Greenhouse Gas Guessing Game: California's Latest Climate Disclosure Legislation
- The California Legislature has recently approved groundbreaking climate change disclosure legislation.
- Even companies that are not subject to the legislation should expect to be affected by the new laws.
- Companies doing business in California should begin to prepare for these climate reporting/disclosure obligations now, even if they are not directly subject to the pending obligations.
The California Legislature has sent two landmark bills to Gov. Gavin Newsom for approval that will have global repercussions. Bundled with Senate Bill (SB) 252 as part of the Climate Accountability Package, SB 253 and SB 261 focus on companies "doing business" in California, but the effect of these laws will be global.
- SB 253, the Climate Corporate Data Accountability Act, will require companies with annual revenues in excess of $1 billion to disclose the greenhouse gas emissions associated with their enterprise, whether direct or indirect. The scope of emissions analysis will put pressure on businesses below the $1 billion threshold that do business with covered entities to track and quantify their own emissions.
- SB 261, the Climate-Related Financial Risk Act, will require companies with annual revenues in excess of $500 million to prepare climate-related financial risk reports to assess and share the risks that they have identified, and what efforts they are employing to mitigate those risks. However, the scope of the risks to be disclosed remains unclear.
Sen. Scott Weiner, one of the primary proponents of these bills, explained at Climate Week NYC that these bills took three years of work to become law. The emphasis in these bills is on transparency. Sen. Weiner expressed his hope that the U.S. Securities and Exchange Commission (SEC) would adopt comparable requirements.
Who Is Affected?
The more than 5,0001 corporations, partnerships, limited liability companies and other U.S. business entities with total annual revenues in excess of $1 billion are potentially covered by this legislation. Unlike the pending SEC climate disclosure rule, SB 253 applies to both public and private organizations. The triggers for these organizations are 1) whether total annual revenues exceed $1 billion and 2) whether they are "doing business" in California. While the bill is silent, it will most likely be up to the California Air Resources Board (CARB) to determine how the $1 billion threshold is calculated, including whether it includes the revenues of all affiliates and subsidiaries, and whether it includes global or only domestic revenues.
The Franchise Tax Board takes a broad view of what it means for a company to be "doing business" in the state. An organization is doing business in California if it meets any of the following:
- engages in any transaction for the purpose of financial gain within California
- is organized or commercially domiciled in California, or
- its California sales, property tax or payroll exceed the following amounts for 2022:
- California sales of more than $690,144
- California property tax in excess of $69,015, or
- California payroll compensation of $69,0152
Any entity that meets these criteria and has total annual revenues in excess of $1 billion is potentially subject to the requirements of SB 253. Because the bill requires a full supply chain analysis, the effects of this bill will be felt by any company doing business with one or more of the businesses generating $1 billion of business in California, whether or not that company itself would be exempt.
When Do These Obligations Go into Effect?
The reporting requirements begin in 2026. The Legislature has tasked CARB with adopting a governing regulatory regime by Jan. 1, 2025.
What Needs to Be Disclosed?
SB 253 uses the "scope" framework from the 2001 World Resources Institute and World Business Council for Sustainable Development.
- Scope 1: These are the direct emissions from owned or controlled sources including, for example, company vehicles or fugitive emissions.
- Scope 2: These are indirect emissions from, e.g., purchased electricity, heating or cooling consumed by the reporting company.
- Scope 3: This catchall scope for remaining emissions will prove the most difficult to show accountability. It includes all other indirect emissions that occur in a company's supply chain and is expected to encompass the bulk of emissions.
- The catchall includes several categories: purchased goods and services; capital goods; fuel-and energy-related activities; upstream transportation and distribution; waste generated in operations; business travel; employee commuting; upstream leased assets; downstream transportation and distribution; processing of sold products; end-of-life treatment of sold products; downstream leased assets; franchises; and investments.
- The Legislature expects that companies will rely on U.S. Environmental Protection Agency's list of accepted emission factor values for common items to avoid in-depth calculations but acknowledges that the burden is not "trivial."
