New California Climate Disclosure Requirements and Their Relevance to Asset Managers and Their Portfolio Companies

On this episode of Ropes & Gray’s California Law for Asset Managers podcast series, asset management partner Catherine Skulan, corporate partner and global ESG, CSR & business and human rights practice head Michael Littenberg and counsel Marc Rotter discuss three new climate and greenhouse gas bills recently signed into California law: AB 1305, SB 261 and SB 253. Each law creates new public disclosure requirements about climate-related issues that may impact asset managers and their portfolio companies.

Transcript:

Catherine Skulan: Hello, and welcome to another installment of our Ropes & Gray podcast series on California Law for Asset Managers. I’m Catherine Skulan, a partner in the Ropes & Gray asset management group in San Francisco. I’m joined today by Michael Littenberg and Marc Rotter in New York. Michael is a senior partner and the global head of Ropes & Gray’s ESG, CSR & business and human rights compliance practice. Marc is a counsel at Ropes & Gray. Michael and Marc have extensive experience advising leading companies and sponsors on their mandatory and voluntary ESG disclosures, including to meet U.S. state and federal, EU and UK requirements, as well as to conform to voluntary frameworks and standards.

There were several bills signed into law in California this year that focus on environmental, social and governance (ESG) issues that may impact asset managers and their portfolio companies. In our last discussion, we talked about SB 54, Fair Investment Practices by Investment Advisers. Today, we’ll talk about a trio of laws focused on climate and greenhouse gas disclosure that were signed by California Governor Gavin Newsom on October 7, 2023. Those three laws are AB 1305, titled the Voluntary Carbon Market Disclosures Act, SB 261, titled the Climate‐Related Financial Risk Act and SB 253, titled the Climate Corporate Data Accountability Act. Each of these bills is drafted broadly enough to affect portfolio companies and at least some asset managers. Let’s talk about each of these pieces of legislation and key open questions that we think will be of particular interest to our listeners. Michael, could you start us off with a high-level overview to orient our conversation?

Michael Littenberg: Certainly, Catherine. I’m happy to do so and thanks for inviting us to join you here today. As you noted, each of these three pieces of legislation imposes new disclosure obligations that may impact asset managers and their portfolio companies. I’ll use the bill numbers today, since that’s how most people are continuing to refer to these Acts. First, AB 1305 addresses the marketing, sale and use of voluntary carbon offsets (VCOs). It also more generally addresses net zero claims and claims regarding significant greenhouse gas emissions reductions. At a high-level, AB 1305 applies to VCOs that are marketed and sold in California, companies that are operating in California and claims made in California. SB 253 requires Scope 1, Scope 2 and Scope 3 greenhouse gas emissions disclosures—and Marc will go into in more detail in a minute what those “Scope” categories mean. As for this second piece of legislation, SB 253 applies to entities organized in the United States that do business in California and have at least $1 billion in annual revenue. Turning to the third law, SB 261 mandates biennial Task Force on Climate-related Financial Disclosures (TCFD) reporting. Like SB 253, it only applies to entities that are organized in the United States that do business in California, but it has a lower revenue threshold of at least $500 million.

Marc Rotter: Of the three bills, AB 1305 has been the biggest focus of asset managers in recent weeks. Unlike SB 253 and SB 261, AB 1305 doesn’t have a revenue threshold. Many asset managers make claims about their carbon impact in sustainability reports, marketing materials and elsewhere. Those claims could bring them into scope of the statute. AB 1305 would require any entity that fits into one of the following two buckets to publish disclosure on that entity’s website. In bucket 1 are entities that market or sell VCOs in California. Entities that fit within bucket 1 will need to include information about each VCO, including the emissions reduced or carbon removed, details about the project and data and calculation methods needed to independently reproduce and verify the number of emissions reduction or removal credits issued using the protocol. Bucket 2 is much broader, requiring disclosure by any entity that makes claims about itself, a related or affiliated entity or a product implying that it does not add net greenhouse gas (GHG) emissions or that it has made significant reductions to GHG emissions. The statute requires that they provide “all information” as to how a “carbon neutral,” “net zero emission,” or similar claim was determined to be accurate or accomplished, how interim progress is measured and if there is independent third-party verification of the data and claims. Entities that fit into bucket 2 and that use voluntary carbon offsets need to make additional disclosures about the VCOs that they use. There’s no private right of action under AB 1305, but it can be enforced by the Attorney General and by any district attorney, county counsel or city attorney in the State of California. The penalties for failing to have the disclosure are monetary fines of $2,500 per day, up to a maximum of $500,000 per violation.

