The Great ESG Divergence: a technical audit of the American Regulatory Schism

We reviewed if this year will be any changes regarding ESG on the USA market and would like to share a recent update that suggests a fundamental, and perhaps irreversible, bifurcation of the American corporate reporting landscape. While the federal government has effectively beat a strategic retreat into the safety of administrative abeyance, the state of California has accelerated into a regulatory vacuum, creating a “de facto” national standard that is as technically demanding as it is legally precarious. The result for the modern registrant is not the promised “standardization” of climate-related disclosures, but a “Balkanization” of mandates that pits the Securities and Exchange Commission’s (SEC) narrow focus on financial materiality against California’s broader, revenue-based transparency regime.

The SEC and the Doctrine of administrative abeyance

The trajectory of federal climate oversight has shifted from the ambitious “Enhancement and Standardization of Climate-Related Disclosures” to a state of near-total regulatory paralysis. Following the narrow 3-2 adoption of Final Rule 33-11275 in March 2024, the Commission initially sought to mandate a rigorous framework for disclosing material climate-related risks and, for the largest entities, Scope 1 and Scope 2 greenhouse gas (GHG) emissions. However, the immediate onslaught of litigation—consolidated in the U.S. Court of Appeals for the Eighth Circuit—forced a voluntary stay by the SEC in April 2024 to facilitate a “merits-based” resolution.

By early 2025, the institutional resolve of the Commission began to fracture under shifting political and judicial pressures. In February 2025, the SEC requested that the court refrain from scheduling oral arguments, citing the need for the Commission to determine next steps in light of significant changes in leadership and the broader federal deregulatory agenda. The most definitive signal of this retreat occurred in March 2025, when the SEC voted to end its defense of the Climate Disclosure Rules entirely. This abdication left a coalition of 18 states and the District of Columbia to intervene and defend the rules, leading to a September 2025 order by the Eighth Circuit to hold the case in abeyance until the SEC either reconsiders the rules through new notice-and-comment rulemaking or resumes its defense—an outcome deemed highly unlikely given the current regulatory climate.

The technical residuals of Rule 33-11275

Despite the current stay, the technical architecture of the SEC’s final rule remains the benchmark against which all other U.S. mandates are measured. The rule’s emphasis on materiality—defined through the lens of a “reasonable investor” determining whether to buy or sell securities—created a high threshold for disclosure. Unlike the universal mandates seen in the European Union, the SEC’s framework conditioned Scope 1 and 2 reporting on their financial significance to the registrant’s operations or strategy.

The rule also introduced quantitative requirements for financial statement footnotes, including the 1% threshold for disclosing expenditures and losses resulting from severe weather events.¹ If the aggregate amount of capitalized costs and charges equals or exceeds 1% of total shareholders’ equity or pretax income, a granular breakdown is required. This attempt to bridge the gap between qualitative narrative and audited financial data remains the most technically sophisticated—and controversial—element of the federal proposal. The “de minimis” thresholds, specifically $100,000 for expenditures and $500,000 for capitalized costs, were intended to prevent immaterial data from cluttering financial statements, yet they represent a significant accounting burden for firms with complex, geographically dispersed assets.

California’s climate accountability package: the new hegemony

As the federal government retreats, California has codified a more aggressive philosophy through its Climate Accountability Package. This suite of laws, primarily Senate Bills 253 and 261, discards the nuance of investor materiality in favor of revenue-based mandates that apply to both public and private entities. This shift represents a fundamental transformation of corporate duty, moving from informing the shareholder to informing the state.

SB 253: The Climate Corporate Data Accountability Act

SB 253 targets “reporting entities”—defined as any United States-domiciled partnership, corporation, or limited liability company with total annual revenues exceeding $1 billion that “does business in California”. The technical core of SB 253 is its mandatory reporting of Scopes 1, 2, and 3 emissions, calculated in accordance with the Greenhouse Gas Protocol.

The inclusion of Scope 3—emissions from the entire value chain—is the primary point of friction with the private sector. While the SEC eventually stripped Scope 3 from its federal rule to avoid “undue burden,” California has doubled down, requiring these disclosures starting in 2027 based on 2026 data. The California Air Resources Board (CARB) has proposed an initial Scope 1 and Scope 2 reporting deadline of August 10, 2026.

