The U.S. Securities and Exchange Commission (SEC)—the regulatory body that oversees corporate disclosures—plays a pivotal role in shaping how companies communicate their financial risks to investors. Amid an unprecedented rise in climate-related disasters that materially affect businesses at an increasing rate, the SEC is set to issue a groundbreaking ruling (expected in October 2023) that promises to set the standards for climate risk disclosures. According to SEC Chair Gary Gensler, the purpose of these regulations is to “help investors better understand their climate-related risks” (SEC, March 2021). But what’s the current status, and what is likely to pass? This article unpacks the SEC’s proposed rule, examines its most debated sections, and covers its implications for both large and small businesses.
What is the SEC climate disclosure rule?
The SEC has increasingly emphasized the need for transparent climate-related financial disclosures. With the National Oceanic and Atmospheric Administration (NOAA) reporting a record-breaking 23 weather events and climate disasters that cost over $1 billion in 2023, the financial risks associated with climate change come into sharp focus. Investors are also pressing for more clarity; a recent McKinsey report showed that 85 percent of the chief investment officers surveyed state that ESG is an important factor in their investment decisions.
According to draft texts, the SEC climate disclosure rule aims to compel public companies to disclose a broad swath of climate-related information. But the impact won’t stop there—a trickle-down effect could bring smaller businesses into the compliance net, as business suppliers will likely be implicated as large companies disclose their climate impact—not to mention consumer pressure.
There are three main components to the anticipated rule:
1. Descriptive reporting
Firstly, the upcoming SEC regulation on climate disclosure mandates companies to offer a detailed description of their governance frameworks, risk management processes, action plans, and performance metrics specifically related to climate-associated financial risks. This would also entail the public release of information regarding the company’s carbon emissions. These disclosure requirements align with the guidelines set forth by the Task Force on Climate-Related Financial Disclosures (TCFD).
2. Third-party verification
The second significant feature of the proposed rule involves the necessity for independent verification and attestation of disclosed information. This clause is primarily aimed at accelerated and large accelerated filers and is focused on scope 1 and scope 2 GHG emissions data. The implementation would be gradual, and the level of assurance required would shift from “limited” to “reasonable” as time progresses.
RELATED: “Limited assurance vs. reasonable assurance”
3. Addendum to financial statements
Lastly, the draft SEC rule stipulates the inclusion of a supplementary note in the company’s financial statements. This note would provide quantitative data on how climate change affects the company’s financial performance. It covers both physical and transitional risks, as well as any mitigation measures undertaken by the company. This condition will be applicable only if the financial repercussions of climate-related risks constitute at least 1% of a specific line item in the financial statements.
It’s anticipated that the SEC climate disclosure rule will be finalized by the end of 2023, meaning reporting would likely begin in late 2024 or early 2025—but on numbers from 2024 or earlier. That means having a plan ready by the end of this calendar year is critical.
Contested areas of the SEC’s climate disclosure rule
The delay in implementing the SEC’s climate disclosure rule is attributable to multiple factors. Critically, this rule had a lengthy public comment period—it was deemed necessary to incorporate views from various stakeholders, including corporations, advocacy groups, and the public. Still, it also extended the timeline for finalization. Additionally, partisan politics played a role in slowing the process. Republican lawmakers and commissioners at the SEC have expressed concerns about the agency’s authority to regulate climate disclosures, arguing it could burden companies and fall outside the SEC’s primary mandate: protecting investors. The complex interplay of public input and political disagreement has contributed to the delay in formalizing the SEC’s climate disclosure rule, with a few areas of the rule at the center of negotiation.
“Materiality” of climate risks
The rule proposes that companies report risks considered to have a material impact to their financial status. The debate centers on how “materiality” should be defined: whether it should be any climate risk that could potentially impact the business or only those with immediate financial repercussions.
For example, suppose a manufacturing company operates multiple factories that emit a large volume of CO2 and other greenhouse gases. If these emissions are significant enough to influence the decisions of investors, regulators, or other stakeholders—or if they could subject the company to regulatory fines or legal actions—these would be considered “material emissions.”
Disclosure of scope 3 emissions
Disclosing scope 3 emissions, which encompass the entire value chain, is particularly controversial. Critics argue that tracking these emissions could be logistically and financially burdensome, particularly for SMEs. For instance, a small business that supplies raw materials to a large retailer would be responsible for tracking and sharing its accurate emissions data, which is no small feat.
LEARN MORE: Sustain.Life’s Supply chain management software features
Financial impact estimations
This contentious point hinges on whether companies should be required to quantify the financial impacts of climate risks and opportunities in dollar terms. Detractors argue that such quantification could be speculative and thus misleading. Many argue that the GHG protocol and strict emissions calculation guidelines allow investors to compare businesses. Still, at the same time, it’s difficult for some investors to translate emissions calculations into financial terms and fully understand the associated risks.
