The SEC's Climate-Risk Disclosure Proposal.
What companies should do now to prepare for climate disclosure rules.
Why climate disclosure rules are good for you.
Last week, the U.S. Securities and Exchange Commission (SEC) released their much anticipated proposed rules for ‘The Enhancement and Standardization of Climate-Related Disclosures for Investors’ (or the ‘SEC climate disclosure rule’, as it is often short-handedly referred to).
Why is the SEC climate disclosure rule important? Most importantly, the proposed rule moves accountability for corporate climate-related communications from the marketing and public relations department to the investor relations department, and there are very different consequences when that accountability is undermined.
Far too many companies have benefited from public goodwill and positive investor attention by issuing slick climate statements, joining vapid industry initiatives, and making a big deal about long-off targets even while not putting in the work to make any such claims a reality--we are, after all, in the height of greenwashing.
All of this has been a competitive disadvantage to the companies that are meaningfully addressing their climate impacts and transitions--the companies that are investing the resources and efforts into understanding their impacts and supply chains, re-structuring their processes, and transitioning their business models and organizational structures and cultures.
For too long, leading companies would invest meaningfully and diligently just to have some do-little competitor gain equal goodwill off of falsified, inflated, and fully unsubstantiated marketing claims. You could address climate in meaningful ways, often at great expense and commitment, or you could simply say you were addressing climate in meaningful ways. Why go to all that work if you could simply benefit from pretending to go to all that work?
The SEC climate disclosure rule could turn this tide. Truth-in-financial-disclosure laws are much more stringent and more frequently enforced than are truth-in-marketing laws--Climate communications are about to transition into the realm of financial disclosures.
This is big…and this will change the competitive landscape as climate greenwashing will quickly transition from being a quick and cheap win to a structural and material liability. Those companies which have been addressing climate meaningfully are already positioned to benefit from this change, those that have not are about to be exposed. No longer will corporate climate leaders be so easily confused with climate laggards.
To say it was much anticipated is not an exaggeration, just look at the spike in ‘SEC Climate Disclosure’ as a search term in Google over the past 12 months:
This is a significant development, not only because the document itself comes in at 500+ pages, but because it incontrovertibly positions climate change as an issue material to investment decision-making.
The document is quite large and densely written by virtue of the regulatory environment it is a product of and for, but please do not let this mislead you: The proposed rules on climate-related disclosures are quite clear, balanced, and (should we say it?) commonsensical.
Let’s look into four of the more important components:
The rule is guidance on disclosures and not on climate outcomes or policies. Climate-related disclosures include:
Discussion of the perceived risks from climate change for the business.
Discussion of the company’s strategy to manage these risks.
Calculation of the company’s GHG emissions.
Discussion of the company’s transition plan toward publicly stated goals, if applicable, such as Net-Zero by 2050 for example.
The rules do not stipulate how to perceive climate risks, how to manage these risks, how to lower GHG emissions, or how to select applicable transition targets, but they do stipulate how companies must disclose information, and remain accountable to these disclosures, about these issues.
For the SEC, climate is a risk not because scientists have convinced them as such but because investors are increasingly acting as such. Without good information, financial markets cannot operate properly, and this proposed rule aims to set the bar on what counts as good climate-related information.
Popular media often use the terms of GHG emissions and carbon emissions interchangeably, however, this isn’t quite accurate, and the proposed rule addresses GHG emissions and not only carbon emissions. Carbon dioxide is the most prevalent of the greenhouse gases (representing 80% of the U.S. GHG emissions in 2020), followed by methane, which is also carbon-based, but also by nitrous oxide, and fluorinated gases. Although carbon predominates, it is not the sole contributor and the SEC climate disclosure rule acknowledges this.
Much is made about the various scopes of GHG accounting, but it need not be overly complicated and a simple review of the taxonomy can help clarify most of the landscape:
Scope 1 emissions are all GHG emissions that originate from the company’s operations. These are the emissions the company is directly producing.
Scope 2 emissions are all GHG emissions that originate from the purchased energy for the company's operations. These are the emissions that the company is indirectly producing.
Scope 3 emissions are all GHG emissions that originate from the supply chain dynamics feeding into the company and the GHG emissions originating from consumer use of the company’s products/services. These are the emissions the company is in-part indirectly causing to be produced.
Scope 1 and Scope 2 emissions are the easiest to identify and measure, and reporting of these accounts will be required by all filers. Scope 3 emissions are relatively more difficult to measure and so are more often modeled under various assumptions than they are measured. For this reason, not all companies will be required to disclose Scope 3 emissions, although all are welcome to do so voluntarily. Also, those companies that will be required to disclose Scope 3 emissions will only be required to do so 12 months after first disclosing their Scope 1 and Scope 2 emissions at the earliest.
