When governments or their regulatory bodies weigh in on an issue — think cigarettes or seatbelts — and determine that there is an unacceptable level of risk to society associated with inaction, the long-term effect is a shift in behavior.
The SEC’s proposed climate rule makes the case that climate risks are an unacceptable blind spot for investors and capital allocators. The standardized disclosures of climate risks will effectively lay bare companies’ readiness to transition to low-carbon operating models and the mounting physical hazards they face. Requiring publicly traded companies to report on greenhouse gas emissions shines a spotlight on the risk of inaction. Of course, disclosure in and of itself will not change corporate operating systems overnight, but it does effectively place a “buyer beware” warning label on companies by requiring them to disclose the GHG emissions associated with their businesses.
The basis for the SEC’s rulemaking is to ensure investors have the information they need to properly assess risk. As SEC Chair Gary Gensler puts it, “the core bargain dating back to the 1930s is that investors get to decide which risks to take.” Presently, and absent required standardized disclosure on climate risks, investors are left to hazard their best guess.
Although a final rule has not been issued (potential timing could be this December), there are several key elements in the SEC proposal that, if finalized, will have a long-term impact, including:
Reporting on GHG emissions
One of the single biggest indicators of a company’s impact on climate change is their annual GHG emissions. The proposal states that beginning in 2023 (filed in 2024), many companies will need to start reporting on their direct (Scope 1) and indirect (Scope 2) GHG emissions. Disclosures on emissions by companies would be required in a newly created section of the Form 10-K. Companies may also have elements of indirect GHG emissions reporting from upstream and downstream activities (Scope 3) if they are material.
While it is not clear where the final rule will land on requirements for Scope 3 disclosures, it is possible they would not be subject to third-party verification and would have a safe harbor period to protect from legal liabilities. The methodology for disclosure of emissions will need to be based on the Greenhouse Gas Protocol, which provides for transparency and consistency on reporting assumptions and methodologies.
Aligning with global markets
The SEC’s requirement to utilize the Greenhouse Gas Protocol is also critical since it is recognized internationally as the leading methodology for the calculation of GHG reduction metrics. The alignment goes beyond just using the GHG protocol and will bring U.S. disclosures more in line with the global approaches of the Task Force on Climate-Related Financial Disclosure and the International Sustainability Standards Board in terms of structure and content.
Tracking progress on commitments
The SEC rule would require companies that have set a net-zero or related GHG reduction target to show how they intend to meet that target. This includes releasing an annual report with data that details whether a company is making progress toward meeting their target and how such progress has been achieved, for example, via specific projects or through the purchase of offsets or Renewable Energy Certificates. This will help establish climate accountability by requiring companies to outline how they intend to reach their targets or goals and to provide a timeframe for achievement. It will also indicate if companies are following what is recommended by groups like Ceres in their Roadmap 2030, which highlights the importance of companies reducing first, for example, through energy efficiency, and mitigating second, for example, via offsets.
Creating a normative effect
We expect there will be substantial indirect beneficial results of the SEC standardizing climate-related financial reporting for publicly traded companies, representing roughly $110 trillion of market capitalization. Reporting obligations related to Scope 3 emissions will require real data collection practices of companies outside of the direct purview of the SEC. Some marquee public companies are sure to position themselves to lead and may push reporting requirements to the suppliers of their suppliers, even if not a strict requirement. Even companies that are in the shadows are sure to feel pressure from employees, potential new hires, and customers. This is especially the case with investments in energy efficiency upgrades, which have proved time and again to carry rapid economic and environmental benefits.
The impact of the SEC rule will be substantial and is critical given that achieving the targets set forth under the Paris Agreement will only be met through significant growth in private investment. The International Energy Agency estimates that to meet net zero, investment in sustainable energy will need to reach $5 trillion per year by 2030. However, the SEC rule is just one piece of the puzzle. Much like the day-to-day hard work being done now to get energy efficiency and renewable energy projects in the ground and operational, progress will come at a slower pace than we ideally want. Nevertheless, the SEC rule would represent yet another turning point as we work to get the upper hand in the battle to keep global warming to less than 1.5 degrees Celsius.