The SEC’s Proposed Rule On Climate Disclosure Has Teeth, Leaving Supporters And Opponents Simultaneously Unhappy
In March 2022, the U.S. Securities and Exchange Commission (SEC) announced a proposed rule for how publicly traded companies will be required to disclose exposure to and potential impact from climate risk. Under the proposal (expected to be finalized this spring), the hodgepodge of standards, frameworks, and voluntary guidelines for climate risk disclosure will become mandatory, metrics-based, and steeped in science. The proposed rule expands on the SEC’s own 2010 guidance and fulfills the promise of the Climate Risk Disclosure Act of 2021. If the rule passes as proposed and without any changes, however, the pivot from suggestion to regulation will require companies to finally take climate risk seriously and do a lot of math. All corporations that file with the SEC will need to be prepared.
Investors Finally Get Much-Needed Transparency
It’s rare to see environmentalists and firms line up on the same side against climate regulation, but the proposed rule accomplishes just that. Environmentalists have argued that the rule doesn’t go far enough to make a dent in climate action, while companies have argued that the proposal goes too far and puts a heavy and expensive burden on them to comply. It’s the investors who have long asked for reliable, consistent, and clear information on climate risk and action who will come out on top.
Even the definition of materiality in the proposed rule is given an investor-centric lens — “ […] a matter is material if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote.” Also, an omission is material if there is “ […] a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
Three New Aspects In The SEC’s Proposed Rule And What To Do About Them
The proposed rule builds on prior governance from the Task Force on Climate-related Financial Disclosures and the Greenhouse Gas Protocol but with a significant difference: It is not voluntary. When finalized, this rule will trigger monumental change in everything from how firms assess “materiality” to how they report the financial impact of those risks in consolidated financial statements. Here are three other aspects of the proposed rule (in its current form) worth noting and what to do about them:
- What’s new: Disclosure isn’t limited to climate-related physical risks. The current SEC proposal requires companies to disclose not only climate-related risks on the business (i.e., storms, floods, droughts) but also transition risks, such as a market shift away from a product your company sells (e.g., fossil fuels). Moreover, it’s no longer sufficient for companies to claim they’re mitigating transition risks by purchasing carbon offsets, funding carbon removal, or paying a premium to emit carbon. Under the proposal, the SEC wants to see the receipts — that is, the levers for internal decarbonization activities — first, as well as the assumptions and calculations used to determine the carbon offset amount. Additionally, firms will be required to disclose the parameters of their climate scenario planning, the costs of their climate adaptation plan, and other assumptions made in their risk management plans.
What to do about it: Ramp up, now. Not only does the SEC want to know your climate-related risks and the risks in how you’re responding to them, but it also wants to know how your board and management structure are overseeing these processes along with their qualifications to do so. This will force your organization to consider decarbonization efforts and accurate measurements across the IT stack, supply chain, procurement strategies, and communications. Without the need for expensive consultants right from the onset, a variety of sustainability management technologies can help you calculate your carbon footprint, perform climate scenario analyses, and package and report the data against an alphabet soup of standards and frameworks. In addition to technology, the risk management planning involved is so granular, layered, and technical that you’ll need resources with expertise involved in the process and time to learn from iterations.
- What’s new: Greenhouse gas emissions must be inventoried and contextualized. Today, one-third of Russell 1000 companies don’t make environmental disclosures such as greenhouse gas emissions, water usage, recycled waste, and climate commitments. Under the SEC proposal, firms will be required to calculate and disclose absolute greenhouse gas emissions for scope 1 and 2 emissions (that is, the emissions from their own operations and from their purchased electricity). As a gauge of a company’s efficiency in managing its emissions, the company will need also to disclose each scope’s emissions intensity, measuring the greenhouse gas per economic value such as revenue.
What to do about it: Get your math right before making big promises. The SEC wants third-party assurance from accelerated filers and large accelerated filers that their emissions are calculated appropriately. And if the filing company has set a target to reduce its emissions, the SEC wants to see the company’s plan for how it will achieve the target. This means that we might see companies roll back some of their vague aspirations about emissions targets in favor of accurately tallying their current emissions first. That’s for the best if it means that the target you eventually set will stand up to stakeholder scrutiny.
- What’s new: Scope 3 disclosure is not off the table. Companies or industries for which scope 3 emissions are “material” or which include scope 3 (emissions from upstream and downstream activities in their value chain) in their targets will also have to calculate and disclose their scope 3 absolute emissions and emissions intensity. This will be particularly prevalent in manufacturing, logistics, and automotive industries. For instance, an auto manufacturer’s scope 3 emissions are material because the sold products emit significant CO2 in their use via the exhaust. Not only would its scope 3 emissions be considered material, the auto manufacturer would be required to disclose the total (entire value chain) and subtotals for each material category (such as supply chain emissions, the emissions resulting from its products’ use, and other relevant categories).
What to do about it: Make climate disclosure part of commercial relationships, and enforce it contractually. Because scope 3 emissions are so hard to measure, the SEC’s proposal grants exemption from disclosure of scope 3 for small companies and grants companies that must disclose scope 3 emissions “safe harbor” from liability, provided the statement is in good faith. Despite the carve-outs, the rule’s scope 3 provision is likely to be revised before publication or shortly thereafter due to widespread industry pushback. Nevertheless, the fact that the SEC is still seriously considering this requirement reflects the direction in which conversation about companies’ responsibility is trending: Sooner or later, because of demands from investors or regulators or consumers, large corporations are going to have to tackle their scope 3 emissions. Start thinking about scope 3 now by building relationships with business partners upstream and downstream in your value chain so you can have access to their data for your emissions inventory. Also, consider incorporating clauses in your contracts with business partners about the need for them to inventory and reduce their emissions.
Want to better understand what the proposed rule means for your organization? Schedule an inquiry or guidance session with Alla Valente or Abhijit Sunil.