The Securities and Exchange Commission’s new proposed rules would require companies to disclose how they manage climate-related risks and what their emissions actually are.
In case you haven’t seen it yet, the last installment of the sixth report from the Intergovernmental Panel on Climate Change (IPCC) came out this week, and our collective existential dread has reached a new high — the window we have for avoiding a 1.5-degree rise in temperatures is quickly closing. The world’s most vulnerable communities will face (and, in fact, are already facing) the worst effects of climate change, and in addition to bringing down emissions, we need to start putting thought and resources into adaptation.
Planning for a New Reality
But it is not only communities and policy-makers who need to worry about an altered climate – businesses (including many of those most responsible for accelerating climate change in the first place) also face substantial disruption because of not only the physical impacts of climate change but also the likely higher degree of regulation and decreased demand for fossil fuels that will come with the transition to a more sustainable energy market. Drought, increased heat, and extreme weather events (such as wildfires, an extended and intensified hurricane season, or flooding) will damage agricultural production and real estate, disrupt supply chains, and decrease the productivity of outdoor labor; in the same vein, some jurisdictions (like California) may begin to regulate or tax fossil fuel use more aggressively, and/or become increasingly dependent on other sources of energy.
Nobody doubts the impact that climate change will have on the financial bottom line of many, if not most, companies. But the damage won’t stop at the balance sheet. If companies don’t address or plan for climate-related risk, the harm they suffer will expand to the entire financial system as a whole. And when the economy takes a hit, the very same communities who are already vulnerable to the effects of climate change stand to lose the most. To avoid this scenario, companies need to understand those risks, and they need to tell their investors about them. And that is what the recent news from the SEC is all about.
In late March, the SEC voted 3-1 in favor of proposed rules for climate risk disclosure. The agency seeks to amend several regulations that address disclosure requirements; if adopted, they would require publicly traded companies to release information to investors about their emissions and how they are managing climate-related risks and the transition to cleaner energy.
Of course, some of the largest investors and financial institutions already require climate risk information from the companies they work with. BlackRock, for example, noted in last year’s letter to clients that it would be asking companies to disclose business plans aligned with the goal of limiting global warming “to well below 2ºC, consistent with achieving net-zero global greenhouse gas emissions by 2050,” and stated in February that climate change “has become a critical factor in companies’ long-term profitability.” These policies are a step in the right direction. But the standards and metrics each of these groups work with are different, making it difficult for investors and customers to assess different companies against each other relative to each other.
Investors, in particular, need consistent and comparable information to use in making their decisions and holding companies accountable – otherwise, businesses will be able to continue artificially inflating their value by glossing over the risks they face. Greater transparency helps us avoid a world where the transition to sustainable energy comes with a financial crash (or at least a great deal of turmoil). This is why the SEC’s climate risk disclosure rule is so important.
What the Proposed Rules Would Require
As proposed, the SEC has defined “climate-related risks” as “the actual or potential negative impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole.” In this respect, the SEC has proposed that the disclosures cover:
- How the company’s board and management make decisions with respect to climate-related risks
- How any climate risks the company identifies have had, or will likely have, a significant impact on business
- The company’s processes for identifying, assessing, and managing climate-related risks and whether those processes are part of the company’s overall risk management framework
- The impact of climate-related events, such as severe weather or a transition to an economy less dependent on fossil fuels, on the company’s bottom line (this would also require the company to disclose the financial estimates and assumptions affected)
- The company’s climate-related goals and transition plan, if any.
The bulk of these disclosures would likely be on companies’ registration statements or annual reports (10-K for U.S. companies, 20-F for foreign private issuers).
The proposed amendments would also require companies to disclose three types of greenhouse gas emissions: Scope 1 (the emissions that come from a company’s direct operations, such as running its machinery), Scope 2 (the indirect emissions that come from the company’s use of energy, such as emissions from power plants providing electricity for air conditioning), and Scope 3 (other emissions that come from the company’s activities or products – such as the emissions that result from burning a gallon of a fossil fuel company’s gasoline).
While the rules would require all companies, no matter their size, to disclose Scope 1 and 2 emissions, companies would only be required to disclose their Scope 3 emissions if they are “material” – that is, if a reasonable investor would consider them important in making decisions in the short, medium, and long term. Small companies would be entirely exempt from reporting Scope 3 emissions. This leaves a fair amount of flexibility for companies. Whether Scope 3 emissions are material or not is up to the company’s judgment (that is, whether the company believes the information would be important to a reasonable investor in making decisions), and the SEC has not specified what “short-, medium-, and long-term” mean. Still, it’s hard to imagine how Scope 3 emissions would not be material for fossil fuel companies — these emissions comprise the vast majority of these companies’ total emissions and thus are the main indicator of what needs to be addressed in order to achieve a low-carbon economy.
Under the proposed rules, companies must also disclose their Scope 3 emissions if they have set their own greenhouse gas emissions reduction target or goal that includes Scope 3 emissions. This, in fact, is one of the most important aspects of the rule — it would help keep companies accountable (and prevent greenwashing) and provide investors the information they need to accurately assess a company’s performance in this area.
The SEC’s proposed rules, along with discussion, come to 510 pages, so we’re still working through them. The public comment period is open and runs until May 20. If you’re an investor, tell the SEC that climate risk disclosures are important to you!
Under “1. Online Form,” click “Proposed Rules.” Then look for rules proposed in the first quarter of 2022 – the rules discussed above are in a proposal called “The Enhancement and Standardization of Climate-Related Disclosures for Investors.” Click “Submit comments on S7-10-22.”
The SEC’s fact sheet on the proposed rules is available here.
Deirdre Dlugoleski is a Bertha Justice Fellow at EarthRights International.