October 2023 Update
On October 7, 2023, California Governor Newsom signed the Climate Corporate Data Accountability Act (“CCDAA”) and Climate-Related Financial Risk Act (“CRFRA”) into law. In nearly identical letters to the California Senate, the Governor pushed back on the implementation deadlines for each piece of legislation, noting that the deadlines for the CCDAA were “likely infeasible” and that the deadlines for the CRFRA “fall short in providing the California Air Resources Board (CARB) with sufficient time to adequately carry out the requirements” of the legislation. With regard to the CCDAA in particular, the Governor noted that the reporting protocol specified in the legislation “could result in inconsistent reporting across businesses subject to the measure.” The Governor is therefore directing his administration to work with the authors of the legislation to address these issues. Finally, the Governor’s letters signaled his concern with the financial impact of the legislation on businesses, noting that he is instructing CARB to closely monitor the cost impacts as it implements the new legislation to make recommendations to streamline the programs.
Given the above, certain aspects of the California climate legislation could be subject to change, including the timeline for reporting under both laws. Nevertheless, despite the Governor’s concerns, the CCDAA and CRFRA are now law. We will continue to closely monitor these developments.
Alongside the CCDAA, the California Legislature also passed a companion bill — the Climate-Related Financial Risk Act (SB 261) (“CRFRA”) — which would require large companies to publicly disclose their climate-related financial risks on a digital platform. California’s Governor has indicated he will sign both the CCDAA and the CRFRA into law and has until October 14, 2023 to do so.2 These two bills signal a new era for sustainability disclosure and presage the overlapping and inconsistent approaches to climate disclosures being demanded of companies by a growing number of jurisdictions. In addition to the forthcoming SEC rule on climate-related disclosures, the European Union has also taken drastic steps in the last year with the passage of the Corporate Sustainability Reporting Directive (“CSRD”) and now, with California’s impending new laws, it will be difficult for larger companies to avoid being subject to some, if not all, of these rules. These rules are often at odds with one another and will have different jurisdictional nexus triggers. Moreover, the rules would require differing disclosures regarding levels of greenhouse gas (“GHG”) emissions and climate change risks.3
Some commentators have hypothesized that the California Climate Accountability Package may provide the SEC with some political cover to push more aggressive positions in its own final climate rules, as the California legislation would already provide significant burdens related to Scope 3 GHG emissions reporting for a large swath of publicly listed companies that would be swept under both reporting mandates given their size and California nexus.
California’s Climate Bills
In January 2023, California legislators introduced the Climate Accountability Package, a collection of bills, to include the CCDAA and CRFRA, with the purported intention to “improve transparency, standardize disclosures, align public investments with climate goals, and raise the bar on corporate action to address the climate crisis.”
The Package could have sweeping implications well beyond California’s borders. The state is currently the fifth largest economy by gross domestic product (GDP) and is close to eclipsing Germany and taking the fourth spot globally, behind the United States, China and Japan. And, if history is any guide, when California lawmakers legislate on environmental matters, they can change the de facto standards globally. This is based on both the sheer heft of the state’s economy and the fact that many companies would prefer creating one, universally applicable set of products and services that meet California’s high bar to providing disparate products and services in separate markets based on various state or international standards.4
SB 253: The Climate Corporate Data Accountability Act
- Publicly disclose (and verify), on an annual basis, Scope 1, 2 and 3 GHG emissions
- Applicable to public and private U.S. companies that are “doing business in California” and have total annual revenue of $1B +
- First reporting due 2026 (covering fiscal year 2025)
GHG Emissions Reporting
The CCDAA provides that the California Air Resources Board (“CARB”) shall develop and adopt regulations on or before January 1, 2025, requiring reporting entities to disclose, annually, their Scope 1, Scope 2, and Scope 3 GHG emissions (in conformance with the GHG Protocol).5 Reporting of Scope 1 and Scope 2 GHG emissions will begin in 2026, or on a date to be determined by CARB, while reporting of Scope 3 GHG emissions will begin in 2027 and must be disclosed no later than 180 days after disclosure of a company’s Scope 1 and 2 GHG emissions.
