The Securities and Exchange Commission (SEC) has released its proposed rule changes for climate-related disclosures. These proposals represent a strong commitment to the principles of ESG on the part of the government and the business community. If enacted, they also promise more rigorous environmental reporting obligations for many organizations.
According to The Enhancement and Standardization of Climate-Related Disclosures for Investors, a 509-page document, disclosure “would require information about a registrant’s climate-related risks that are reasonably likely to have a material impact on its business, results of operations, or financial condition. The required information about climate-related risks would also include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks. In addition, under the proposed rules, certain climate-related financial metrics would be required in a registrant’s audited financial statements.”
Summary of the Proposals
Current disclosure frameworks like the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol form the basis of the proposed disclosures from the SEC. As such, many organizations will already be familiar with or reporting on these disclosures. In summary, the proposals require that domestic or foreign registrants provide the following climate-related information in their reporting:
- Risks related to climate and their potential material impacts on business strategy.
- Governance and management of climate-related risks, such as severe weather events related to climate change and the cost of transition to a low-carbon economy.
- Greenhouse gas (GHG) emissions subject to assurance.
- Disclosures on climate-related metrics in notes to audited financial statements.
- Targets, goals and transition plans related to climate.
Perhaps the most significant new rules for many organizations are those that relate to Scope 1 (emissions resulting from direct operations), Scope 2 (emissions created indirectly as a result of purchased energy) and Scope 3 emissions (emissions further down the supply chain, such as those generated by suppliers or from use and disposal of the organization’s products).
If the rule changes move forward as proposed, large organizations will be required to report on Scope 1 and Scope 2 in FY 2023, while smaller organizations will begin reporting in FY 2024. Based on the current proposal from the SEC, organizations will need to report on Scope 3 emissions if they are material or if the organization’s emissions reduction goals include Scope 3 emissions.
The proposed rules require accelerated filers and large accelerated filers to include attestation reports covering disclosures for Scope 1 and Scope 2 emissions. There is also safe harbor for liability from Scope 3 emissions, while smaller reporting companies will be exempt from the disclosure requirement for Scope 3 emissions. These proposed requirements would be phased in over time according to the filer status of each registrant. Given the complexity of their requirements, Scope 3 emissions would have an additional phase-in period.
Context of the Proposals
In the last few years, investors have become increasingly concerned with the environmental, social and governance (ESG) principles of the organizations they invest in. They want to understand more about how these organizations are conducting their business strategies and how they are meeting the risks of new threats and opportunities, particularly those related to climate change. However, until recently, the means by which organizations have been able to report that information has been inconsistent and fragmented.
These proposals, in conjunction with standardized reporting frameworks, will help to provide the consistency and reliability organizations need to disclose clear, explicable ESG information to investors. SEC Chair Gary Gensler states: “Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions.”
What Do You Need to Do?
The reporting requirements for Scope 1, Scope 2 and Scope 3 emissions represent significant obligations for many organizations, particularly for Scope 3, which often form the largest portion of the carbon footprint and are the most difficult to track. While the proposals could change as a result of the information gathered during the comment period, the obvious appetite among investors for strong ESG reporting requirements demonstrates that organizations should act now to avoid falling behind on their obligations during their reporting period.
The amount of data required to meet the reporting requirements for emissions is considerable, and if anyone needs proof that the days of tracking environmental data in a spreadsheet or home-grown tool are over, the proposed rules from the SEC are that proof. As such, organizations need an ESG management system that integrates and automates ESG data collection, calculation and reporting. Despite the phased-in approach the SEC will take with the new, proposed reporting requirements, organizations need time to build and integrate the technology systems required to support their ESG data management. It’s important that organizations begin planning now for the inevitable ESG reporting requirements from the SEC in the near future.
The proposed rules would include a phase-in period for all registrants, with the compliance date dependent on the registrant’s filer status, and an additional phase-in period for Scope 3 emissions disclosure.
The proposing release will be published on SEC.gov and in the Federal Register. The comment period will remain open for 30 days after publication in the Federal Register, or 60 days after the date of issuance and publication on sec.gov, whichever period is longer. Comments can be submitted here.
A fact sheet is available from the SEC that summarizes the proposed rule changes. You can find it here.