The global push for standardization and transparency on climate disclosures is picking up steam – and it’s coming from one of the most powerful players in the game.
On March 21, the United States Securities and Exchange Commission (SEC) gathered to discuss a single agenda item: mandatory climate risk disclosures for publicly traded companies in the U.S.
While the SEC has been encouraging companies to disclose their climate-related risks since 2010, that guidance has been flexible and principle-based – and therefore easy for companies to either gloss over or evade altogether. The rule proposed yesterday represents a significant step forward for the SEC in terms of accountability and prescriptive transparency in ESG investing.
The SEC has historically fallen behind other bodies when it comes to climate-related regulations. According to an analysis from financial regulation aggregator CUBE, the SEC issued just .00004% of all climate-related regulatory guidance (not even formal regulations!) in 2021. This is significantly less than smaller entities like the state government of Hawaii and larger supranational and domestic peers in Europe or APAC. For example, last year, New Zealand and the UK introduced mandatory TCFD*-aligned climate-related financial disclosures, while the European Union’s (EU) SFDR** came into force – with more regulations due from the EU in the coming months. (See the Task Force on Climate-Related Financial Disclosures and the European Union’s Sustainable Finance Disclosure Regulation for more information.)
The March 21 meeting was the latest in the SEC Chair Gary Gensler’s campaign for transparency, which kicked off with the creation of the Task Force for Climate and ESG around this time last year. Ultimately, the proposed rule is making good on a promise in July 2021 to introduce mandatory climate risk disclosure in the United States.
Though we are still some time away from these rules coming into force, there’s no time like the present to prepare. Here’s what businesses need to know about the outcomes of yesterday’s meeting, what comes next, and the steps they need to take to ensure cost-effective compliance with any new rules that emerge in the months to come.
Establishing a Framework for Mandatory Disclosure
The SEC’s proposed rule entails a number of provisions, all aimed at helping investors better understand how climate change-related risks – including those companies contribute to – affect businesses’ operations, strategies and financial performance. The most important provisions to note include:
- Mandatory reporting of all climate-related risks that could materially affect the company’s performance – everything from natural disasters being exacerbated by global warming to the impact of potential carbon taxes
- Mandatory reporting of Scope 1 and Scope 2 emissions, which must be audited by a third party to validate
- Mandatory reporting of Scope 3 emissions if they are material to the business’ financial performance, or if companies have made public commitments to Scope 3 reductions
The proposed rule offers a phased implementation, with the largest organizations expected to comply by 2023, and smaller organizations by 2024. It also includes carve-outs and exceptions, as well as significant flexibility when it comes to whether and how businesses measure and report their Scope 3 emissions. It is nevertheless notable that Scope 3 emissions were even included in the rule, as they are a source of contention for critics of the SEC’s larger drive towards enhanced climate risk transparency.
Hurdles are likely to remain.
The path to implementation of the proposal is far from straightforward. The next step in bringing the new rule into force is opening it up for public comment. This phase will last for at least the next 60 days, leaving investors and businesses plenty of opportunity to attempt to shape the final rule in their favor.
The first challenge we can likely expect is pushback from companies who foresee an increased cost of compliance, particularly from working with outside providers to validate the Scope 1 and 2 data they will have to report. We’re likely to also see robust legal challenges. A sticking point for many lawmakers and businesses is the inclusion of Scope 3 emissions, which they argue are difficult and overwhelming to track – especially for massive multinationals that have sprawling, complex supply chains and unclear boundaries as to where their liabilities end and another’s begin.
Several state attorneys general have also taken issue with the SEC’s definition of climate-related risk as “material,” arguing that Scope 3 emissions are not financially material to a business’ investors, and thus the SEC does not have the authority to regulate their disclosure.
Finally, there are limits to what a mandatory disclosure rule can accomplish when it comes to addressing the climate crisis. First and foremost, its scope is inherently limited; the SEC cannot mandate that businesses reduce their GHG emissions or become more sustainable. They can only hope that these new rules will satisfy investor demands for greater transparency and incentivize businesses to mobilize as a force for good to make more sustainable choices. Beyond that, the rules would only apply to public companies, leaving privately held companies to their own devices – and interests – when it comes to disclosing and/or mitigating their climate risks.
Preparing for What’s Next
Whether or not the SEC’s proposed disclosure framework is finalized and implemented, it is in all businesses’ best interests to get a handle on their GHG emissions and take proactive steps to measure and reduce them. The simple fact is that the stakes are much higher than fines for non-compliance – they are existential.
As we’ve written before, disclosure is just one step in the right direction, helping climate-conscious investors ensure their dollars are going to businesses that do the right thing for the planet. But it’s a step that can cascade into meaningful, sustained action and momentum across the board – for both public and private companies – in a variety of ways, including:
- Seeing sustainable businesses thrive and grow, while those who fail to act falter – thereby encouraging the latter group to take more aggressive action on sustainability
- Helping businesses develop a better view of GHG emissions throughout their supply chain, including Scope 3, so that they can make smarter, more informed decisions about how to reduce them
- Allowing end customers and consumers to make more sustainable choices and contribute to more impactful collective action
- Moving the needle towards a standardized global approach to reporting and reducing emissions in the all-important drive to achieving net zero
So, what should businesses be considering right now to ready for the challenge ahead?
1. Assess in-house expertise
Understanding your ability to cost-effectively oversee a robust ESG reporting requirement while ensuring compliance and progress is an essential first step.
2. Analyze the health of current third-party data
Considering whether a third-party provider would be beneficial to plug data gaps – and if one is in place, investigating if it is accessible and comprehensive enough to meet upcoming standards.
3. Consider the software solution required
Knowing that Scope 1, 2 and 3 emissions will require input from sources that need to be accounted for and then consolidated into clear, insightful and compliant metrics will help you choose the right tools.
For more information about how you can navigate your sustainability journey in today’s rapidly changing regulatory environment, get in touch with one of our ESG experts.