Michael Littenberg: One of the big topics of discussion concerning AB 1305 is when it comes into effect. Unlike the other two laws, AB 1305 doesn’t specify an effective date. Under California law, that means it would automatically come into effect on January 1, 2024. That’s left a lot of asset managers and corporates scrambling to quickly understand the statute and also to put together disclosure to satisfy its requirements. Muddying the waters a bit, the bill’s sponsor, Assembly Member Gabriel, recently published a letter stating that his intent was for the deadline for the first disclosures under the Act to be January 1, 2025, not the beginning of 2024. While that letter cannot and does not unilaterally amend the statute to add an effective date of January 1, 2025, managers and other subject companies are taking that letter into account in their compliance strategy.

Catherine Skulan: There’s a lot for asset managers to unpack here. In addition to the effective date, a key question for asset managers is going to be if they or their portfolio companies are in scope. And apologies for the avalanche of questions, but, for example: What’s a “claim” and do the statements made by asset managers count as claims? Similarly, do financial products count as “products” under the statute? How does one interpret the requirement to present “all information”? Does disclosure need to be updated over time?

Marc Rotter: All great questions. AB 1305 presents a lot of interpretive questions, and very little in the way of guidance or definitions. At its core, AB 1305 is an anti-greenwashing statute intended to help people evaluate carbon-related claims that are being made about entities and products. Following from that, many commentators appear to be interpreting “claim” and “product” broadly. As for the “all information” standard, presenting “all information” is obviously impossible. But, given the purpose of the statute, in the absence of guidance, many commentators appear to be landing at a “reasonable person” standard—i.e., what information would a reasonable user of the information be expected to care about. With respect to updating, the statute says that the disclosure needs to be updated “at least” annually. That seems to imply that updates may be required more frequently than annually. While the statute doesn’t provide any guidance as to when updates are required, again, we think many market participants will in the absence of guidance use a “reasonable person” standard.

Catherine Skulan: One last question on AB 1305: Are you seeing any trends in how asset managers are thinking about how they plan to comply with it?

Michael Littenberg: We are starting to see some emerging trends, Catherine. With respect to VCO disclosure, many asset managers are putting together tables that include the information that’s required by the statute, for posting on their website. Unlike the “all information” standard for claims about carbon impact that Marc spoke about a moment ago, the disclosure requirements specific to VCOs are fairly prescriptive and in most cases can likely be addressed in tabular form. With respect to the information about claims on carbon impact, many of those subject entities already are making responsive information public, so in most cases compliance with that part of AB 1305 is unlikely to be a big lift.

Catherine Skulan: That’s good news. Let’s move on to the other two laws, SB 253 and SB 261. What do asset managers need to know about these?

Marc Rotter: Fortunately, both of those laws have a longer fuse than AB 1305. They both require reporting to begin in 2026. SB 253 has phased in reporting requirements, with reporting of Scope 1 and Scope 2 emissions to begin in 2026 and Scope 3 emissions in 2027. Scope 1 emissions are an asset manager’s emissions from its own operations. Scope 2 emissions are emissions from purchased energy. Scope 3 emissions are emissions of other entities in the asset manager’s value chain—that typically includes, for example, portfolio companies and service providers. Assurance requirements for disclosure under SB 253 will also phase in over time. Scope 1 and Scope 2 emissions need to receive limited assurance from an independent third-party assurance provider beginning in 2026, moving to reasonable assurance in 2030. Scope 3 emissions need to start receiving limited assurance in 2030.