3) Not Reinventing the Wheel The proposed components are not entirely novel as they draw quite heavily from the Task Force on Climate-Related Financial Disclosures (TCFD). The TCFD, currently chaired by Michael R. Bloomberg, was launched in 2015 by the Financial Stability Board, which is an international body that monitors and makes recommendations about the global financial system.
The TCFD is one of the most frequently used climate-related disclosure frameworks by public companies worldwide meaning the new SEC proposed rules can leverage existing practices, established approaches, historical data, and a network of advisors, researchers, and related service providers. If you are familiar with the TCFD, or if you were to familiarize yourself with the TCFD, you would quite effectively be familiar with what is being proposed by the SEC.
4) Timeline The SEC climate disclosure rule is currently a proposed rule which must make it through a period of public review and comments and any legal challenges which may arise. If the rule is finalized by December 2022, as is anticipated, companies would be expected to begin filing climate-related disclosures with their financial disclosures in 2024 with respect to their 2023 operating calendar. So, for example, calendar year-end large accelerated filers would include their first disclosures in February 2024 with the intention of adding Scope 3 emissions data to these disclosures in February 2025.
Just to emphasize, and this needs to be stressed, the proposed SEC climate disclosure rules are not environmental rules nor policy--this proposal is entirely about enhancing and standardizing the disclosure of information financial markets have deemed to be of material interest. Companies and investors are free to act on climate as they see fit, but they will no longer be able to mislead, confuse, or lie about acting on climate as they see fit.
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A Few Extra Articles on the SEC The SEC climate disclosure rules were a ‘big news’ event carried by all major media channels, but here were a few articles we found helpful. NPR provided an accessible overview along with a 2-minute audio recap, while JD Supra provided a few legal perspectives into the matter. Forbes brought an investor angle to the story which was much appreciated, while the Sierra Club brought an environmentalist angle noting that even though the SEC was not dabbling in environmental policy, the new proposed rule could shape the climate movement nonetheless.
The Price of Uncertainty An article from the Federal Reserve Bank of Richmond finds that markets have started to price climate risks, however, pricing varies across markets and time with evidence of substantial inefficiencies. In short, investors are acting on perceived climate risks but their perceptions of climate risks often deviate quite strongly from any scientific basis of these risks--there is just not enough credible information to guide these market decisions at this time. Likewise, academic research does demonstrate that investors are increasingly taking into account the carbon intensity of firms in anticipation of exposure to climate transition risks. While another study finds inefficient pricing of climate risks with some stock prices underreacting and others overreacting to climate risks as climate-related information is not fully nor efficiently incorporated into markets.
An End to Greenwashing? A report in the Financial Times demonstrates how greenwashing is getting out of hand. Global Banks continue to finance fossil fuels despite having quite vocally supported new climate plans and a transition to Net-Zero. The world’s 60 largest lenders provided $742 billion in financing to fossil fuels industries in 2021, led by JP Morgan Chase, Citi, Wells Fargo, and Bank of America, with Canadian-based RBC closing out the top-5.
In a similar vein, Climate Action 100+, the largest investor engagement initiative on climate change, released its second Net Zero Company Benchmark assessment. Of the 166 companies on the organization’s focus list, 69% are now committed to achieving net-zero by 2050, 90% report some level of board oversight of climate change, and 89% have claimed alignment with TCFD recommendations, however:
Only 17% of companies have actually set any medium-term emissions reductions targets;
Only 42% of companies include Scope 3 emissions in their ‘comprehensive’ net zero plans;
Only 5% of companies commit to aligning capex plans with long-term GHG emissions reduction targets;
No companies have demonstrated that their financial statements are prepared using assumptions consistent with net zero by 2050.
On all fronts, there seems to be a lot of talk but much less follow-through…and it is precisely because of this that climate-related risk disclosure regulations are required.
But What if the Proposed Rules Fail? The SEC plan is still just a proposal and is hopeful to become effective by December 2022. Although a few political machinations could interrupt this process, it seems reasonable to expect the proposal to become a rule. As an HBR report shows, shareholders are pressing for climate disclosures. Shareholder resolutions have been pushing more companies to disclose climate-related risks. In the days following shareholder-induced disclosures, respective firms’ stock prices increased an average of 1.21%. Climate is increasingly perceived as a financial risk and investors want more information to better manage these risks.
In the end, The SEC climate disclosure rule has been a long-time coming and seems well-positioned to deliver upon most stakeholder expectations. The world of ESG and Sustainability never rests. We are focused in this space and will have more to say in our next edition, in the meantime, please connect with us on Twitter and LinkedIn, or from our website to continue this discussion in greater detail.
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