The Securities and Exchange Commission (SEC) recently proposed new rules that will require U.S. public companies to disclose a number of aspects related to their climate exposures. Once enacted, these new rules would compel companies to disclose how climate risks affect their business and mandate that public companies be held to account for their exposures and strategies for managing environmental risks as well as targets to mitigate climate change.
It is important to note that these SEC rules are an effort to provide uniform information to investors but are not requirements for companies to actually reduce their climate footprints. That role will be left to the market.
The SEC originally issued voluntary climate-related guidance in 2010, but this is the first time mandatory disclosure rules were put forward. This action was highly anticipated, being a chief cause supported by SEC Chairman Gary Gensler. The SEC issued and approved, with a 3-1 vote, this 510-page proposal on March 21, with the next step being a two-month public comment period during which the proposed rules will evolve. This will take a while to fully play out, but it will nonetheless be a catalyst for major changes.
“This is a core bargain Congress laid out in the 1930s,” SEC’s Gensler said following the proposal’s release, adding that “investors get to decide which risks to take as long as public companies provide full and fair disclosure and are truthful in those disclosures.” The SEC action is part of a governmentwide effort to identify climate risks, with new regulations planned from various agencies touching on the financial industry, housing, and agriculture, among other areas.
The number of investors seeking additional and more consistent information on risks related to global warming has grown dramatically in recent years. Many companies already provide climate-risk information voluntarily as companies, public and private, have historically been able to tell their own narrative most often in their own way. Climate disclosures are a unique challenge, much different from more familiar and much longer standing financial disclosures. This nouveau market still remains predominantly unregulated with various levels, or scopes, of emissions and a number of ways to measure, account, report, and mitigate and/or offset them. These are some of the many difficulties with this rapidly developing market that SEC is looking to help resolve.
Attempts to standardize and disclose these environmental factors will come with a significant degree of dissent, particularly over what many insist are added burdens imposed by compliance to these new rules and their effects on costs and to consumers. There exists a significant threat that opponents could take the SEC to court over these new climate-related regulations.
Proponents, however, are staunch in their view that these rules will increase transparency and comparability into a company’s climate-related risks and allow capital to flow from perceived climate laggards towards those companies that are more proactive when it comes to measuring and tackling their climate exposures, thus helping to reduce their cost of capital.
The SEC is proposing that any climate-related information that poses risks to a public company’s financial condition will have to formally be reported in SEC required reports, such as in prospectuses, and in scheduled 10-Q and 10-K Forms, for example.
Public companies that have promised to eliminate greenhouse gas emissions or reduce their impact with a net-zero plan must report annually on their progress, including detailed reports of the use of carbon offsets.
Additionally, at least two forms of emissions date will have to be reported: Scope 1 data, which is the carbon footprint resulting directly from the company’s operations; and Scope 2 data, which are the emissions resulting from the energy the company consumes in its operations.
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Larger public companies will be required to disclose their Scope 3 emissions data if deemed to be “material” to investors or if the company has a Scope 3 commitment in place. Scope 3 emissions are those that are produced from a company’s indirect activities, such as from its supply chain, distribution networks, and customers. Given that materiality will be judged by companies themselves, investors and the SEC itself would be able to challenge a company's assessment of what counts as material information. Smaller companies would be exempted from reporting their Scope 3 emissions.
Most companies have yet to get a firm handle on how to calculate Scope 3 emissions. This endeavor is no small matter and will likely be problematic, increasing the demand for climate-related consultants and accountants, as companies would be required to obtain assurance from an independent third party that their emissions disclosures are accurate. Many companies and trade groups, including the nation’s premier business lobby, the U.S. Chamber of Commerce, have opposed mandated reporting of Scope 3 emissions saying it would be too burdensome and complicated to estimate these emissions across a company's operations.
As the proposal stands now, a safe harbor would shield companies from legal repercussions stemming from misreporting Scope 3 data, which in large part relies on third parties providing accurate information to the companies. This safe harbor allowance, along with a company’s own judgement of Scope 3 materiality, is a cause for significant concern for many climate action advocates.
Scope 3 emissions can account for the vast majority of certain company’s total emissions, such as with fossil fuel companies. For example, Scope 3 emissions account for 75% of electric utility emissions and 88% of emissions from oil and gas companies, according to research from IHS Markit.
Given all the new complexities being introduced by this climate reporting proposal, formalized exceptions and phase-ins, especially for Scope 3 disclosures, are likely to be added to any final version of this new rule as it eventually takes effect.
Even if rules are finalized this year, the largest, most accelerated filing companies may not have to file information on climate risks until at least 2024 (for reporting year 2023) with an extra year out to 2025 (for reporting year 2024) for any Scope 3 disclosures. For smaller companies, the disclosure requirements will likely be extended out an additional year beyond these dates. 1
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