Preparing for Compliance with California’s New Landmark Climate Disclosure Laws

Preparing for Compliance with California’s New Landmark Climate Disclosure Laws

October 9, 2023, Covington Alert

On October 7, 2023, California governor Gavin Newsom signed into law Senate Bill 253 (“SB 253”) and Senate Bill 261 (“SB 261”), which together comprise the core of California’s “Climate Accountability Package.” Although the laws may be modified by future legislation, as they currently stand, these laws impose extensive new climate-related disclosure obligations on thousands of public and private U.S. companies with operations in California.

In this alert, we summarize key provisions of SB 253 and SB 261, including when the new disclosure requirements are expected to take effect, highlight open questions with regard to the new laws and outline what companies can do now to prepare for compliance with these new reporting obligations. Some additional context regarding these bills can be found in our previous posts on SB 253 and SB 261.

SB 253 requires U.S.-based partnerships, corporations, limited liability companies, and other entities with $1 billion or more in annual revenues that do business in California -- an estimated 5,400 “reporting entities” -- to file annual reports publicly disclosing their direct greenhouse gas (“GHG”) emissions from operations (“Scope 1 emissions”), indirect GHG emissions from energy use (“Scope 2 emissions”) and indirect upstream and downstream supply-chain GHG emissions (“Scope 3 emissions”). Applicability will be determined based on the entity’s revenue for the prior fiscal year. The reporting requirements with regard to Scope 1 and Scope 2 emissions will begin in 2026, and required disclosure of Scope 3 emissions will begin in 2027. Reports must conform to the Greenhouse Gas Protocol standards and guidance developed by the World Resources Institute and the World Business Council for Sustainable Development. A reporting entity must also obtain an assurance engagement from an independent and experienced third-party provider on all of the reporting entity’s Scope 1, Scope 2 and Scope 3 emissions.

The bill authorizes the California Air Resources Board (“CARB”) to contract with a qualified “emissions reporting organization” and to adopt regulations to require a reporting entity to submit the annual emissions report to that emissions reporting organization. Under these regulations, CARB also may impose administrative penalties of up to $500,000 per year if a reporting entity fails to file, files late, or otherwise violates the provisions of SB 253. Through 2030, however, companies will only be subject to penalties related to their Scope 3 emissions reporting if they fail to file anything at all. After 2030, a reporting entity cannot be subject to penalties related to its Scope 3 reporting if its Scope 3 disclosures were made in good faith and with a reasonable basis.

Notably, in contrast to the climate-related disclosure rules proposed by the Securities and Exchange Commission (the “SEC”) in 2022 (details of which can be found in our prior alert), SB 253 requires disclosure of Scope 3 emissions by all reporting entities. The proposed SEC rules would require disclosure of Scope 3 emissions only if material, or if the registrant had set an emissions target or goal including Scope 3 emissions. While disclosure requirements related to Scope 3 emissions could be revised or removed in the SEC’s final rules, companies subject to SB 253 would still be required to report such emissions. The California laws will create significant new climate-related reporting requirements for a large number of public and private companies, regardless of the outcome of the SEC’s rulemaking.

SB 261 requires U.S.-based partnerships, corporations, limited liability companies, and other entities with $500 million or more in annual revenues that do business in California—estimated to be over 10,000 “covered entities” —to prepare biennial reports disclosing climate-related financial risk and measures they have adopted to reduce and adapt to that risk. The first report will be due by January 1, 2026 and must disclose (1) the company’s climate-related financial risk in accordance with the recommended framework of the Task Force on Climate-Related Financial Disclosures (“TFCD”) and (2) measures the company has taken to reduce and adapt to the climate-related financial risks disclosed in the report. Applicability will be determined based on the entity’s revenue for the prior fiscal year, and any entity subject to regulation by California’s Department of Insurance or that is in the business of insurance in any other state will not be considered a “covered entity.” To the extent a report contains a description of an entity’s GHG emissions or voluntary mitigation of those emissions, such claims must be verified by an independent third-party verifier. SB 261 also contemplates satisfying reporting obligations by compliance with an equivalent reporting requirement under other mandatory regimes, which may be an effort to avoid potentially duplicative reporting, including in anticipation of final SEC rules. Covered entities that CARB finds to be in violation of SB 261 will be subject to penalties of up to $50,000 in a reporting year.

3.         Timeline

While the new laws are fairly prescriptive, a number of questions will need to be resolved.

Possible Legislative Modifications

In signing the bills, Governor Newsom issued signing statements urging both legislative modifications and careful regulatory action by CARB. Specifically in the Signing Statement for SB 253 the Governor observed that the bill’s implementation deadlines are likely infeasible, and that the GHG reporting protocol could result in inconsistent reporting across businesses. The latter comment seems to refer to the complexity and lack of standardization around Scope 3 disclosure, although it could reflect a broader concern with the Greenhouse Gas Protocol. In the Signing Statement for SB 261 the Governor also noted that the implementation deadlines fall short in providing CARB with sufficient time to adequately carry out the requirements in this bill. Both statements indicate that the Governor would direct his administration to work with the author of the bills to address these issues in the next legislative session. In addition, in both signing statements the Governor expressed concern about the overall financial impact of the bills on businesses and so instructed CARB to closely monitor the cost impacts as it implements the bills and to make recommendations to streamline the program. 