Defining the “Doing Business” Nexus

The reach of California’s laws depends entirely on the interpretation of “doing business.” CARB has proposed aligning this definition with the California Revenue and Taxation Code (RTC) § 23101, which establishes an economic nexus based on sales, property, or payroll. Notably, the “doing business” threshold is remarkably low: having sales in California that exceed approximately $735,019 (adjusted annually) or represent 25% of the entity’s total sales.

The judicial injunction of SB 261 and the first amendment battle

While SB 253 remains on track for its 2026 debut, its sibling, SB 261 (the Climate-Related Financial Risk Act), has encountered a significant judicial roadblock. SB 261 requires entities with over $500 million in revenue to publish biennial reports on their climate-related financial risks and mitigation strategies, using frameworks like the Task Force on Climate-related Financial Disclosures (TCFD).

On November 18, 2025, the U.S. Court of Appeals for the Ninth Circuit granted a temporary injunction of SB 261, effectively pausing the original January 1, 2026, reporting deadline. The court’s decision was rooted in the argument that the law potentially constitutes “compelled speech” in violation of the First Amendment. During oral arguments on January 9, 2026, the panel of judges expressed concern regarding the narrative nature of SB 261, questioning whether forcing companies to express views on climate change—which the court noted some consider controversial or political—crosses the line into unconstitutional speech.

The Data vs. Narrative Distinction

The legal defense of SB 253 and SB 261 rests on whether the required disclosures are classified as “commercial speech,” which receives a lower level of constitutional protection if the speech is “purely factual and uncontroversial”. The industry plaintiffs, led by the U.S. Chamber of Commerce, argue that climate disclosures are inherently political and theological, not commercial.

A critical distinction has emerged in the Ninth Circuit:

1. SB 253 (Data): The court has allowed SB 253 to proceed, potentially viewing GHG emissions data as closer to factual commercial disclosure.
2. SB 261 (Narrative): The court’s injunction suggests that qualitative risk assessments and strategic descriptions are more likely to be viewed as “compelled opinion”.

CARB has indicated it will not enforce SB 261 during the pendency of the appeal, though it has opened a voluntary public docket for companies that choose to disclose anyway.

Technical nuances of assurance and verification

The transition from voluntary to mandatory reporting has elevated the importance of third-party “assurance.” Under the now-stayed SEC rule, Large Accelerated Filers were expected to progress from “limited assurance” (a negative-confirmation review) to “reasonable assurance” (a positive-confirmation audit equivalent) over a period of seven years. California’s SB 253 follows a similar path but with a more compressed timeline. While CARB’s proposed regulations for the first year (2026) do not yet codify a strict limited assurance requirement—instead allowing for a “good faith effort” or a statement on company letterhead for those not yet collecting data—the statutory mandate for assurance remains a long-term liability.

The Assurance Phase-In comparison

The reasonable assurance requirement represents a massive technical hurdle. It requires rigorous internal controls over data collection, traceability to the source, and a high degree of confidence in the underlying calculations—mathematically represented as the sum of activity data multiplied by emission factors, with an error margin () that must be minimized through auditable evidence. The complexity of Scope 3—where data is often sourced from thousands of un-audited suppliers—makes “reasonable assurance” for value-chain emissions an almost insurmountable challenge for the current professional services infrastructure.

AB 1305: The war on greenwashing and the carbon offset market

While SB 253 and 261 battle in court, California’s Voluntary Carbon Market Disclosures Act (AB 1305) is already in effect, having become law on January 1, 2024. AB 1305 is perhaps the most immediate threat to corporate communication, targeting greenwashing by requiring specific, technical evidence for any claims of “net zero,” “carbon neutral,” or “significant greenhouse gas reductions”.

The Three Prongs of AB 1305

The statute establishes three distinct reporting categories, each requiring annual website updates:

1. Sellers of Voluntary Carbon Offsets (VCOs): Must disclose project location, durability, protocols used, and verification standards.
2. Purchasers/Users of VCOs: If a company uses offsets to support a “net zero” claim, it must disclose the registry, the project ID, and the methodology used to calculate the offset’s benefit.
3. Makers of Climate Claims: Any entity making a claim of carbon neutrality—even if not using offsets—must disclose the science-based targets and data used to substantiate that claim.

