How California’s Climate Disclosure Law Impacts Lenders in Subscription Credit Facilities
Executive Summary
As part of its Climate Accountability Package, California passed a law last year that creates disclosure requirements related to greenhouse gas (GHG) emissions for thousands of U.S. companies, including certain borrowers and lenders in subscription credit facilities. In this Legal Update, we explain the scope of this law, the obligations it may create for lenders in subscription credit facilities, and pending litigation regarding the law.
Background
Last October, California passed Climate Corporate Data Accountability Act (SB-253), which requires disclosures related to GHG emissions.1
Subscription credit facility lenders (SCF Lenders) may be subject to certain disclosure requirements regarding GHG emissions under this law. Although there is pending litigation challenging the constitutionality of the law and seeking to overturn it (as further described below), SCF Lenders should understand the statutory disclosure requirements, including nuances regarding a fund’s portfolio companies and what an SCF Lender should consider when deciding whether to lend to a fund.
What to Know About SB-253: the Climate Corporate Data Accountability Act
SB-253: Climate Corporate Data Accountability Act
Under SB-253: Climate Corporate Data Accountability Act, U.S. partnerships, corporations, LLCs, and other US business entities “doing business”2 in California and generating over $1 billion in total annual global revenue must annually disclose their Scope 1, 2, and 3 GHG emissions to a nonprofit emissions reporting organization contracted by the California Air Resources Board (CARB).
Scope 1 emissions are direct GHG emissions from sources controlled or owned by an entity, such as vehicle emissions. Scope 2 emissions are indirect GHG emissions resulting from an entity’s energy use, including the purchase of electricity, steam, heat, or cooling. Scope 3 emissions – or “value chain” emissions – are indirect upstream and downstream GHG emissions that an entity doesn’t produce or are the result of an entity’s activities, such as operations-generated waste, business travel, investments, and, importantly for SCF Lenders, financed emissions. Financed emissions are, among other things, emissions linked to a lender’s loan portfolio.
Given that SB-253 currently requires reporting entities to disclose Scope 3 GHG emissions, SCF Lenders could be required to make disclosures related to relevant GHG emissions resulting from activities that were financed by a subscription credit facility. Under SB-253, such disclosures would need to be made to the emissions reporting organization and prepared in accordance with the GHG Protocol Corporate Accounting and Reporting Standard and the Greenhouse Gas Protocol Corporate Value Chain (the “GHG Protocol”).
It is currently unclear whether reporting on financed emissions would be optional or required for SCF Lenders, particularly with respect to a fund’s portfolio companies. Currently, under the GHG Protocol, an SCF Lender’s relationship with a fund’s portfolio companies may be considered “debt investments (with no known use of proceeds),” and reporting on such category for financed emissions is currently optional if borrowed at the fund level. However, if borrowed at the portfolio company level (i.e., the qualified borrower level), reporting may not be optional if the SCF Lender knows that the portfolio company will use the proceeds for a particular project (for example, a specific power plant).
Additionally, not only do the reporting obligations for financed emissions at the fund level appear to be optional, but the GHG Protocol also does not offer any detailed guidance or calculation guidance for investments covered by short-term debt (such as revolving credit facilities). The GHG Protocol offers calculation methodologies applicable to investments covered by long-term debt, but investments covered by short-term debt pose additional accounting challenges that are not covered in the guidance.