Such emissions disclosures are to be subject to assurance which is to be performed by an independent third-party assurance provider. Assurance for Scope 1 and 2 GHG emissions is to be performed at a limited assurance level beginning in 2026 and at a reasonable assurance level beginning in 2030. With respect to Scope 3 GHG emissions, CARB is to “review and evaluate trends” in assurance during 2026 and may establish, on or before January 1, 2027, applicable assurance requirements. Notwithstanding that, however, the CCDAA sets out that assurance for Scope 3 GHG emissions will be performed at a limited assurance level beginning in 2030.6
The CCDAA applies to a “reporting entity” which, per the legislation, is defined as the following:
- A partnership, corporation, limited liability company, or other business entity formed under the laws of California, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the United States;
- With total annual revenues exceeding $1 billion ($1,000,000,000);
- That does business in California.
The legislation fails to define what “doing business” in California means. However, according to the legislative history of the assembly discussion, the term intends to cover companies “engaging in any transaction for the purpose of financial gain within California, being organized or commercially domiciled in California, or having California sales, property or payroll exceed specified amounts: as of 2020 being $610,395, $61,040, and $61,040, respectively.”7 Under the tax code, “California sales” is defined to include: (i) sales of tangible personal property if the property is delivered or shipped to a purchaser within California regardless of the f.o.b. point or other conditions of the sale, (ii) the purchaser of services received the benefit of the services in California, or (iii) sold, leased, or licensed tangible property is located in California.
Each U.S. entity with annual revenues over $1 billion and clear California operations is likely to be subsumed under this bill. For those entities that meet the first two prongs of the definition of a “reporting entity” but otherwise have no obvious regular business operations in California, they will need to take a fact-and-circumstances evaluation of their nexus to the state to determine if they would be subject to the reporting requirements of the CCDAA.8
One of the CCDAA’s sponsors, Representative Scott Wiener (D-San Francisco) has indicated that the CCDAA’s revenue threshold would capture approximately 5,400 reporting entities. The CRFRA, with its lower revenues threshold of $500M, is likely to capture thousands more.
As noted above, the CCDAA would require reporting entities to report their complete carbon inventories — Scope 1, 2 and 3 GHG emissions. Although Scope 3 GHG emissions often account for over 90% of an organization’s overall carbon inventory, such emissions are exceptionally challenging to measure. Companies would also be required to have their emissions data validated by an independent auditor and publicly disclose such reporting via a digital platform, which must be capable of allowing stakeholders, consumers and investors to view the data in an “easily understandable” manner.
With respect to enforcement mechanisms, CARB is to adopt regulations that will authorize it to seek administrative penalties for non-filing, later filing, or any other failure to meet the requirements of the CCDAA. Such administrative penalties are limited to $500,000 or less and, for Scope 3 GHG emissions reporting, shall only occur for non-filing between 2027 and 2030.
SB 261: The Climate-Related Financial Risk Act
- Publicly disclose a climate-related financial risk report every other year (in line with the Task Force on Climate-Related Financial Disclosures (“TCFD”) recommendations or equivalent disclosure requirements of the International Sustainability Standards Board’s (“ISSB”) climate-related disclosures standard)
- Applicable to public and private U.S. companies (other than insurers) that are “doing business in California” and have total annual revenue of $500M
- First reporting due on or before January 1, 2026
Climate-Related Financial Risk Report
The CRFRA requires that a “covered entity” prepare and make publicly available a climate-related financial risk report on or before January 1, 2026, and biennially thereafter. The report is to be prepared in accordance with the TCFD recommendations or an equivalent reporting requirement, to include any “law, regulation, or listing requirement issued by any regulated exchange, national government, or other governmental entity, including a law or regulation issued by the United States government, incorporating disclosure requirements” (e.g., the forthcoming SEC rule on climate-related disclosures) or the International Financial Reporting Standards Sustainability Disclosure Standards, as issued by the ISSB.