A critical clarification from the California Attorney General in July 2024 noted that Renewable Energy Credits (RECs) do not fall under the definition of VCOs, as they represent the environmental attributes of electricity generation rather than a specific atmospheric reduction or removal. This distinction is vital for utilities and tech companies that rely heavily on RECs to achieve Scope 2 targets.

The federal deregulatory pivot: a growing disconnect

The stagnation of the SEC rule is not an isolated event but part of a broader federal retreat from climate-related financial supervision. In October 2025, the Treasury Department, the Federal Reserve, and the FDIC officially rescinded their “Principles for Climate-Related Financial Risk Management for Large Financial Institutions,” arguing that existing risk management processes were sufficient and that specific climate principles were a distraction.

Simultaneously, the Environmental Protection Agency (EPA) proposed a rule in September 2025 to effectively end its Greenhouse Gas Reporting Program for most source categories, potentially making 2024 the final year of data collection. This federal trend, coupled with Executive Order 14192 (the “10-in, 1-out” regulatory budgeting rule), creates a stark contrast with California’s trajectory.

The impact of regulatory balkanization

The primary consequence of this divergence is the “California Effect” on national standards. Because the $1 billion revenue threshold for SB 253 captures roughly 5,400 of the world’s largest companies—many of which are headquartered outside California—the state is effectively setting the reporting standard for the entire U.S. market.

Companies now face a compliance paradox:

• Federal regulators are providing relief and rescinding rules.
• State regulators are imposing mandates that are more stringent than the federal rules ever were (e.g., mandatory Scope 3).
• Judicial courts are creating a wait-and-see environment where enforcement is stayed but statutory deadlines remain technically firm.

The ninth circuit oral arguments: a deep dive into “Compelled Speech”

The oral arguments held on January 9, 2026, before the Ninth Circuit (Judges Nguyen, Bennett, and Matsumoto) represent the frontline of the legal battle over climate transparency. The panel repeatedly returned to the burden of Scope 3 emissions reporting under SB 253, asking whether the state could justify forcing a company to assume responsibility for emissions data generated by third parties.

Judge Nguyen’s questioning focused on the breadth of SB 261, asking the State to distinguish California’s requirements from those already mandated by federal securities laws. The State acknowledged an overlap but argued that SB 261 provides “decision-useful” information that federal laws lack. A pivotal moment in the hearing occurred when the panel suggested that if the Scope 3 requirements of SB 253 were found to be unconstitutional, they might be “severable,” allowing the Scope 1 and 2 mandates to remain in place.

The Commercial Speech Threshold: Zauderer vs. Central Hudson

The legal debate hinges on which First Amendment standard applies. The State of California argues for the Zauderer standard, which allows the government to compel “purely factual and uncontroversial” commercial disclosures to prevent consumer deception. The industry plaintiffs argue for Central Hudson or even “strict scrutiny,” claiming that climate change is a matter of intense public debate and therefore “controversial” by definition.

If the court views GHG emissions as a “fact of production” (like a nutrition label), SB 253 likely survives. If the court views the risk report of SB 261 as a “narrative on public policy,” it is significantly more vulnerable.

The accounting burden: identifying material impacts

The technical specifications of the SEC’s Rule 33-11275, though currently stayed, offer a glimpse into the granular data expected by sophisticated investors. The “1% rule” for financial statement impacts is particularly onerous. Under this rule, registrants must disclose the aggregate amount of expenditures expensed as incurred and losses resulting from severe weather events and other natural conditions, such as:

• Hurricanes and tornadoes.
• Wildfires and extreme temperatures.
• Sea level rise and flooding.

This requires companies to develop internal “attribution” models to determine if a specific expenditure (e.g., the repair of a warehouse) was a “direct result” of a climate event or merely routine maintenance. The rule’s safe harbor provision for forward-looking statements pertaining to transition plans and scenario analysis provides some protection, but it does not apply to “historical facts”.

Future outlook: the resurgence of semi-annual reporting?

