Tune in for a conversation with Sphera CEO Paul Marushka as he talks about the Scope 1 and 2 emissions components of the SEC’s March 21st climate disclosure proposal.
The following transcript was edited for style, length and clarity.
Philippe Guillard:
Hello and welcome to the SpheraNow ESG podcast, a program focused on safety, sustainability and productivity topics. I’m Philippe Guillard, vice president of Global Solutions and Operations at Sphera. Today we’re joined by Sphera’s CEO, Paul Marushka. Paul is leading the ESG charge at Sphera and is the force behind growing businesses by bringing innovative solutions to market by leveraging software, analytics and technology services. Thank you for joining the podcast, Paul.
Paul Marushka:
Great to be here, Philippe.
Philippe Guillard:
Today we’re discussing the SEC’s March 21st Climate Disclosure Proposal, which is loosely based on the Taskforce and Climate Related Financial Disclosures or TCFD. If the SEC disclosure proposal is passed, it will force publicly traded companies in the US to measure and report on Scope 1, 2 and 3 emissions, as well as all climate-related risks that could materially affect the company’s performance. Larger companies will have to comply in 2023 and smaller publicly traded companies in 2024. This podcast is one of a three-part series on the topic. We’ve already discussed Scope 3 emissions and climate risk. Today we’re going to focus on Scope 1 and Scope 2 emissions reporting. Before we begin, I’m going to give a quick overview of the SEC’s proposal, and then we’ll get into the questions with Paul.
The SEC’s proposed rules entail several provisions all aimed at helping investors better understand how climate change related risk affects their business operations, strategies and financial performance. While there’s quite a few provisions, here are some of the more important ones to note for our discussion. Number one: Mandatory reporting of Scope 1 and Scope 2 emissions, which must be audited by a third party to validate the results.
Two, mandatory reporting of Scope 3 emissions if they are material to the business’ financial performance, or if companies have made a public commitment to Scope 3 reductions. Three, 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, or just what changes might come to their business with those changes in climate risks.
Four, the proposed rule offers a phased implementation with the largest organizations expected to comply by 2023 and smaller publicly traded 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.
Further, on May 9th, the SEC extended the 60-day discussion period to June 17th, 2022. Paul, how is the SEC justifying its regulatory oversight of businesses’ greenhouse gas or GHG emissions?
Paul Marushka:
That’s a great question, Philippe. This is one that’s near and dear to my heart. I started my career as a corporate attorney and I worked initially for the former head of the Securities and Exchange Commission, who was a partner at the law firm I worked at. I got to really understand what the role of the SEC is. The SEC has a triple mandate. First is investor protection. Second is the maintenance of orderly markets. And third is the facilitation of capital formation. First and foremost, it’s about investor protection. Think about it from a financial perspective. As public corporations issue their financial statements, you want to make sure as an investor you are getting a standard set of documents. That’s been accepted for years within the US economic system.
Many companies are issuing information about their sustainability initiatives. In fact, 69 percent of corporations globally have set net zero targets. Many of them report on those through their corporate sustainability reports, and those are issued with their financial reports. Investors are having a difficult time understanding whether those disclosures are consistent.
Investors, as well as communities in general, need a better understanding of the standardization associated with the specific information that’s being provided. The SEC, in regulating information that’s provided to the public around corporations, is the perfect body to provide the guide rails so that we all understand what those companies are reporting. In fact, there are calls for standardized disclosures from investors who manage over $130 trillion in assets. This is not just something coming from the regulators. It really is about the investors, and the investors are driving this. It’s very confusing to understand what exactly a sustainable initiative is and how companies are progressing to net zero, because there is no standardization associated with that. The SEC is trying to put standard metrics in place that will be reported by publicly traded companies.
Philippe Guillard:
Well, that’s great, Paul. You mentioned guide rails and bringing in standardization. With that in mind, how is the SEC determining whether a company’s emissions are material to its financial performance?
Paul Marushka:
Materiality is not a new concept for accountants, for lawyers, the SEC or for regulators. It’s used in other parts of disclosures that are made to investors and the public. The SEC has taken this definition of materiality as it applies to risks that a company must disclose in its financial statements and has taken it and applied it to climate related issues. For the SEC, its proposed requirement is that an organization should determine materiality for climate related issues consistent with how they determine the materiality of other risks affecting their business and with their financial filing requirements. As you begin to put in place the risks associated with your financial organization, you should use that in parallel with sustainability.
Given the difficulty and the lack of standardization for measuring sustainability initiatives, it is difficult for organizations to determine whether sustainability or greenhouse gas risks are a significant risk to them. In fact, recent studies have found that 44 percent of companies did not disclose information related to sustainability and cited materiality as the main reason. I think that will change with time as more companies begin to put in processes, mechanisms and software like Sphera’s that help them really validate and standardize the metrics. They will then understand the risk associated with sustainability and will begin to disclose that as required by the SEC, should these regulations be put in place.
Philippe Guillard:
What I’ve noticed as well in reading articles is that not everyone at the SEC is totally on board with the proposals. For instance, Hester Peirce, who’s an SEC commissioner, recently said that the SEC doesn’t stand for the Securities and Environment Commission. Is there a case to be made that the SEC is overreaching here?
Paul Marushka:
I don’t think so. It’s a significant risk for businesses and it’s a risk for investors. The SEC plays a role in protecting investors and making sure there’s standardized information. It’s also going to be the case also from a climate related perspective. This is not new. But that’s how it works in our system. The debate of ideas goes back and forth and hopefully the best issues bubble to the top and we have regulations that are appropriate and protect the investor.
