California’s Bold Step Towards Sustainability: SB 253 & SB 261

Farah Chowdhury Dec 15, 2023

esg,
cpm

Introduction

While ESG (Environmental, Social, and Governance) targets and reporting have been the subject of considerable debate in the corporate world, many organizations have moved forward with integrating these factors as essential components of investment decisions and corporate strategies. Most recently, the state of California (one of the world’s top five largest economies) has taken a bold step aimed at promoting ESG by enacting two groundbreaking bills under The Climate Accountability Package: Senate Bill 253 (SB 253) and Senate Bill 261 (SB 261). In this article, we’ll delve into these two laws and explore their potential impact on the corporate landscape in the United States and globally.

Senate Bill 253: The ESG Disclosure Act

SB 253, also known as the ESG Disclosure Act, was signed into law in California to enhance transparency and accountability among corporations operating within the state. This legislation creates new GHG emissions reporting requirements for companies that:

are organized in the United States;
have total annual revenues in excess of $1 billion; and
do business in California (known as a Reporting Entity).

According to the September 7, 2023, Assembly Floor Analysis, SB 253 is expected to impact more than 5300 companies.

SB 253 will usher in a new era of corporate responsibility by requiring all Reporting Entities to annually disclose their Scope 1, Scope 2, and Scope 3 greenhouse gas (GHG) emissions to a newly established statewide GHG emissions reporting organization. Under the umbrella of the California Environmental Protection Agency, the California Air Resources Board (CARB) will play a pivotal role in implementing this groundbreaking reporting program by January 1, 2025.

Starting in 2026, Reporting Entities will need to provide annual reports for Scope 1 and Scope 2 GHG emissions for the preceding fiscal year, with specific filing dates to be determined by CARB. The disclosure of annual Scope 3 GHG emissions will follow suit in 2027, with CARB setting the deadline no later than 180 days after the Scope 1 and Scope 2 GHG emissions deadline. However, on or before January 1, 2030, CARB is required to revisit and potentially update the date of these annual deadlines with the goal that the deadline for disclosure of Scope 3 GHG emissions would fall “as close in time as practicable” to the deadline for disclosure of Scopes 1 and 2 GHG emissions.

Defining the Scopes

As passed by the legislature, SB 253 includes the following definitions:

“Scope 1 emissions” means 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.
“Scope 2 emissions” means indirect greenhouse gas emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a reporting entity, regardless of location.
“Scope 3 emissions” means 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.

Alignment with GHG Protocol

Reporting Entities will be required to measure and report their emissions in accordance with the GHG Protocol’s standards and guidance. To streamline reporting efforts, CARB must minimize duplication and allow Reporting Entities to submit reports designed to meet other national and international reporting requirements, including federal government mandates, as long as they meet SB 253’s requirements as well. This should make setting up reporting to meet the new laws more efficient.

Independent Verification and Assurance

SB 253 mandates that third-party assurance providers – approved by CARB and with expertise in GHG emissions accounting – independently verify each Reporting Entity’s disclosures. Companies will need to establish processes and procedures for the auditing body to be able to carry out their independent verification. A financial reporting system like OneStream, which provides transparent and flexible reporting, in turn supports transparent auditing processes. Assurance for Scope 1 and Scope 2 GHG emissions will start at a limited assurance level in 2026 and move to a reasonable assurance level in 2030. Scope 3 GHG emissions might also require limited assurance beginning in 2030.

Transparency and Accountability

CARB, too, will be subject to its own reporting obligations, including contracting with an academic institution to prepare a comprehensive report by July 1, 2027 on the disclosures made by Reporting Entities. This report will consider “the context of state GHG emissions reduction and climate goals.” All emissions disclosures from Reporting Entities, as well as CARB’s report, will be made accessible to the public through a digital platform established by the new emissions reporting organization.

Fees and Penalties

To support the administration and implementation of the law, Reporting Entities will be required to pay an annual filing fee determined by CARB. SB 253 also authorizes administrative penalties of up to $500,000 for noncompliance, including late reporting or failure to report. Notably, there is a safe harbor provision for Scope 3 GHG emissions, exempting from penalties those misstatements that were “made with a reasonable basis and disclosed in good faith.” Until 2030, penalties will only apply to failures to disclose reporting on Scope 3 emissions.

Key Differences with SEC’s Proposed Rules

SEC’s proposed rules are set to apply only to public companies and investment firms, while the two California bills are applicable to both private and public companies.

The other major difference is the stringency relating to reporting of Scope 3 GHG emissions. While the SEC proposed regulations only require public companies to report Scope 3 emissions where such emissions are material or part of a reduction target, SB 253 requires Scope 3 emission reporting by all Reporting Entities, regardless of whether these emissions are material to the entity. It’s possible that the SEC rules might change between the proposed regulation and the final issued regulation, expected sometime in 2023.

Lastly, SB 253 authorizes (although does not require) CARB to establish third-party assurance for Scope 3 emissions in addition to required assurances for Scope 1 and 2 emission disclosures in line with the requirements outlined in the previous article. The SEC’s proposed rules will only require third-party assurance for Scope 1 and 2 GHG emissions.

Senate Bill 261: The Climate-Related Financial Risk Act

SB 261 imposes new reporting requirements on companies (1) organized in the United States, (2) with total revenues exceeding $500 million, and (3) conducting business in California. These companies, referred to as “Covered Entities,” will be obligated to prepare a biennial report disclosing their climate-related financial risks and the strategies they have adopted to mitigate these risks. The first of these reports must be publicly available on the company’s website by January 1, 2026.