As the regulatory environment shifts, broader structural changes to corporate reporting are being discussed. In September 2025, President Trump revived proposals to move from quarterly to semi-annual reporting as a cost-saving measure for public companies. If adopted, this would represent the most significant change to the Exchange Act’s reporting regime in decades, further distancing the U.S. from the frequent and granular sustainability reporting seen in the UK and EU.

Furthermore, the SEC’s “Spring 2025 Reg Flex Agenda” included deregulatory rulemaking proposals to amend existing rules to “reduce burdens on registrants”. This suggests that even if the climate rules were to survive the Eighth Circuit, they might be “rescinded or substantially revised” through a new notice-and-comment process.

The burden of compliance in a fractured market

The current year is defined by a paradox: a federal “deregulatory spring” occurring simultaneously with a “California compliance winter.” For the global investor, the result is a massive information asymmetry. Companies that operate in California will be forced to disclose deep value-chain emissions and narrative risk reports that their competitors in other states may avoid—unless those competitors also meet the “doing business” threshold.

For executive boards, the takeaway is clear: the federal pause is not a reprieve. The center of gravity for ESG regulation has shifted from Washington D.C. to Sacramento. Those who wait for federal clarity risk being caught in the crosshairs of California’s enforcement division, where “good faith” only buys so much time before the $500,000-per-year penalties begin to accrue. The era of voluntary ESG is over; the era of legally-defensible, state-mandated climate data has arrived. The technical rigor required to comply with California’s August 10, 2026, deadline means that data collection systems must be finalized this fiscal year. Any delay in establishing internal controls over GHG inventories will likely result in misstatements that the Ninth Circuit may or may not protect under the First Amendment. In the fragmented republic of American ESG, silence is no longer a viable strategy.

Detailed analysis of SEC Rule 33-11275 technical requirements

The SEC’s final rule, spanning nearly 900 pages, is a testament to the complexity of quantifying environmental risk within a financial framework. The Commission’s decision to move away from the proposed “line-item-by-line-item” reporting to the 1% aggregate threshold was a concession to registrants who argued that the original proposal would have been “unworkable”. However, the 1% rule still requires a sophisticated level of disaggregation.

Financial Statement Metrics (Article 14 of Regulation S-X)

The final rule requires registrants to disclose the following in a note to the financial statements:

1. Severe Weather Events and Other Natural Conditions: The aggregate amount of expenditures expensed as incurred and losses, excluding recoveries, resulting from severe weather events.
2. Carbon Offsets and RECs: If carbon offsets or renewable energy certificates (RECs) have been used as a material component of the registrant’s plan to achieve climate-related targets or goals, the registrant must disclose the capitalized costs and expenses incurred.

The “materiality” of these offsets is a recurring theme. Unlike AB 1305, which requires disclosure of all offsets, the SEC rule only triggers disclosure if they are “material” to the achievement of stated goals. This provides a significant loophole for firms that use small numbers of offsets to claim “carbon neutrality” without triggering SEC-mandated technical disclosures.

Governance and Risk Management (Subpart 1500 of Regulation S-K)

The qualitative side of the SEC rule is modeled heavily on the TCFD framework. Registrants must describe:

• The board’s oversight of climate-related risks.
• Management’s role in assessing and managing these risks.
• The impact of climate-related risks on the registrant’s business strategy, results of operations, and financial condition.

The “time horizons” for these risks—short-term (next 12 months) and long-term (beyond 12 months)—require firms to engage in scenario analysis that many have not previously performed at a level suitable for SEC filings.

SB 253 and the technical mechanics of the GHG Protocol

California’s SB 253 is not just a reporting law; it is an adoption of the Greenhouse Gas Protocol (GHGP) as a legal standard. The GHGP is the most widely used international standard for calculating emissions, but its application in a mandatory legal context raises several technical challenges.

Organizational Boundaries: Financial vs. Operational Control

One of the most complex decisions for a “reporting entity” is defining its organizational boundary. The GHGP allows for “equity share,” “financial control,” or “operational control” approaches. The SEC rule originally required the same boundaries as the consolidated financial statements, but the final rule allowed more flexibility, provided the registrant explains any differences. California’s SB 253, however, mandates strict adherence to the GHGP, which may force companies to report emissions from joint ventures or subsidiaries that are not consolidated in their 10-K.

