Policy Corner | March 22, 2022

SEC disclosure rules signal the arrival of climate accountability

Amy Cortese
ImpactAlpha Editor

Amy Cortese

ImpactAlpha, March 22 – Better than expected. 

That was the consensus among advocates for greater transparency for corporate climate-related risks and impacts after the Securities and Exchange Commission’s preliminary approval of new climate disclosure rules yesterday.

The new rules, which will affect more than 6,000 publicly traded companies, were more thorough than many investors had dared to hope in the face of expected pushback from fossil fuel interests. The rules were approved by a 3-1 vote and will now be subject to a 60-day public comment period.

“The idea that environmental risks have risen to the level of financial risk is a historic step,” CDP’s Paula DiPerna told ImpactAlpha. “Prior to this, environmental risk was in the eye of the beholder. Now it’s in the eye of the shareholder.”

A surprise breakthrough: Inclusion of rules for the disclosure of so-called Scope 3 emissions, which include the emissions generated by companies’ supply chains and customers’ use of their products. Such indirect emissions often account for the bulk of companies’ carbon footprints.

The rules also cover corporations’ use of climate scenarios, transition plans, carbon offsets and internal carbon pricing. They provide the first official guidelines for climate-related disclosures by U.S. public companies, including greenhouse gas emissions and physical and transition-related risks. 

The rules “would provide investors with consistent, comparable decision useful information for making their investment decisions and would provide consistent and clear requirement obligations for issuers,” said S.E.C. chair Gary Gensler. 

“This is a watershed moment for investors and financial markets,” added commissioner Allison Lee. Climate change risk is “one of the most momentous risks to face capital markets since the inception of this agency. The science is clear and alarming and the links to capital markets are direct and evident.”  

Living in the material world 

Reactions to the proposed rules from impact and climate investors ranged from cautiously optimistic to nearly ecstatic. 

The U.S. Impact Investing Alliance called the new reporting requirements “one of the boldest steps a U.S. regulator has taken toward accounting for the risks of climate change to our economy in a transparent and meaningful way.”

Vert Asset Management’s Sam Adams said the SEC has recognized climate risk as an investment risk. “It’s not a niche or partisan issue,” he said. “It’s a pervasive concern for all investors.”

In anticipation of expected legal challenges, SEC chair Gary Gensler hewed closely to the doctrine of “materiality.” The Supreme Court has defined information as material if “there’s a substantial likelihood that a reasonable shareholder would consider it important” in investment decision-making or voting. 

A more ambitious doctrine of “double materiality” would include information on a company’s external impacts, for example on communities or the environment. 

The commission majority threaded the needle to include Scope 3 emissions when such information is material to a company’s financial performance, or if the company itself has set goals to reduce its Scope 3 emissions. Many companies already disclose Scope 3 climate risks, in addition to their direct emissions (Scope 1) and those generated by their power use (Scope 2). Gensler said SEC staff had reviewed nearly 7,000 annual reports and found about one-third included some climate disclosure.

“The S.E.C. is walking the middle line with Scope 3 emissions,” said Danielle Fugere of As You Sow, by leaving it to investors and companies to determine what exactly constitutes materiality. “Companies that get it wrong might expect (shareholder) proposals.”

Such indirect emissions make up the bulk of many companies’ carbon footprints – 85% in the case of ExxonMobil, of which tailpipe emissions from Exxon-fueled vehicles is a major component. Exxon’s Scope 3 emissions for 2019 equaled 730 million metric tons of carbon dioxide, about the same as Canada’s. Exxon, Chevron and other companies have bowed to investor pressure to report the full scope of emissions. 

The SEC said Scope 3 reporting will be phased in, with disclosure by large companies to begin in 2024. Small companies are exempted. The SEC also created a “safe harbor” for Scope 3 disclosures, to assuage concerns that companies would be held liable for emissions outside of their control.

Opponents say that Scope 3 data is hard to obtain and is imprecise. Yet the more companies that report their emissions, the more accessible and accurate the information will become. 

“Everybody’s Scope 1 and 2 disclosures are someone else’s Scope 3,” notes Fugeres.  

Prices on carbon

Many corporations have adopted internal carbon prices to inform capital investment, deal underwriting and other decision-making. The prices vary widely, from $1 to $1,600 or more. Microsoft, for example, charges its business units $15 per ton of carbon and uses the proceeds to help fund carbon reduction and offset investments. 

The SEC for the first time will ask companies to disclose if they have set an internal price on carbon and the assumptions that underlie the price. 

“Transparent price signals are very important,” says DiPerna of CDP, which surveys corporations on their use of internal carbon prices. “Once you start seeing the price and what is being included in it, you start to see operational risks and opportunities. We talk about risks, but there are opportunities, too.”

The rules also include information on companies’ use of carbon offsets or renewable energy certificates to meet their climate-related “net zero” goals. Offsets are useful in helping companies cancel out hard-to-abate emissions by channeling money to carbon reduction or removal projects. But critics worry that they can distract companies from absolute emission reductions from their own operations and foster “greenwashing,” or misinformation about actual performance. 

The Science-based Targets Initiative, which sets best practices for emissions reductions, stipulates that offsets not be used for more than 10% of emissions. 

“The SEC is saying you have to be very clear if you are using offsets to reduce your emissions,” says Fugeres. 

Reporting tools

The guidelines for verification will be a boon for third-party auditors as well as startups with tools to help companies measure and report on their greenhouse gas emissions and identify and understand their climate risks. 

Climate risk analytics startups like Jupiter, OneConcern, Cervest, and The Climate Service, and carbon accounting companies Persefoni, Watershed, and Sweep, are “set to benefit,” tweeted Sophie Purdom of Climate Tech VC. 

The disclosure requirements are based on information already provided by companies using frameworks developed by groups including the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. 

KPMG’s Rob Fisher said CEOs should not see the rules as an exercise in compliance, “but a unique opportunity to respond to the demands of investors, customers, and employees to unlock value and build trust.” He said the SEC’s proposal “will raise the bar across businesses, demanding deeper ESG engagement to gain that edge.”