On March 21, 2022, the Securities and Exchange Commission proposed rule amendments that, if passed, would require public companies to disclose specific climate-related information. This proposal advanced with a 3-1 vote, and after a 60-day public comment period, could be codified into law.
This means there is a real chance we could see enforceable climate disclosure mandates soon. While some nuanced language remains in the proposal, this is a step towards transparent, comparable disclosure about climate risks and opportunities faced by businesses and investors.
Enhancing and Standardizing: Proposal Basics
There are a lot of elements to this proposal and the full fact sheet can be found here. Here are a few items that stand out:
- This proposal contains elements similar to existing disclosure guidance from groups such as the Task Force on Climate-Related Financial Disclosures (TCFD) and Greenhouse Gas (GHG) Protocol.
- There are specific mentions of climate-related risks, such as “severe weather events and other natural conditions”. If passed, organizations will have to report on the impacts of these events to the business.
- If there are publicly set climate targets, companies will need to provide information on the scope of activities and emissions included in the target, defined time the target is expected to be achieved and relevant data on progress.
- Perhaps the most actionable piece of the proposal is how companies will execute GHG accounting. Scope 1 and 2 emissions will need to be accounted for, (for some) independently attested to and validated, and then disclosed. Scope 3 disclosure, known to be the most difficult to measure and largest in environmental impact, will have a longer phase in period and smaller companies will be exempt from this disclosure.
The Scope 3 Challenge
As mentioned earlier, nuance remains on some aspects of the proposal. One example of which is, “Indirect emissions from upstream and downstream activities in a registrant’s value chain (Scope 3), if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions…”
“If material” is doing a lot of work here. Scope 3 calculation is difficult to account for since it is the largest and most complex aspect of emissions. If passed as is, there will be a phase-in period for disclosure of Scope 1 and 2 and an additional phase-in period for Scope 3. In addition to the longer phase-in period and exemption for smaller reporting companies, there will also be a “safe harbor for liability” for Scope 3 disclosure.
It's worth noting that this does try to walk a fine line between business concerns around measuring Scope 3 emissions while holding organizations as accountable as possible for their climate related disclosures. “Smaller reporting companies” is not defined at present, and softening the requirements for Scope 3, while probably necessary due to the complexity, leaves some room for interpretation (and hopefully, improvement).
3 Actionable Steps for Companies to Take Now
It is looking more and more likely that this proposal will pass after the 60-day comment period. Though the earliest disclosure requirements would be for the 2023 fiscal year, affected organizations would benefit from getting an earlier start. Here are three steps companies can take now to stay ahead of upcoming disclosure requirements.
Start Calculating Scope 1 and 2 Emissions Now
Scope 1 emissions are “direct” from resources owned and controlled by the company. This includes emissions from the company’s own facilities and vehicle fleet. Scope 2 refers to “indirect emissions” which are generated from purchased energy or utilities.
These emissions are fairly straightforward to calculate, but the process does require significant time and resources, and greatly benefits from automation and dedicated software. Though manually tracking Scope 1 and 2 is possible, it is rife with issues and not scalable for larger organizations. If these rules pass, disclosure of Scope 1 and 2 will be required by the SEC, so implementing these practices before it is required will help companies stay ahead of the curve. Not only is it a sound business decision to stay in compliance, but it is also the right thing to do for organizations to make meaningful progress to decrease their environmental impact.
Get Familiar With the TCFD Framework
Those familiar with the ESG disclosure landscape are well-aware of the alphabet soup that needs to be deciphered. The Task Force on Climate-Related Financial Disclosures is an important one to be intimately familiar with.
Understanding the disclosure framework helps to frame how emissions are calculated and disclosed. Again, doing so manually increases the likelihood of mistakes and is arduous process. Getting familiar with the disclosure frameworks before the mandate takes effect is a show of good faith that the organization is prioritizing these efforts and gets the program up and running earlier. This is a solid case for the benefits of being proactive versus reactive.
Put a Plan in Place for Attestation
If passed, some organizations will fall under the “accelerated or large accelerated filer” category, meaning the company will need to obtain an attestation report from an independent provider that covers, at a minimum, Scopes 1 and 2 emissions disclosure. Essentially, this means some companies will need to partner externally to audit and verify GHG emissions disclosure information. Though this won’t affect every public entity, this is an added layer of complexity and planning to secure the resources needed to complete this process.
Gathering, measuring, compiling and disclosing GHG emissions doesn’t happen overnight, so planning ahead of time is crucial. Because these expected disclosures would fall into the regulatory compliance sphere, there has never been a better time to firmly establish who should own the oversight of ESG. Which business unit should “own” ESG has been widely discussed, and there is a strong case for the risk and compliance function to oversee ESG – especially in light of this proposal.
The proposal still has to undergo the comment period before it can be formally adopted, but companies that have yet to take action on ESG should heed the writing on the wall. Though there are still many variables that need to be defined clearly, this is a step in the right direction and likely to take effect in some form.
For a long time, ESG was considered to be “nice to have”, but the tides are shifting and this is becoming; a “need to have” imperative. Many organizations are setting examples by tying executive variable compensation to ESG metrics or, even better, incorporating sustainability into the corporate culture.