Lawsuit Challenging Constitutionality of SB-253; Governor’s Proposed Amendments
On January 30, 2024, the US Chamber of Commerce, the California Chamber of Commerce and several other business groups filed a lawsuit against CARB challenging the constitutionality of SB-253 and another law passed under the Climate Accountability Package, SB-261: Climate-Related Financial Risk Act. 3 The plaintiffs allege that these laws violate the First Amendment by requiring companies to make “high-stakes, public guesses” on climate change, a politically controversial topic. The lawsuit also raises Supremacy Clause arguments and asserts that these laws impose significant burdens on commerce without adequate corresponding benefits. While the result of the litigation is uncertain and additional legal challenges may arise, SCF Lenders should be aware of the law’s requirements so they are prepared if and when they take effect. 4
Furthermore, on July 15, 2024, Governor Newsom proposed amendments that would, among other things, delay initial reporting deadlines for two of California’s recently enacted climate-disclosure laws by two years.5 However, these proposed amendments were not ultimately enacted by the California legislature and covered entities, and therefore did not receive the benefit of these proposed delays in the initial reports deadlines. Instead, on September 27, the California legislature passed SB-219, which, among other things, provides CARB with an additional six months to publish regulations for GHG emissions disclosures, as well as the flexibility to set the schedule for Scope 3 GHG emissions disclosure, with the initial disclosure required by a to-be-specified date in 2027.6
Given these developments and uncertainties, SCF Lenders should continue to monitor developments and any guidance regarding disclosure requirements for Scope 3 emissions by SCF Lenders. Specifically, in its current form, SB-253 requires CARB to develop implementing regulations with respect to the disclosures and levels of assurance required by the beginning of 2025, so if and when issued, these regulations should provide more light on the nature and extent of the disclosures.7 Should it be determined that reporting on Scope 3 emissions would ultimately be required by SCF Lenders, they would be required to disclose any Scope 3 emissions in 2027. Penalties for non-compliance are up to $500,000 per year.
While Scope 3 disclosure reporting does not begin until in 2027 under the current form of SB-253 (as amended by SB-219), SCF Lenders should consider tightening their approval processes for qualified borrowers and reporting procedures now, so they are prepared if the GHG Protocol is updated regarding revolving credit facilities and debt investments.
Key Takeaways
It is currently unclear whether reporting obligations for Scope 3 emissions for SCF Lenders are required or optional, and detailed calculation guidance for optionally reported investment types are currently not available. Additionally, pending litigation challenging the law may jeopardize the viability and scope of the rules, or otherwise change the requirements and timing for compliance. Nonetheless, and as potentially covered entities await further guidance from the CARB regulations to be provided by July 1, 2025, SCF Lenders may want to preemptively assess the GHG impact of the portfolio companies that are part of the fund borrowing under a subscription credit facility. In addition to potential penalties for non-compliance, SCF Lenders should consider the possibility of reputational risk when lending to funds with portfolio companies that have high GHG emissions that could ultimately be disclosed. Although actual Scope 3 emissions are not under the lender’s control, SCF Lenders may still want to consider a portfolio company’s anticipated emissions when making investment decisions, which could influence a fund’s decision to invest in portfolio companies with high emissions.
For Additional Information:
Are you “Doing Business” in California?
Lawsuit Challenges Recent California Climate Disclosure Laws
Governor Newsom Proposes Delay of California Climate Disclosure Laws
1 See our prior Legal Update on SB-253. This update also addresses the other law passed as part of the Climate Accountability Package, which relates to disclosures relating to climate-related financial risk – SB-261 or the Climate-Related Financial Risk Act.
2 See our prior Legal Update discussing what it means to be “doing business” in California. While SB-253 does not – on its face – define “doing business,” the law’s legislative history suggests that “doing business” will be determined on the basis of the test established by the California Revenue and Tax Code.
3 See our prior legal update discussing this legal challenge in detail, which can be accessed here.
4 In addition to this lawsuit, on March 6, 2024, the SEC published final rules mandating climate risk disclosures by public companies and in public offerings. The final rules eliminated the requirement to provide Scope 3 emissions disclosure, based on comments that the SEC received to the proposed rules. However, on April 4, 2024, the SEC stayed the climate disclosure rules pending review in the U.S. Court of Appeals for the Eighth Circuit.
5 See our recent legal update on the Governor’s proposed amendments here.
6 See the text of SB 219, Greenhouse gases: climate corporate accountability: climate-related financial risk.