Final CARB Regulations

Unless the legislature changes the deadlines as urged in Governor Newsom’s signing statements, CARB is required to adopt, on or before January 1, 2025, regulations to implement SB 253, which will provide additional clarity regarding the disclosure requirements for reporting entities. CARB is also required to adopt regulations implementing the penalty provisions of both bills. Unless the legislature were to extend this date early in the next legislative session, CARB could find it challenging to meet it, given the time it usually takes for CARB to complete informal and formal rulemaking for a rule of this scope and complexity and several other regulatory priorities that the CARB personnel likely responsible for the SB 253 rulemaking (the Industrial Strategies Division) are currently advancing, including proposed amendments to the Low Carbon Fuel Standard and Cap-and-Trade Program and adoption of a Carbon Capture, Removal, Utilization and Storage Program pursuant to SB 905 (Caballero, 2022).

Defining “Doing Business in California”

SB 253 and SB 261 do not define what it means to “do business in California.” CARB may need to specify what will qualify as “doing business in California,” and whether there will be any exceptions to the reporting requirements for entities with de minimis activity in the state.

Application of Revenue Tests

CARB may need to clarify whether the annual revenue requirements for “reporting entities” or “covered entities” under each of the bills is applied (i) on a gross rather than net basis, (ii) with respect to world-wide revenue, not only revenue generated in California and (iii) on a consolidated basis for all affiliates of the entity.

Compatibility with the EU’s Corporate Sustainability Reporting Directive

The European Union’s Corporate Sustainability Reporting Directive (“CSRD”) will require companies to report on material sustainability impacts beginning in 2024 (as discussed in our recent client alert). Under the CSRD, companies that are not established under the laws of an EU Member State (e.g., the U.S.) but are subject to the reporting requirements of the CSRD by way of their operations in the EU can satisfy their reporting obligations by complying with sustainability reporting standards of their home jurisdiction that the EU considers equivalent. It remains to be seen whether the California reporting requirements will be considered “equivalent” by the EU.

Legal Challenges

SB 253 and SB 261 and the associated CARB rulemakings could be subject to legal challenges in California or federal courts for claims as wide-ranging as failure to adhere to the requirements of the California Administrative Procedure Act or California Environmental Quality Act in CARB’s promulgation of the associated rules, to claims that California’s approach to requiring climate disclosures offends the dormant Commerce Clause of the Constitution. Notably, in the case of any such latter claims, the Supreme Court issued a decision last term endorsing the reach of California legislative and regulatory measures that arguably regulate activity outside of California. See Nat’l Pork Producers Council v. Ross, 598 U.S. 356 (2023) (rejecting a per se rule on state laws with extraterritorial effect in upholding California law concerning sales of pork within the state produced from gestational sows confined in crates).

Build Carbon Fluency

To prepare for climate reporting, companies should develop and/or sharpen fluency in the language of climate regulation and reporting amongst their disclosure teams. For companies that will be subject to SB 253, this may involve developing or strengthening an understanding of the Greenhouse Gas Protocol standards and guidance, including guidance regarding accounting for Scope 1, Scope 2 and Scope 3 emissions. For those entities subject to the requirements of SB 261, this may require building an understanding of the recommended framework of the TFCD. Companies should work to establish a system of collaboration among the teams involved in gathering, drafting, reviewing and publishing climate-related disclosures.

Engage Outside Carbon Accounting Professionals

Companies will need to engage carbon accounting firms to assist with the collection of emissions data and preparation of disclosure. Companies should ensure that such advisors are independent, experienced in the company’s business and industry and prepared to provide data and disclosures that will comply with reporting requirements under the California laws. Additionally, companies will need to engage an independent third-party assurance provider to provide an assurance engagement of the entity’s public disclosure, as required by SB 253.

Subject Emissions Reporting to Disclosure Committee Review

Although some companies have already begun voluntary emissions reporting, the move to mandatory reporting will heighten the need for companies to apply “disclosure committee” rigor to their emissions reporting. Companies may consider implementing additional internal and external procedures to assess internal controls around climate-related disclosure and measurements to confirm the accuracy of such disclosure. Public companies should also consider obtaining disclosure committee approval of climate-related disclosures prior to public dissemination.  

Monitor the Rulemaking Process

CARB will be responsible for developing and adopting the specific rules and regulations to implement SB 253 and SB 261 and the rulemaking process will involve a public notice and comment period. Companies may consider monitoring the rulemaking process and submitting comments once solicited.

Update Board and/or Committee Oversight Responsibilities

Boards are responsible to take reasonable measures to assure that companies maintain effective compliance programs. Accordingly, the addition of new material compliance obligations will merit board attention, including with respect to delegated responsibility for oversight to various board committees.

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Carbon accounting, disclosure and reduction mandates are proliferating and new questions are emerging regularly. If you have any questions concerning the material discussed in this client alert, please contact the members of our Securities and Capital Markets or Carbon Management and Climate Mitigation practices.