The Scope 3 Quantification Dilemma

The “Scope 3” requirement in SB 253 is the primary driver of compliance costs. Scope 3 covers 15 categories of emissions, ranging from “Purchased Goods and Services” to “Use of Sold Products.” For many firms, Scope 3 represents over 90% of their total climate impact.

The technical challenge lies in data quality:

1. Primary Data: Sourced directly from suppliers (rarely available for the entire supply chain).
2. Secondary Data: Based on industry averages or spend-based emission factors (less accurate, but more feasible).

SB 253 includes a “safe harbor” for Scope 3 emissions until 2030, meaning companies will not be penalized for unintentional misstatements as long as they are made in “good faith” and have a “reasonable basis”.

SB 261: TCFD and the Narrative of Financial Risk

SB 261 is often overshadowed by the emissions data of SB 253, but its narrative requirements are arguably more dangerous from a litigation perspective. By requiring companies to describe their “financial risks” from climate change, the law forces executives to make public predictions about the impact of future regulations, market shifts, and physical disasters.

The TCFD framework, which SB 261 adopts, is built on four pillars:

1. Governance: The organization’s governance around climate-related risks and opportunities.
2. Strategy: The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning.
3. Risk Management: The processes used by the organization to identify, assess, and manage climate-related risks.
4. Metrics and Targets: The metrics and targets used to assess and manage relevant climate-related risks and opportunities.

The Ninth Circuit’s concern is that these narrative pillars require companies to take a stance on “controversial” topics, such as the likelihood of a carbon tax or the speed of the transition to electric vehicles.

AB 1305 and the Substantiation of “Net Zero”

While SB 253 and 261 are about transparency, AB 1305 is about truth in advertising. It is effectively an “anti-greenwashing” statute with teeth. Any company doing business in California that makes a “net zero” or “carbon neutral” claim must provide a technical “substantiation” on its website.

The disclosure must include:

• The science-based targets used for emission reductions.
• Whether the claims have been verified by an independent third party.
• How interim progress toward the goal is being measured.

This requirement applies to claims made “within the state,” which California interprets to include any claim accessible via a website in California. This “extraterritorial” reach is a hallmark of California’s regulatory strategy.

Market-wide implications: The “California Effect” on supply chains

The interaction between these laws creates a ripple effect across the U.S. economy. A $1 billion company subject to SB 253 will be forced to ask its $10 million suppliers for their emissions data in order to calculate its Scope 3 inventory. Thus, even though the $10 million company is not technically subject to the law, it must comply with California’s data requirements to maintain its contract with the larger firm.

This “contractual mandate” is precisely what the U.S. Chamber of Commerce argued against in its litigation, claiming it effectively regulates businesses that have no nexus to California.

The new regulatory equilibrium

The American ESG landscape has reached a new, unstable equilibrium. The federal government, once the driver of standardized climate disclosure, has retreated into a defensive posture, leaving companies and investors in a state of “litigation-induced blindness” regarding federal rules. California, meanwhile, has moved forward with a regime that is broader, more technical, and less forgiving than anything previously proposed at the national level.

For firms caught in the middle, the cost of capital will increasingly depend on the ability to navigate this regulatory schism. Those who can produce auditable, GHGP-compliant data will find favor in a market that is hungry for “decision-useful” information. Those who rely on narrative fluff and unsubstantiated “net zero” claims will find themselves increasingly vulnerable—both to California’s aggressive regulators and to the “sharp” scrutiny of a judicial system that is still deciding whether climate risk is a fact or an opinion.

The message for the current year is clear: do not wait for the Eighth Circuit. California has already spoken, and its August 2026 deadline is approaching with the relentless certainty of the next wildfire season.

To determine if an entity is in scope for the California laws, CARB has proposed using the “lesser of the last two fiscal years” of revenue.

Note: Revenue is based on “gross receipts” as defined by RTC § 25120(f)(2).

As companies finalize their FY 2025 accounts, these calculations will determine the next decade of their regulatory relationship with the Golden State. The time for technical preparation is now.