The Securities and Exchange Commission (SEC) has published its long-awaited proposal on climate disclosure. The vote to move forward on the proposal is one step in an ongoing and uncertain process which is now in a public comment period, after which the SEC may amend the proposal based on that feedback. Once completed, it will kick off a sprint to implement the rule ahead of an uncertain political future in Washington.
The proposed rule changes include enhanced disclosure requirements on US or foreign registrants to include greater reporting on climate-related governance, risk management, impact and transition activities as it relates to the business model, strategy and outlook.
The proposal covers companies’ direct and indirect operational emissions (Scope 1 and 2) as well as upstream and downstream value chain emissions (Scope 3) to provide better, more consistent climate data to investors.
Below are key considerations in assessing and reacting to this vote:
The Arrival of Mandatory Climate Disclosure?
The proposal places the US at the center of a global conversation around mandatory climate requirements, with the potential for sweeping effects to the global economy as a result, including accelerating ESG trends towards the standardization of climate metrics and increasing pressure on companies to plan and report accordingly.
- Takeaway: Momentum continues to build for mandatory climate-related disclosures. Firms should plan accordingly by improving measurement and monitoring of emissions data and providing robust material data on their Scope 1, 2 and 3 emissions through their sustainability/ESG reports, while considering adding climate disclosure to other public reports, such as the 10-K and proxy statements.
Prepare (the Reports) Accordingly:
The proposed disclosures would push companies to detail their greenhouse gas (GHG) emissions data through annual reports and alignment with current, widely used frameworks that could also be subject to third-party assurance after a phase-in period.
- Takeaway: For those that have yet to produce disclosure publicly, now is the time to get ahead of the curve and start developing your disclosure practices in line with the SEC’s stated expectations. Companies should continue or accelerate efforts to collect relevant data, set near- and long-term ESG targets and build in holistic risk management strategies, including scenario planning, while embedding the proper oversight and infrastructure to ensure accountability year over year. As part of this ongoing process, businesses must explore how to best incorporate the resulting data into their annual reports, such as a 10-K, to provide additional transparency to prepare for this component included in the new rules.
Walking the Talk:
It’s imperative that businesses continue to communicate their holistic ESG strategies, including climate-related risk, in both the near and long-term. The rigor with which that communication is assessed is likely to increase, along with the potential scrutiny that comes with it if companies aren’t able to support that communication with tangible evidence.
- Takeaway: It’s more important than ever that ESG messaging and materials are given the same level of compliance attention as any other business reporting. Scrutiny of the sustainability and/or ESG function within companies will increase, as will the need to integrate company sustainability efforts into the core business model to ensure alignment on reporting and communications. As climate data becomes part of official reporting practices, it will be critical that all public-facing content is also based on the same data. To the extent that companies are already providing regular public-facing reporting on climate goals, ensure that the proper controls are in place so that those reports can evolve along with the SEC’s disclosure requirements to maintain credibility and build trust.
Digging Deeper on Scope 3 Emissions
After much speculation, Scope 3 emissions, which are indirect emissions in a company’s value chain, were included in the proposed SEC rules. While the SEC has indicated that Scope 3 emissions disclosure will not be required as soon as the phase in for disclosures on Scopes 1 and 2 (as early as 2024), Scope 3 emissions are indeed a part of the rules.
- Takeaway: The SEC has made it clear that Scope 3 emissions must be a part of climate-related disclosure for certain companies. While Scope 3 disclosure has long been a practice of leaders, it will increasingly become standard. Despite the data challenges and some of the evolving Scope 3 reporting standards, companies should work to improve the credibility of their Scope 3 inventories through expanded disclosure and engagement with their value chain. These emissions will continue to come under the microscope both through these rules and throughout the market more broadly.
Finance Prepares For What’s Next
The vote makes clear that corporate issuers must take climate disclosure seriously. But last year’s request for comment that began this process also drew responses from across the financial world, including from asset managers, pension funds, and retail investors, as increased corporate disclosure around climate-related risks has ramifications for all market participants. That’s in part because these disclosure rules will likely inform future guidelines for other types of financial firms, such as asset managers.
- Takeaway: Many larger asset managers already provide at least some information to their investors about the climate-related risks involved in their portfolios. In the absence of a current framework for these types of disclosures, the amount and type of data provided can vary by firm and asset class. If the SEC rule comes into effect, their clients will be expecting to receive disclosures that reflect the new SEC’s standards, and that regulation could be coming for them next.
As mentioned, the vote is only one step in an ongoing and uncertain process ahead. Market participants have the opportunity to provide comment on the proposal during the comment period. The rule is open to public comment until at least May 20. Further instructions on how to have your perspective included in the comment file are available on the SEC’s website.
The rule is also almost certain to face opposition in the form of legal action amongst other hurdles. In the meantime, firms at all stages of their sustainability journey have an opportunity to be proactive and embed strong ESG practices as part of their strategy to avoid risk, drive long term value creation and build trust.
Joby Gaudet is Senior Vice President, Social Impact & Sustainability and Natalie Short is Senior Vice President, Financial Communications.