Similar to the three prongs of the CCDAA, the CRFRA defines “covered entities” (those subject to the requirements) as the following:
- A corporation, partnership, limited liability company, or other business entity formed under the laws of California, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the United States;
- With total annual revenues in excess of $500 million ($500,000,000);
- That does business in California.
This does not include a business entity subject to regulation by the Department of Insurance in California or that is in the business of insurance in any other state.
The report may be consolidated at the parent company level.
The report is to include the measures adopted by the reporting entity to “reduce and adapt to climate-related financial risk.” To the extent the report contains the covered entity’s GHG emissions, or voluntary mitigation of the same, those claims will be considered by CARB if verified by a third party. Covered entities are to publish the report on their own websites.
With respect to enforcement, CARB is again to adopt regulations that will authorize it to seek administrative penalties. In this case, covered entities may be subject to administrative penalties of no more than $50,000 in a reporting year for failure to make the report publicly available on the company’s website or if the report is inadequate or insufficient.
Why It Matters and What’s Next
Once signed into law by Governor Newsom, both the CCDAA and the CRFRA promise to shape climate disclosure practices and emissions reporting for thousands of companies, both public and private, with advocates asserting that increased accountability will help reduce the carbon footprint of large corporations that are major greenhouse gas emitters. The proposed legislation is predicated on the position that it would enable consumers and regulators to identify companies lagging behind and encourage them to take climate action, additionally revealing those companies that are significantly exposed to climate-related financial risks. Although the bills are targeted to California-based entities, these regulations could have sweeping impacts on entities of requisite size that have relatively small applicable sales in California and limited — to no — real physical nexus to the state.
As investors increasingly demand consistent, comparable, and reliable climate-related financial information for their investment decisions, many companies are already attempting to meet such demands while also preparing for emerging disclosure regimes, including the SEC climate-related disclosures rule and the E.U.’s CSRD. However, the California legislation could end up being much broader than the SEC’s final rule, sweeping in many private companies not accustomed to mandatory disclosures of any kind, leaving them trying to understand the patchwork of climate reporting frameworks they may be subject to (which, taken together, often lack cohesive and consistent applicability and scope of reporting). The new California regulatory framework will only add further complications to the already challenging task of grappling with quantifying, tracking, and reporting GHG emissions data and risk management — especially now that companies may be subject to reporting Scope 3 GHG emissions data, which is inherently difficult to gather and validate as accurate.
A Brief Comparison to the SEC’s Proposed Climate-Disclosure Rule
Although the CCDAA shares some similarities with the SEC’s proposed climate-related disclosure rule, it deviates in two crucial respects:
- Emissions Reporting: The SEC’s proposed climate-related disclosure rule mandates that all public companies disclose Scope 1 and Scope 2 GHG emissions. A company is only required to report Scope 3 GHG emissions if (a) it has set a climate target which incorporates Scope 3 GHG emissions or (b) if it has determined that such emissions are “material.” By contrast, the CCDAA would require all three types of emissions for any U.S. company operating in California if it meets the applicable annual revenue threshold and “does business” in the state. This is significant — Scope 3 GHG emissions typically constitute a substantial portion of a company’s carbon inventory and is inherently the most difficult to calculate with any level of accuracy.9
- Applicability: The SEC’s proposed climate-related disclosure rule applies exclusively to publicly traded companies, while the CCDAA (and CRFRA) targets both public and private companies.
