The Securities and Exchange Commission (SEC) recently proposed a new rule that could require companies to provide more detailed reporting of their climate impacts and emissions, should it be adopted.
Regardless of the outcome of the proposed rule, climate-related events are already impacting businesses and portfolios. Businesses and financiers should be planning and preparing to minimize their climate-related risk exposure, and to preserve their asset values.
SEC and Disclosure Rules
The information companies are required to disclose to the SEC pertains to matters that materially affect a business and its financial health. The SEC is now joining the chorus of asset managers who have pushed for public companies to disclose climate-associated risks as they understand that the material impacts of climate change affect corporate financial health and must be accounted for.
The proposed rule focuses on Scope 3 emissions; emissions which stem from assets not owned or controlled by the reporting organization, but that are indirectly impacted by company activities. Until now, only Scope 1 and 2 emissions (coming from direct operations and electricity consumption) were taken into account by the SEC.
The newly proposed SEC rule would require companies to engage in disclosures on three fronts: material risks, greenhouse gas (GHG) emissions, and transition plans.
Material Risks
If enacted, the SEC rule will require companies to disclose any risk stemming from climate-related hazards. A given company would have to describe in detail its governance of climate-related risks and relevant risk management processes.
It would also have to focus on the identified and potential impacts of climate-related risks on its business model, strategy, and outlook – as well as on its financial statements. Filers should not only disclose impacts, but also their processes to manage the risks.
GHG Disclosures
The proposed SEC rule goes beyond the bounds of the guidelines for Scope 1 and 2 emissions, and now includes Scope 3 emissions. As such, a registrant with a set GHG emissions target, or whose disclosures are material, would now be required to disclose GHG emissions from upstream and downstream activities in its value chain.
Until now, Scope 3 emissions were not taken into account – this would significantly change the way financiers and companies think about the intersection of investments, climate impacts, corporate risks, and enterprise value. Beyond this, Scope 1 and Scope 2 emissions would have to be separately disclosed on a disaggregated and aggregated basis. All disclosures would be required on a gross basis and relative to emissions’ intensity.
Transition Plans
Under this framework, companies would have to disclose any existing targets around low-carbon strategies. The SEC would then require specific information on how the company’s plan will achieve the set targets.
Application
Should the rule be adopted by December 2022, major companies would have to disclose most of this information as of fiscal year 2023, and smaller companies as of fiscal year 2024. If not done so already, companies should establish clear, temporally bound plans for emissions reductions, and must prioritize high fidelity data collection. Policies and procedures should be in place to gather data required for reporting, and to fulfill assurances related to emissions reporting.
The SEC would provide time for planning and reporting of Scope 3 emissions by allowing an additional year beyond the aforementioned deadlines. As such, investors and firms can initially focus on mitigating and reporting Scope 1 and 2 emissions, which should provide a more secure foundation on which to develop detailed understandings of scope 3 emissions from within and beyond their supply chains.
Scope 3 emissions reporting and reduction still represent a challenge for most companies. While the SEC protocol provides specific guidance on how to measure them, accessing the information required for accurate reporting represents a significant challenge. Quantifying Scope 3 emissions is particularly difficult and requires comprehensive consideration of all sourcing, product usage, and end-of-life disposal activities. Quantification hinges on robust data collection and accounting, which is ideally done in a collaborative manner, enabling data sharing across supply chains to enhance accuracy and to avoid double-counting.
Public Reception
As the conversation around climate change heats up within the public debate, investors, and more generally big financial firms, have been supportive of measures to reduce climate risk and stranded assets. This SEC rule will serve as a guidebook for investors seeking to quantify and assess financial risks posed by climate change, and direct their funds to the most resilient enterprises.
The proposed rule has been met with some criticism, with certain groups fighting back, arguing that the commission lacks the authority to issue this type of guidance, and threatening to remove their investments from banks supporting the rule. Despite this push back, most investors seem to favor the new rule – it is both the right thing to do for the environment and society, and it would provide another tool for financiers and corporates as they strive to make sound investment decisions.
How to Prepare
Although the final SEC decision won't be revealed until November – during midterm elections – asset managers and corporate executives should assume some new requirements will unfold, and pre-emptively prepare for the impacts the requirements might have on disclosure plans.
Whether or not the rule is enacted, requirements like these are inevitable, as are new regulations and changing consumer preferences. It is only a matter of time before climate risks are incorporated into 10-Ks and/or other corporate filings. As a result, investors, board members, and shareholders are changing the way they think about corporate financial health. Sound corporate governance and risk management is key.
Emissions reduction targets must be coupled with tangible and achievable roadmaps, and plans must be implemented. Decision-makers should prioritize investments in energy efficiency, renewable energy procurement, and other similarly de-risked climate-friendly solutions. Doing so can have the added benefit of minimizing operating costs – consider the value of locking in long-term competitive electricity prices and decreasing consumption needs – while contributing to the activity's requisite for Scope 1, 2, and 3 emissions reporting and reduction. As emissions reduction activities ensue, companies should ensure ongoing data collection, analysis, and address risks as they arise.
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References:
https://www.wsj.com/articles/the-sec-climate-rule-wont-hold-up-in-court-west-virginia-epa-agency-congress-11657659630
https://cleantechnica.com/2022/07/14/republican-attorneys-general-fight-sec-over-corporate-climate-disclosures/
https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/understanding-the-secs-proposed-climate-risk-disclosure-rule
https://www2.deloitte.com/us/en/pages/audit/articles/sec-climate-disclosure-guidance.html
https://www.sec.gov/news/press-release/2022-46