New rules from the Securities and Exchange Commission requiring companies to disclose their greenhouse gas emissions and climate risks underscores the need for industrial companies to speed up their decarbonization efforts.
After a two-year process, the SEC rules mean that companies must disclose their Scope 1 (direct emissions from owned or controlled sources) and Scope 2 (indirect emissions from the generation of purchased energy) emissions – and the business risks that climate change poses to their company’s operations.
Unlike regulations passed in the European Union, US companies will not be required to report their Scope 3 emissions – indirect emissions that come from their supply chains or their customers’ use of their product (like coal or crude oil).
Even without these Scope 3 requirements, the new rules will provide a signal that investors will find hard to ignore.
Companies with higher environmental, social, and governance scores typically outperform their peers, according to a recent McKinsey study. And the market signal sent by lower carbon intensity in business operations should lead to greater appetite for investors.
The impacts of climate change are already affecting the bottom lines at some of the biggest energy companies in the US. Wildfire liabilities have cost companies like PacifiCorp, Xcel Energy, Hawaiian Electric and PG&E billions of dollars, and investors will be looking to see how companies mitigate the risk to their businesses that increased greenhouse gas emissions pose.
Companies can expect that the greater transparency on carbon intensity will encourage their customers to buy from firms that are more resilient and ready by decarbonizing their energy consumption.
While most of the attention is on the emissions reporting requirements from companies, the risk reporting requirements may be as much, if not more, of a driver for lowering emissions.
What are the guidelines on Climate Risk:
- Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition;
- The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook;
If, as part of its strategy, a registrant has undertaken activities to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that directly result from such mitigation or adaptation activities; - Specified disclosures regarding a registrant’s activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices;
- Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks;
- Any processes the registrant has for identifying, assessing, and managing material climate-related risks and, if the registrant is managing those risks, whether and how any such processes are integrated into the registrant’s overall risk management system or processes;
- Information about a registrant’s climate-related targets or goals, if any, that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition. Disclosures would include material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal;
- The capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds, disclosed in a note to the financial statements; and
- If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements.
Impact on Industrial Decarbonization Efforts:
These requirements are likely to accelerate industrial decarbonization efforts by making GHG emissions a critical factor in investment decisions, encouraging companies to reduce their emissions to attract and retain investors.
By standardizing the way emissions are reported, and risks are assessed, it will be easier for investors and other stakeholders to assess and compare the environmental performance of companies, pushing those with higher emissions to adopt cleaner practices.
Companies are encouraged to begin early preparation and data collection to comply with these rules, which involves developing processes for collecting, validating, and disclosing emissions data.
Comparison to International Standards and Challenges:
The SEC’s proposal shares similarities with climate disclosure standards in other jurisdictions, such as the UK and the EU, but with a narrower scope and greater specificity. The proposal aligns with the Task Force on Climate-Related Financial Disclosures (TCFD) frameworks but is distinguished by its prescriptive requirements around financial metrics.
Scope 3 emissions, which include all other indirect emissions that occur in a company’s value chain, present a significant challenge for companies, especially in quantifying emissions from upstream and downstream activities, which is why the SEC did not include them in final rulemaking.
With the exclusion of Scope 3 emissions reporting requirements, the SEC thinks it will be able to withstand potential lawsuits from states that want to block the rulemaking entirely.
Meanwhile some of the world’s largest investors already are praising the rules as a step towards much needed standardization.
The $968 billion Dutch financial services firm ING praised the new rules. “The SEC’s landmark climate disclosure rule brings the US one step closer to the sustainability reporting ecosystem in jurisdictions such as the EU. It is game-changing in a sense that companies and investors will have a larger and more consistent data pool to contextualize a company’s climate performance. Clearer reporting of climate risks and opportunities will make a better case for business or investment adjustments,” the bank said in a report.