One key difference with SB 253 is that SB 261 doesn’t rely on the California Air Resources Board (CARB) to develop additional regulations to facilitate the reporting program. Instead, companies will be required to follow the recommended frameworks outlined in the Final Report of Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

Defining Climate-Related Financial Risk

SB 261 defines “climate-related financial risk” as any “material risk of harm to immediate and long-term financial outcomes due to physical and transition risks, including, but not limited to, risks to corporate operations, provision of goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health.” This is a comprehensive definition that reflects the multifaceted nature of climate-related risks in today’s business landscape.

TCFD Framework as the Reporting Standard

One of the significant aspects of SB 261 is its reliance on the Task Force on Climate-related Financial Disclosures (TCFD) framework. TCFD provides comprehensive recommendations for businesses to assess and report their exposure to climate-related risks. These recommendations span four crucial areas: governance, strategy, risk management, and metrics and targets. TCFD’s guidance is already widely recognized and used by businesses across various sectors, providing a consistent and established framework for climate risk reporting, though it is not without detractors.

Alternatives to TCFD

While TCFD is the primary framework recommended by SB 261, Covered Entities can also comply by preparing a publicly accessible report voluntarily or pursuant to a law, regulation, or listing requirement issued by a government entity or regulated exchange. This alternative report must follow a framework consistent with SB 261’s requirements or the International Financial Reporting Standards Sustainability Disclosure Standards issued by the International Sustainability Standards Board (ISSB).

Oversight and Penalties

To ensure compliance, SB 261 requires the California Air Resources Board (CARB) to contract with a climate reporting organization that will prepare a biennial report analyzing the disclosures of Covered Entities. The report will assess systemic and sector-wide climate-related financial risks, including potential impacts on vulnerable communities. The climate reporting organization would also be responsible for gathering input on required disclosure from “representatives of sectors responsible for reporting climate-related financial risks, state agencies responsible for oversight of reporting sectors, investment managers, academic experts, standard-setting organizations, climate and corporate sustainability organizations, labor union representatives whose members work in impacted sectors, and other stakeholders.”

Violations of SB 261 can result in penalties of up to $50,000 per reporting year. Covered Entities are also required to pay an annual fee to cover CARB’s administrative and implementation costs related to the law.

Future Considerations

Now that Governor Newsom has signed SB 253 and SB 261 into law in California, the regulatory landscape for climate change disclosures in the United States is on the cusp of transformation.

In practical terms, companies that qualify as Reporting Entities or Covered Entities should begin by conducting an inventory of their existing climate-related disclosures. This includes what they’ve already published in SEC filings and on their websites, particularly on ESG-focused pages, or in standalone ESG reports. It will be crucial to assess what additional disclosures might be necessary to meet SB 253 and SB 261 requirements.

For privately held companies with little to no history of public climate-related disclosures, there might be a significant amount of work ahead. These businesses will have to build their reporting frameworks almost from the ground up.

SB 253, in particular, represents a milestone as the first broadly applicable law in the U.S. to mandate the assurance of Scope 1 and Scope 2 emissions reporting. This requires companies to explore options for conducting the necessary GHG emissions attestation. One key consideration will be whether to engage the services of an external auditor or other specialized provider. It’s important to note that any third-party assurance provider must obtain CARB’s approval by demonstrating expertise in GHG emissions accounting.

In addition to assurance considerations, companies might need to revamp their data collection and measurement processes for GHG emissions. For Scope 3 emissions, this might involve collaboration with industry resources and partners across their value chains. Such efforts might also necessitate adjustments to existing GHG emissions data collection schedules, potentially aligning them with fiscal years instead of calendar years.

Governor Newsom has voiced concerns about the overall financial impact of the bills and said that he is instructing CARB to closely monitor the cost impact and make recommendations to streamline the programs.

Now that these new laws are in effect, companies must become proactive in understanding the implications and intricacies of compliance. Early preparation will not only help in navigating the changing regulatory landscape, but also foster a commitment to sustainable and responsible business practices.

Corporate performance management (CPM) software such as OneStream is a powerful tool that can help both public and private companies establish successful measuring and reporting of all three types of emissions. OneStream can provide all of the following:

centralized data management
advanced analytics and scenario modelling
data validation and quality assurance
streamlined reporting
integration with financial planning processes and systems
transparent auditing capabilities

Companies that want to set up successful ESG reporting in order to comply with impending California and SEC regulations should consider a powerful platform like OneStream.

Conclusion

As California leads the way in ESG and climate accountability, businesses across the U.S. and globally can look to these laws as a benchmark for the future of corporate reporting. By embracing these changes and utilizing tools like OneStream, companies can ensure compliance with regulations. Furthermore, they will be actively contributing to a more sustainable and resilient future, while also maximizing financial gains and minimizing financial risks. It’s not just about compliance; it’s about making a positive impact and creating a world where responsible business practices are the norm, not the exception.

Citations & Sources

https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=202320240SB253.

The September 11, 2023 Senate Floor Analysis (the “SB 253 Analysis”) notes that existing tax code provisions define “doing business” in the state as “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.” Senate Rules Committee, Office of Senate Floor Analyses, SB 253, 2023-2024 Reg. Sess., at 2 (September 11, 2023)

https://leginfo.legislature.ca.gov/faces/billAnalysisClient.xhtml?bill_id=202320240SB253

https://www.gibsondunn.com/california-passes-climate-disclosure-legislation/#_ftn4