Last March, the U.S. Securities and Exchange Commission (SEC) proposed new climate rules that would require registrants to report greenhouse gas (GHG) emissions and climate-related financial risks, among other metrics. Since the proposed rules were released, more than 14,000 comment letters have been submitted to the SEC, and companies have begun implementing the systems needed to support audited reporting. While the final rules and the timeline for their release and adoption are not definitive, publicly listed/traded companies can anticipate complying with these disclosures soon, with the earliest compliance period likely to start in 2025 using 2024 numbers.
Here, we dig into a high-level overview of the existing proposal and what may stay the same or change before the final ruling expected later in the coming months, as well as how you can prepare.
SEC RULES: WHAT TO EXPECT
Reporting of GHG Emissions
Proposed Rule: SEC registrants must disclose emissions from their operations (Scope 1 and 2) and these emissions must be assured by an independent third party. Larger companies with material value chain emissions (Scope 3) must also disclose these emissions as they are phased in over time.
Comments: The SEC has received significant feedback from companies regarding the disclosure of Scope 3. In part, this is due to the heavy lift inherent in gathering and calculating emissions across the value chain; however, it also appears to be due to a misperception of the SEC rule as requiring actual data from suppliers for Scope 3 disclosure. The proposed rule aligns with GHG Protocol guidance and permits the use of actual data as well as of estimations for emissions calculations, and also builds in a safe harbor for disclosure of Scope 3 emissions. There has also been contention around the inclusion of third-party assurance for Scope 1 and 2. Even if final rules do not depart from the proposed rule, we can expect more explicit guidance and justification around these aspects of the rule.
Climate Risk
Proposed Rule: SEC registrants must report on perceived physical and transition climate risks and opportunities, how these risks and opportunities were identified, the strategy for addressing them, and any targets that have been set.
- Physical climate risks include acute risks driven by specific weather events such as floods and wildfires, and chronic risks driven by longer-term shifts in climate patterns such as sea level rise and increasing average temperatures.
- Transition risks are related with the move toward a low-carbon economy and include drivers such as regulation, technology, market shifts, and changes in consumer and investor sentiment.
Comments: This aspect of the proposed SEC rules is fully aligned with the widely recognized and broadly accepted recommendations from the Task Force on Climate-Related Financial Disclosure (TCFD), as well as the draft guidelines published by the International Sustainability Standards Board (ISSB) in March 2022. Given this alignment and the SEC’s mission to promote fair dealing in the market and ensure that important market information is disclosed to those who make decisions based on an assessment and pricing of risk, it seems unlikely that this provision will be altered in the final rules.
Financial Statement Impacts
Proposed Rule: SEC registrants must include a footnote to their financial statement that discusses the financial impact of each line item if climate-related impacts represent a change of greater than 1% to that line item.
Comments: A 1% impact threshold is comparatively low. According to legal professionals close to the development of these standards, this provision as is will likely not be included in the final rules. Adjustments to the proposed rule may include a higher threshold, or making the rule subject to a materiality assessment, or the provision may be thrown out altogether.
SEC RULES: HOW TO PREPARE
How can companies begin preparing for the final ruling? For companies that are just beginning on their climate journeys and are subject to the SEC rule, we recommend taking two actions this year:
#1: Develop a comprehensive GHG inventory inclusive of your operations and value chain emissions (Scope 1, 2, and 3).
This inventory will provide the exact data you need to meet a key aspect of the SEC’s disclosure rules. And while much of this data may be estimated in 2023, an inventory will put you on the path to refining your data collection processes and calculations ahead of needing to disclose. A comprehensive inventory will also confirm whether your company will be required to disclose Scope 3 emissions.
#2: Once you have a sense of the data required for disclosure, put in place more controls around this data.
This can be done through a variety of mechanisms, both manual and automated. On the manual side, defining GHG data processing and calculation through an Inventory Management Plan (IMP) is a critical step toward ensuring consistency, accuracy, and transparency in your data and calculations year over year. It’s also a key tool that can help streamline the third-party assurance process.
On the automation side, software can help collect and validate underlying data, such as utility and financial data, as it’s generated. Beyond products such as utility bill management software, some sustainability software providers can also help calculate emissions. We would encourage anyone considering implementing a software to be thoughtful about vetting potential providers and considering the best time for implementation. Our experience with corporate clients new to data disclosure has shown that software implementation is best considered after the GHG inventory development process when data inputs, processes, and challenges have been defined and can inform the selection of a best fit software tool.
The Stok team is here to support you in preparing for disclosure and in building the data management systems to back it up. If you’re ready to develop a GHG inventory, advance your data management systems, prepare for third party assurance, conduct a physical risk assessment, and/or are considering new ESG software tools – or aren’t sure where to start – please reach out!