When signing SB 253 and SB 261, Governor Newsom stated that he had concerns about the timeline and costs of SB 253 and SB 261, and that he planned to work with the legislature to address those issues. However, just recently, the sponsor of SB 253 stated that he would not support any delays. We’ll be closely watching how that shakes out over the next year.

Catherine Skulan: Thanks, Marc. Now, Michael, you mentioned at the outset that both SB 253 and SB 261 have revenue thresholds. Entities only need to report under SB 253 if they have more than $1 billion in annual revenue and only need to report under SB 261 if they have more than $500 million in annual revenue. Do asset managers need to consolidate revenue from their portfolio companies when considering this threshold?

Michael Littenberg: Neither SB 253 nor SB 261 specifies how revenue is to be calculated. Unlike AB 1305, each of SB 253 and SB 261 give the California Air Resources Board (CARB) authority to adopt implementing regulations. I’m optimistic that those will provide clarity on that question that does not go beyond U.S. GAAP principles of consolidation.

Catherine Skulan: Does that mean privately owned portfolio companies could need to report?

Michael Littenberg: Yes, that’s right. At the portco level, none of the three statutes that we’ve discussed today are limited to public companies. Each of them will pick up a significant number of private companies in fact.

Catherine Skulan: Now, that’s interesting, especially with respect to SB 261. In many cases, the portfolio companies that are privately owned don’t publish much in the way of public disclosure. SB 261 would require them to publish TCFD reports, which go beyond just greenhouse gas emissions and talk about, among other things, climate-related risks, governance and strategy. Portfolio companies will need to think about how to present and contextualize that information to the market in the absence of more fulsome public financial disclosure.

Now, I’m mindful of the time, but there is one last question I wanted to pose to you: How do you think these new California rules will interact with other climate disclosure requirements that apply to asset managers and portfolio companies?

Marc Rotter: The California rules are only part of the climate disclosure requirements that asset managers and portfolio companies will need to comply with. SEC Chairman Gensler has already stated that the new California requirements will change the cost-benefit analysis for the SEC’s proposed climate rules for issuers, which as proposed would affect any portfolio companies planning to IPO in the United States, because many companies will already need to produce at least some of the information called for by any final SEC rule in order to comply with the California requirements. More generally, asset managers and portfolio companies will need to think about complying with EU requirements such CSRD and SFDR, requirements in other jurisdictions like the UK and other state laws. For example, last session, the New York legislature considered, but did not adopt, a law similar to but not identical with some of the California requirements we discussed today. New disclosure requirements are also being considered in other jurisdictions.

Michael Littenberg: I think preparing consistent disclosure to address all of these different requirements is going to become an increasing challenge and compliance with some of the new requirements will be time consuming and costly. We’re hopeful that many jurisdictions will eventually coalesce around consistent global standards, but, I think that’s likely to take some time and there will in any event continue to be divergence across jurisdictions, which in some cases will wind up being substantial. It’s particularly important, I think, for private equity managers to understand significant new portfolio disclosure requirements relating to climate and also to proactively make sure their portfolio companies are taking appropriate steps to meet these new requirements. Over the last several months, we have been participating in numerous meetings and presentations on these topics with asset managers and portcos—too many to count—reflecting the importance that they are placing on this topic.

Catherine Skulan: Thanks, Michael and Marc—there’s certainly a lot to do. And unfortunately, that’s all we have time for today—I hope this discussion on AB 1305, SB 251 and SB 263 has been helpful. For our listeners, please visit www.ropesgray.com for additional news and commentary about other important asset management developments as they arise. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including on Apple and Spotify. If you’d like to learn more about any of the topics we discussed today, or if we can help you to navigate any of the three new laws discussed today in a more tailored way, please do not hesitate to contact us. Thanks again for listening.