Philippe Guillard:
Great. Well, I appreciate that response, Paul. We’ve talked about materiality quite a bit. You mentioned that 44 percent of companies couldn’t report or had trouble reporting because of identifying materiality. How is the SEC defining materiality?
Paul Marushka:
Materiality is being defined the same way it is for financial disclosure. Companies themselves will have to determine if climate risk is a risk that affects their business that’s consistent with their financial filing requirements. For instance, if there’s a risk to the business associated with an investment in a certain building, exposure to a certain product or supply chain risk.
The reason why it is so tenuous right now is that there’s a lack of standardized information and tracking capabilities. That’s where Sphera comes into place because we help companies determine that risk, and then they’ll have a much easier time determining how material that risk is to their business. Is it 10 percent, 15 percent? Does it affect their supply chain? Does it affect their buildings? Does it affect their people or the communities they work in? Companies will have a much better and clearer disclosure with time as more companies adopt systems like Sphera’s to get a better understanding of their climate risk.
Philippe Guillard:
Great. In terms of getting that information together – reporting and pulling from different data sources you said with software such as Sphera’s – there is that aspect of the third-party validation. The proposed rule is going to require that a third party validates that public company’s emissions reporting. Who would those third parties be?
Paul Marushka:
It’s going to be very much like the financial reporting that happens today. There are third party validators out there that are providing standards like the TCFD that is working on validations. I think you’re going to have accounting firms that are going to follow these standards and will potentially audit the information. I think it’s going to be a mirror image of what happens in financial reporting, where you have an independent agency or a group of third parties that will come together and set the standards.
There are a whole bunch of companies right now that have standards out there associated with various geographies. It is a little bit inconsistent. The Climate Disclosure Project is one that’s working on trying to get standardization. I think within certain geographies, like in the U.S., we probably will have standards that are self-adopted by corporations as they disclose it, and will probably be accepted by the SEC. You’re going to have third parties that’ll be validating. You already see the big accounting firms as a natural place to make that happen. But again, at the end of the day to make that happen, you’re going to need mechanisms like our software capabilities that produce that data in a very objective manner at a deep level, so that investors can feel comfortable that they’re getting the right information when they need it.
Philippe Guillard:
In general terms, could you describe how third parties would determine the validity of a company’s reporting?
Paul Marushka:
The Climate Disclosure Project and others are working on what should be the standards across the various industries so that we can report on it in a consistent manner. I think the SEC will get involved in that and really provide its opinion on which is the most acceptable standard. I think that’s an evolving area today. It’s going to come down to what is the most relevant and material reporting to a business to get an accurate sense of the risk associated with climate and sustainability so they can report on what is most relevant for an investor.
Philippe Guillard:
There’s that old cliche that garbage in equals garbage out when it comes to data. Who is determining what data is good and what data isn’t good?
Paul Marushka:
In our personal experience, there are companies that are getting to a very detailed level of product level sustainability information going through Scope 3, meaning they’re going through the entire supply chain to understand what the exposure is. And then there are other companies that try and just to do what is needed at a minimal level, because it does require some investment to get there. I think that’s something that is going to be worked out over time. The SEC regulations propose that companies go into Scope 3 and that’s probably the appropriate way to go. Scope 1 emissions, which are what’s happening within the four walls of a corporation, are not really where the environmental impact is.
The environmental impact of your supply chain is important as well. That data is more difficult to gather, but when you have systems like ours that demonstrate and help you understand Scope 3 emissions, you’ll have that information. Over time, that’s the information and granularity that will be required like it is on the financial side. Financial statements are quite granular, and you have objective ways of measuring them. There are objective systems that are aggregating and reporting that information, like Sphera’s, and you’ll be having that on the sustainability side with time as well.
Philippe Guillard:
When we talk about the SEC, it’s often when there’s a regulatory change like this one. Or you hear about a penalty where someone has broken the rules in the financial world and they’re getting held accountable. Do you know of any potential ramifications or penalties if inaccurate ESG data is submitted?
Paul Marushka:
I’m positive the SEC will have penalties in place. But the far greater ones are the ones that will come from investors. On the financial side, you get investor lawsuits for intentionally fraudulent information. On the climate side, investors rely on information. Even if information is unintentionally vague, if an investor relied on it, that may lead to some liability. I recently saw an editorial in the Wall Street Journal that said if companies are not careful, this will open them up to lawsuits for providing inappropriate information that’s not valid. And I think that’s part of how our system works. Those actors who adhere to information standards will do just fine.
Those that try to cut corners, intentionally or unintentionally, will face penalties either from the government or from the market. Not only will they see it from investors, but you could see it from consumers. I often see a very consumer-centric part of this as well, where consumers want more information about the sustainability of products and services that they use so they can make a rational decision about whether they want to use a product or service that may not be as sustainable as others. This is a whole new way of looking at things that is very exciting. It’s going to benefit corporations, so they have a clear vision of standards relating to sustainability disclosure, consumers of products, goods and services, as well as investors. It’s a very exciting time for all of us.
Philippe Guillard:
Well, that completes our discussion for today. Paul, I want to thank you for taking the time to speak with us today on the SpheraNow ESG podcast.
Paul Marushka:
Well, it’s been great Philippe, I appreciate the time.
Philippe Guillard:
To the audience, thank you for listening. If you’d like to learn more about this topic, please join us for our webinar on May 19th. We’ll be talking about how business leaders can prepare for the SEC’s new climate ruling. That’s going to be held at 3:00 PM Central Time, and you can find out the details on our website at sphera.com/about/events. Again, thank you for listening to the podcast, and we’ll speak to you soon.