Preparing for California’s New Regulations
It is very likely that the California legislation will face staunch legal challenges, including with respect to the state’s authority to force companies — both public and private — to report their GHG emissions, especially for those companies with relatively minimal footprints in the state. Regardless of the timing or outcome of any such litigation, however, businesses with a nexus in California should proactively prepare for the Climate Accountability Package. Large companies should initiate an action plan for climate disclosure now, because gathering emissions data and climate risk information for fiscal year 2025 will be subject to disclosure come 2026.
Please reach out to your Vinson & Elkins team to discuss the potential impacts of this legislation on your business and how you should be preparing for these developments.
1 For instance, on September 15, 2023, the state filed a complaint in the San Francisco County Superior Court alleging five of the largest oil and gas companies (Exxon Mobil, Shell, Chevron, ConocoPhillips and BP) had actively engaged in a “decades-long campaign of deception” regarding climate change and the risks posed by fossil fuels. As a result of this purported deception, the California complaint asserts that the state has spent tens of billions of dollars to address the damage caused and to adapt to climate change and would likely have to continue to spend multiple billions of dollars in the future.
2 Governor Newsom emphatically told the audience during climate week in New York City on September 17, 2023 “of course I will sign those bills.” But he also mentioned the need for some “cleanup in language.” It is our understanding that he may be seeking certain technical corrections to enhance the discretion and flexibility for CARB to implement the new law.
3 There are likely to be some equivalency exemptions within the various reporting frameworks, for example, if such reporting entity already complies with a similarly robust framework elsewhere, but the specific details of such equivalencies remain to be seen.
4 For example, in August 2022, CARB approved regulation to phase out new internal combustion cars, requiring that by 2035 100% of new cars and light trucks sold in the state will be zero-emission vehicles. See California moves to accelerate to 100% of new zero-emission vehicle sales by 2035, Cal. Air Res. Bd. (Aug. 25, 2022), https://ww2.arb.ca.gov/news/california-moves-accelerate-100-new-zero-emission-vehicle-sales-2035.
5 The GHG Protocol is the globally recognized GHG emissions accounting standard developed and updated by the World Resources Institute and the World Business Council for Sustainable Development. It provides the framework for corporate GHG emissions accounting and reporting and defines and categorizes emissions as scopes 1, 2, and 3 emissions. The CCDAA provides the following applicable definitions: (i) Scope 1 emissions are defined as “all direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities”; (ii) Scope 2 emissions are defined as “indirect greenhouse gas emissions from consumed electricity, steam, heating or cooling purchased or acquired by a reporting entity, regardless of location”; and (iii) Scope 3 emissions are defined as “indirect upstream and downstream greenhouse gas emissions, other than scope 2 emissions, from sources that the reporting entity does not own or directly control and may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.”
6 The rules would provide for a safe harbor with regard to Scope 3 GHG emissions disclosures made with a reasonable basis and disclosed in good faith — an approach that aligns with the SEC’s proposed rule establishing a safe harbor for Scope 3 GHG emissions disclosure. Further, between 2027 and 2030, penalties assessed on Scope 3 GHG emissions reporting would only be assessed for failures to disclose.
7 SB 253, Senate Rules Committee, Office of Senate Floor Analyses.
8 CARB may need to clarify whether the $1 billion total annual revenue test is applied (i) on a gross rather than net basis, (ii) with respect to world-wide income, not income generated in California, and (iii) on a consolidated basis for all affiliates of a reporting entity. CARB may also need to clarify whether the California reporting entity reports emissions only for its activities and not those of its world-wide affiliates. As currently drafted, the legislation does not clarify these points.
9 The CCDAA provides that reporting of GHG emissions will be “in conformance” with the GHG Protocol, to include the GHG Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard. Under that Standard, there are fifteen distinct reporting categories of Scope 3 GHG emissions. Companies will have to wait until CARB’s implementing regulations are released to know how expansive the Scope 3 GHG emissions reporting will be under the CCDAA (i.e., whether all fifteen categories will be utilized), but the fact that the legislation limits reporting to be in conformance with the GHG Protocol indicates this is likely to be the case.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.