What you need to know about the SEC Climate Disclosure Rule

In March, the Securities and Exchange Commission (SEC) released a rules proposal that would oblige the U.S. companies to disclose their climate-related risks and greenhouse gas emissions. While it will take time for the proposal to evolve and become a law after the commentary period, we could already spot some significant changes that will definitely impact American business. 

The SEC Climate Disclosure Rule is called upon to provide transparency for investors, customers, and other stakeholders transforming business reporting and building a case for cleaner alternatives.

What exactly is being proposed for companies to disclose?

The most important provisions of the proposal address clarity and comprehensiveness of greenhouse gas emissions reporting, companies’ transition plans, and climate-related risks assessment and management.

In particular, the US listed corporations will be required to disclose both Scope 1 and Scope 2 emissions regardless of materiality. In addition, Scope 3 emissions would be mandated to report to the extent of materiality or to the extent they are referenced to a target or metric used by a company. Companies will also have to disclose what gaps they have in their ability to calculate Scope 3 emissions and the basis for the estimates and assumptions. The important thing to be mindful of here is that Scope 1 and Scope 2 disclosures would be subject to attestation by a third accredited party.

Moreover, companies would also need to provide narrative disclosures about climate-related risks on their business strategy as well as to reveal detailed information on decarbonisation targets and goals if those are adopted. At a high level, the SEC proposal is directed at, among other things, the financial metrics used in communicating the identified risks to investors.

Thus, the rules aim to “provide investors with consistent, comparable, and decision-useful information for making their investment decisions and would provide consistent and clear reporting obligations for issuers,” as the SEC Chair Gary Gensler said.

What are expert’s main concerns?

As mentioned previously, the SEC Climate Rule is currently on the commentary stage, meaning that the agency is open to public feedback and debates that would help to improve and adjust the provisions before enforcing them. At the moment, industry experts have highlighted several critical issues potentially undermining the effectiveness of the proposed rules.

1. Unclear terms for the Scope 3 disclosures make compliance and reporting burdensome.

To start with, Scope 3 emissions are quite a broad concept that can basically apply to an entire company’s value chain – from raw materials extraction to product utilisation and after-use treatment. An abstract nature of the Scope 3 reporting clause further complicates the situation.

Let’s think about it from a senior management perspective. The proposed rules do not oblige companies to estimate and reveal their Scope 3 emissions, unless they are material to the business. Ok, now how do I determine whether this is the case for my company? I would most probably need to conduct a comprehensive analysis of the business supply chain, spot emission sources and estimate them and their materiality. From the managerial point of view, that is obviously going to be a heavy lift for business in many aspects as it will require companies to expand their resources.

2. The unidentified destiny of internal climate targets holds a risk to disincentivise companies from incorporating those.

Surprisingly, the SEC Climate Rule does not mention how to deal with internal climate-related targets and goals and whether it will be necessary to make them public. Particularly, it is not clear how to tackle targets associated with non-material Scope 3 emissions reduction. In this sense, the rules may discourage companies from incorporating Scope 3 emissions reductions plans.

3. There does not seem to be clear universal standards provided to determine materiality and assess emissions.

The proposed rules generally track the common GHG protocols, without specifying any particular frameworks. That being said, there is a lot of space for subjectivity. In addition, the concept of materiality definitely requires more guidelines for companies to be able to determine the relevance of business activities to investors and customers depending on industry.

Who are the winners and losers of the SEC Climate Rule?

Without going into extra polemics, one can easily spot the evident beneficiaries of the proposed rules. Obviously, the primary goal of the SEC Climate Rule is to enable clear and transparent information available to investors, shareholders, and customers. That would allow the stakeholders to divest from the companies with poor environmental performance and opt for cleaner alternatives, thus, minimising potential financial risks.

“Publicly traded companies can no longer cherry-pick climate reporting, and investors will have a much better sense of their exposure to material climate risks,” Senator Jack Reed, Democrat of Rhode Island said.

Another apparent winner of the provisions are companies that have already stepped onto net-zero path relying on clean energy and aiming to further decarbonise their business substantially. On the contrary, large carbon-intensive companies would lose out over time and have to adjust to new realities to keep revenues. The emitters, who managed to conceal bad carbon footprints this whole time, will now pay the highest price. In addition, international corporations would probably reconsider their supply chains in many ways to reduce excessive Scope 3 emissions.

“Industries with more complex supply chains, especially those reliant on international providers (apparel, pharma, manufacturing), will face more challenges in the short term, and may eventually bring back parts of their supply chains or manufacturing to domestic providers,” The Senior Director at ISN, Joe Schloesser, said.

More subtle beneficiaries of the rules proposed by SEC would be the experts in compliance and emission reporting such as accredited advisors, consultants, and auditors. A drastic demand increase for these professionals can be safely prognosed. Same applies to the analytical software providers and AI technologies that help to automatise carbon data accounting and reporting.

What to expect?

Hence, the SEC Climate Disclosure Rule seems to be still missing some clarity, but the direction in which corporate America will be moving in the following years is in fact quite coherent. Moreover, the proposed innovations are neither revolutionary nor unexpected. This is a logical continuation of the SEC’s acts in the field of non-financial reporting over the past decades and the consistent development of the ESG agenda and the challenges that investors are facing today.

Once improved, the SEC Climate Rule will bring transparency to climate-related risks communication and boost more environmentally friendly players. Certainly, heavy industries shouldn’t be expected to decarbonise overnight. However, as they would have to report emissions, one could expect to witness a more substantial efforts towards net-zero from them in the long run.