Last month we witnessed a tectonic shift in the regulatory environment for large, publicly traded companies in the U.S. The U.S. Securities and Exchange Commission (SEC) announced emissions reporting requirements to achieve greater transparency and understanding around the impact of climate change on these businesses, as well as the impact these businesses have on climate change.
Though the SEC’s regulations focus on large companies, smaller enterprises will also feel their impact. With its proposed Scope 3 emissions reporting requirements, the SEC has made it clear that we’re all in this together. So, buckle in and get ready for what will likely be a bumpy ride.
But First: Scope 1, Scope 2 and Climate Risk
The proposed regulations require publicly traded companies to calculate and report on the risk that climate change poses for their operations and performance. Given our changing weather patterns, this won’t be easy.
These companies must also report on their Scope 1 and Scope 2 emissions. Scope 1 emissions are direct greenhouse gas (GHG) emissions from sources owned or controlled by the company. Scope 2 emissions are those linked to the purchase of electricity, steam, heat or cooling, and while the emissions occur where these commodities are produced, the company that uses them must account for them.
What Investors Want to Know About Scope 3 Emissions
Some of the largest ripples from the SEC’s big splash are those that have formed around Scope 3 reporting requirements. Scope 3 emissions are the indirect emissions—both upstream and downstream—that come from a company’s value chain.
Scope 3 emissions reporting would become mandatory if the company has made a public commitment to Scope 3 reductions or if the emissions are material to a company’s financial performance. In other words, would an investor consider these upstream and downstream emissions as having the potential to affect the company’s financial performance? There is some ambiguity here, but given the urgency of the IPCC’s latest Climate Change 2022 report, business leaders would be wise to build capacity for Scope 3 reporting—and encourage that capacity building among partners.
Smaller reporting companies are exempt: Though they will have to account for risks related to climate change, as well as Scope 1 and Scope 2 emissions, they are not required to disclose Scope 3 emissions. However, the regulatory environment is dynamic, and proactive companies will likely have Scope 3 emissions reporting on their radar, so as not to be caught off guard if (rather, when) they eventually fall under the Scope 3 requirements.
The Long Reach of Scope 3
For companies that offer a diverse range of services or products—each with its own complex value chain—Scope 3 emissions reporting represents a herculean task. Large companies purchase goods and services; they send employees on business trips; and they have investments and assets. They also sell to retailers. They’ve woven webs of relationships that stretch across industries and geographic regions, and Scope 3 reporting requirements demand that they follow every thread of each web to determine their partners’ GHG emissions.
In some cases, a thread will lead to a smaller enterprise, which can present a major challenge for large reporting companies. Many smaller businesses are not collecting quality data that can be used to calculate GHG emissions, if they’re collecting it at all.
Scope 1 and Scope 2 emissions reporting requirements force companies to get their own house in order. Scope 3 requirements demand that they get their partners’ houses in order too.
Appreciating the Complexity of Scope 3 Reporting
As an example, consider the challenge a clothing manufacturer faces with respect to calculating and reporting on Scope 3 emissions from fuel consumption. One component of that calculation is fuel consumed by employees as they commute to and from work. Then there’s the fuel consumption of their fabric suppliers and the distributors of the coats they manufacture. A large retailer may move the coats from one store to another. And some coats will be purchased online, so they’ll need to be shipped to the consumer.
It’s likely that some of these calculations will be built on assumptions. But the reporting companies that have confidence in their suppliers’ and partners’ Scope 1 and Scope 2 emissions data are that much closer to accurate and defensible Scope 3 emissions reporting.
The Possible Threat of Liability
The challenge of gathering Scope 3 emissions data is compounded by the possible threat of liability. Companies will be held liable for the GHG emissions tied to their own operations, as they should be. But some business leaders fear that the SEC’s regulations may also hold them liable for any incorrect data from their suppliers. While the SEC has included a safe harbor for liability for Scope 3 emissions disclosure, concerns around liability will certainly be aired during the public comment period for these regulations.
Disclosure Compliance Dates Are Coming Soon
A significant number of large companies are already reporting their Scope 3 emissions, primarily to reduce reputational risk. Large businesses that have not been reporting Scope 3 emissions will need to act quickly given the proposed disclosure compliance dates.
Large accelerated filers are required to comply with Scope 1 and Scope 2 reporting requirements in FY 2023 (filed in 2024) and Scope 3 reporting requirements in FY 2024 (filed in 2025). Accelerated filers and non-accelerated filers must comply with Scope 1 and Scope 2 reporting requirements in FY 2024 (filed in 2025) and Scope 3 reporting requirements in FY 2025 (filed in 2026).
Building Capacity for Reporting
As companies prepare for a more stringent regulatory environment, they need to consider several things:
- Do they have in-house expertise that’s capable of distinguishing good data from poor data?
- Do they have the right tools to analyze the data?
- Do they have access to defensible emissions factors for the calculation of their Scope 3 emissions?
- Do they have adequate governance over emissions calculators?
- Do they have solid relationships across the value chain - both upstream and downstream – that will enable them to get meaningful information and data?
- Do they need to build capacity along their value chain to support proper GHG emissions reporting?
- Do they have partners who can help them overcome gaps that could compromise their reporting?
Not Easy, but Necessary
The SEC’s regulations require disclosure of a company’s vulnerability to climate-related risks, as well as disclosure of direct GHG emissions and emissions related to its energy consumption. And while Scope 1 and Scope 2 emissions reporting is not easy, it’s comparatively easier than reporting Scope 3 emissions. Legal challenges to Scope 3 requirements are on the horizon, and we may see changes in these requirements once the public has weighed in. Still, the regulations will demand the mastery of data and partnerships that enable a company to achieve compliance.
With its proposed regulations, the SEC aims to give investors more power to effect change in the way Corporate America addresses its impact on the environment. Despite the pain companies may feel under the weight of these regulations, there’s no denying that it’s for the greater good.