SEC moves to mandate Scope 3 emissions reporting

Public companies will soon have to measure and report their Scope 3 emissions if a rule proposed Monday by the Securities and Exchange Commission is finalized.

Securities issuers would also have to report Scope 1 and 2 emissions, or those that are directly from their operations and the energy they use, on their registration statements and periodic reports. For those two emissions categories, the SEC’s proposal calls for independent third-party assurances that the numbers companies provide are accurate.

Additionally, companies would be required to disclose how much they rely on carbon offsets as part of their greenhouse gas reduction goals.

Such requirements will lead to standardized reporting that will help investors make more informed decisions around risk, according to the SEC.

The lingering question leading up to Monday’s publication was whether the regulator would only make companies report Scope 1 and 2 emissions, as the much wider-ranging Scope 3 emissions, which can apply to anything in a business’s value chain, are more difficult to measure. Any doubt about that was erased Monday, when three of the four SEC commissioners voted on a more aggressive climate-reporting rule than opponents would like.

“With climate change, we have ample, well-documented warning of potentially vast and complex impacts to financial markets,” commissioner Allison Herren Lee said in a prepared statement at the meeting. “Physical and transition risks from climate change can materialize in financial markets in the form of credit risk, market risk, insurance or hedging risk, operational risk, supply chain risk, reputational risk and liquidity risk, among others.”

NOT UNANIMOUS

Lee, along with commissioner Caroline Crenshaw and chair Gary Gensler voted in favor of the proposed rule, while commissioner Hester Peirce, who represents the commission’s conservative minority, voted against it.

“Many people have awaited this day with eager anticipation. I am not one of them,” Peirce said at the beginning of a lengthy objection. “[T]he proposal will not bring consistency, comparability and reliability to company climate disclosures … [but] will undermine the existing regulatory framework that for many decades has undergirded consistent, comparable and reliable company disclosures. We cannot make such fundamental changes to our disclosure regime without harming investors, the economy and this agency.”

In seeking mandatory climate-data reporting, the SEC is overstepping its statutory mandate and catering to environmental stakeholders rather than the needs of issuers and investors, Peirce said. The commissioner also disagreed about whether climate issues could clearly be material considerations for investors.

“There will continue to be some discussion around what does ‘material’ mean, but that has always been an issue,” said Danielle Fuguere, president and chief counsel at As You Sow. The Science Based Targets Initiative provides one indication for Scope 3 targets, for example, if those emissions account for at least 40% of a company’s total emissions.

“Scope 3 disclosures are, in essence, saying a company understands what is happening in its value chain,” Fuguere said.

INDUSTRY OBJECTION

Joining Peirce in her stance against the proposed rule is the U.S. Chamber of Commerce, which said in a statement that ESG reporting by public companies is already strong.

“[T]he prescriptive approach taken by the SEC will limit companies’ ability to provide information that shareholders and stakeholders find meaningful while at the same time requiring that companies provide information in securities filings that are not material to investors,” said Tom Quaadman, executive vice president for the group’s Center for Capital Markets Competitiveness, in a statement. “The Supreme Court has been clear that any required disclosures under securities laws must meet the test of materiality, and we will advocate against provisions of this proposal that deviate from that standard or are unnecessarily broad.”

THIRD-PARTY ASSURANCE

The proposed rule, which spans 510 pages, could be finalized in 60 days, during which time the agency is collecting public input.

The details around the verification that companies will need for emissions reporting are not yet clear, given the length of the proposal and limited time for stakeholders to fully analyze it.

But it is a very positive development for investors, Fuguere said.

“We are glad to see assurances. We know they don’t kick in immediately … we understand that companies need time to go through their assurance processes,” Fuguere said.

“Bringing climate into the financial statement is something that investors have been asking for over the last three years.”

Although many public companies disclose at least some emissions and climate-risk data, that information is not necessarily audited by an independent third party. There are almost certainly big differences how issuers measure emissions and what they choose to report.

For Scope 1 and 2 emissions, some big public companies would have to begin reporting by 2024, getting “limited assurance” from a third party to verify what they report by 2025. They would have to have a higher level of “reasonable assurance” by 2027. Smaller companies that are “accelerated filers” would have until 2025 to start reporting, with limited assurance by 2026 and reasonable assurance by 2028.

MORE DISCLOSURE

The requirements could be a boon for contractors that provide ESG assurance. One such firm, Verdantix, estimates that companies will spend $6.7 billion on climate strategy, assurance, compliance and data processing between 2023 and 2025.

The proposed rule includes exemptions for smaller companies for Scope 3 emissions reporting.

“I don’t think we are in agreement with a full exemption forever … But that is something that can be commented on,” Fuguere said. “At this point it might make sense, but I do think companies should be looking to their full value chain if we want to solve this [climate change] problem.”