Only Scope 1 and 2 reporting obligations go into effect in 2026. Scope 3 reporting obligations will begin in 2027. CARB will review and may update disclosure deadlines in 2029. CARB is required to consider industry stakeholder input on reporting timelines and to avoid duplication if data from other required emissions reports meets the requirements of SB 253.
What Happens if You Get it Wrong?
SB 253 requires that companies' disclosures be audited by a third party. Initially, the audit only needs to be performed at a "limited assurance" level, typically given as a negative opinion: based on the audit: e.g., nothing in the audit indicates an error or misstatement in the disclosures. However, beginning in 2030, the audit for Scope 1 and 2 emissions must achieve the more rigorous "reasonable assurance" threshold requiring the concurrence of the auditor in the conclusion. The bill takes a more lenient approach for Scope 3 emissions, requiring only a reasonable basis and good faith disclosure.
Administrative penalties for violations may not exceed $500,000 per reporting year, and CARB is directed to consider relevant circumstances, such as an organization's history of compliance and good faith efforts to comply, in determining the final penalty.
Importantly, there is no private right of action in the enrolled bill. Instead, enforcement is expected to be handled by CARB or referred to the California Department of Justice.
Who Is Affected?
The 10,000 companies doing business in California that have gross revenues exceeding $500 million annually.3 Insurance companies are excluded as they are already subject to climate-related risk regulation by the state's Department of Insurance. Unlike the SEC proposed climate regulations, which apply only to publicly traded companies, SB 261 would apply to both public and private companies. The Legislature anticipates that only 20 percent of companies covered by SB 261 are publicly traded.
When Do Obligations Go into Effect?
The requirements begin on Jan. 1, 2026.
What Needs to Be Disclosed?
Every two years, a covered entity must prepare a climate-related financial risk report in accordance with the recommendations in the Final Report of Recommendations from the Task Force on Climate-Related Financial Disclosures.
Covered entities must prepare and disclose reports on their climate-related financial risk. SB 261 defines climate-related financial risk as "material risk of harm to immediate and long-term financial outcomes due to physical or transition risks." Under this definition, climate-related financial risks are broad and include risks to corporate operations, supply chains, employee health and safety, investments, financial standing of loan recipients and overall economic health.
The exact scope of the required disclosure is not yet clear. The bill requires CARB to contract with a "nonprofit climate reporting organization" that will be required to convene representatives, including from corporations, "to offer input on current best practices regarding the disclosure of financial risks resulting from climate change," the "definition of 'climate-related financial risk'" and a "framework or disclosure standard" for the reports.
The disclosure must be completed to the best of the entity's ability with a detailed explanation of reporting gaps and a description of the steps that the company will take to ensure complete disclosure. Companies may satisfy SB 261 through compliance with another reporting regime such as future SEC climate regulations or the European Union's Corporate Sustainability Reporting Directive. Reports can be consolidated at the parent level.
What Happens if You Get it Wrong?
CARB would be authorized to seek administrative penalties for failure to prepare a sufficient report or to "to make the report . . . publicly available" on the corporation's website. Penalties would be limited to $50,000 per "reporting year." As with SB 253, there is no private right of action.
What Can You Do Now?
Companies expecting to be impacted by SB 253, whether or not they meet the $1 billion threshold, should begin by establishing a strike team to manage the various climate reporting obligations coming into play. In particular, this team should:
- establish a baseline inventory using existing reports, if possible, and identify data gaps against California's more expansive proposal
- review contracts with an eye to ensuring that Scope 3 emissions can be accurately captured from partners in the supply chain
- develop a protocol for internal audits and reports
- participate in CARB's rule development process
Similarly, companies expecting to be impacted by SB 261 should use their strike teams to prepare preliminary risk assessments and identify their preferred reporting standard as CARB undertakes the regulatory process to better define the scope of necessary disclosures. As detailed above, CARB is required to provide reporting organizations an opportunity to participate in the formulation of key definitions, best practices and the applicable standard for disclosures, which is an opportunity that companies expecting to be impacted should not miss.
For more information or questions on how SB 253 and SB 261 may impact your business, please contact the authors.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.