What could be on the chopping block from the SEC’s proposed rule
SMEs and disclosure
Opponents of the rule—such as the U.S. Chamber of Commerce and the Business Roundtable, some political stakeholders, and leaders in highly impacted industries—suggest that the compliance burden could be insurmountable for small and medium-sized enterprises, leading to a chilling effect on entrepreneurship. Advocates counter that climate risks impact companies of all sizes and should be disclosed accordingly.
International supply chain emissions
The inclusion of extensive emissions disclosures on overseas supply chains faces resistance due to feasibility and jurisdictional issues. Critics also argue that it may deter companies from global sourcing and disrupt global trade dynamics.
What’s likely to pass through
Mandatory scope 1 and 2 emissions reporting
Given SEC’s history and the rising institutional demand for emissions data, scope 1 and 2 emissions reporting are almost certain to be in the finalized rule.
Governance disclosures
Given their less controversial nature, requirements for disclosing how a company governs climate risks, including board oversight and executive compensation links, are also likely to stay.
Implications for businesses
Directly impacted businesses
Compliance costs and benefits: Initial compliance will require significant investment in data collection, software systems, and third-party auditing. However, businesses that comply earlier may have a competitive advantage, better risk management, and could attract more sustainable investment.
Tips for execs and sustainability leads
- Seek legal consultation: Proactively consult legal experts well-versed in SEC regulations.
- Built a solid data infrastructure: Invest in robust data collection systems.
- Engage stakeholders: Keep stakeholders in the loop, involve them in resilience planning and transparently convey ongoing compliance steps.
Supply chain partners
If scope 3 emissions make the final cut, businesses in the supply chain will have to follow suit. Even without scope 3, increased transparency in upstream scope 1 and 2 emissions will pressure suppliers to disclose their climate risks and emissions.
Four actions to gear up for the upcoming SEC climate reporting requirements
Getting a head start on preparing for the expected SEC climate disclosure regulations is crucial. Early preparation will ensure robust data control, accurate greenhouse gas (GHG) reporting, and minimize risks related to last-minute rush jobs, which could lead to legal complications and harm your reputation. Below are four proactive steps to begin enhancing your climate disclosure readiness today.
1. Train your staff
Understanding your environmental impact and shaping a solid climate disclosure strategy is a collective endeavor. Although it may seem overwhelming initially, numerous resources—including the Sustain.Life blog and the 100+ step-by-step guides in the product—can guide you.
2. Begin tracking your carbon footprint
The anticipated SEC regulations stipulate that companies must disclose their scope 1 and 2 greenhouse gas emissions and potentially scope 3 emissions if they are significant or if the company has set emissions reduction targets (e.g., a net-zero target)that include these emissions. Gone are the days when calculating emissions required cumbersome spreadsheets and manual tallying. Modern carbon accounting software solutions—like Sustain.Life—can make the process of carbon tracking much smoother, decreasing errors and enhancing both audibility and stakeholder confidence.
3. Identify and assess climate-related risks
Recognizing and planning for climate-related risks—both physical (like natural disasters) and transitional (such as shifting consumer preferences)—is a core aspect of the SEC’s proposal.
Creating and implementing a strategy informed by climate risks isn’t a one-and-done job. Start by allocating responsibility for risk assessment to specific teams within your organization and motivate them to include climate risks in their regular evaluations.
4. Seamlessly merge climate reporting with existing reporting mechanisms
The expected SEC final rule will necessitate the inclusion of climate-specific financial risks in your registration statements and annual reports like Form 10-K or Form 20-F. This implies that most companies will need to integrate these disclosures into their current reporting procedures.
Your readiness for this disclosure is contingent on various aspects of your organizational structure, procedures, value chain, and even your current position on the path to carbon neutrality. The key takeaway here is that your reporting process will undergo continuous refinement, even after your initial required disclosure. Initiating the process now will allow you to set up and document the control systems needed to ensure the reliability of your regulatory disclosures.
The forthcoming SEC rule on climate disclosure is a seismic shift in the regulatory landscape. While its final shape remains somewhat uncertain, its arrival is inevitable. The rule represents not just a compliance challenge but also an opportunity for businesses to align their decarbonization strategies with the imperatives of climate change. Begin preparations now by consulting experts, investing in necessary infrastructure, and engaging with your stakeholders. Stay abreast of developments by regularly checking SEC publications and consider engaging robust carbon accounting platforms like Sustain.Life to help navigate these changes.
Sources
1. JD Supra, “SEC Climate Change Disclosure Rule Expected in October 2023,” https://www.jdsupra.com/legalnews/sec-climate-change-disclosure-rule-9207708/ Accessed September 25, 2023
2. National Oceanic and Atmospheric Administration, “U.S. saw its 9th-warmest August on record,” https://www.noaa.gov/news/us-saw-its-9th-warmest-august-on-record Accessed September 25, 2023
3. McKinsey & Company, “Investors want to hear from companies about the value of sustainability,” https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/investors-want-to-hear-from-companies-about-the-value-of-sustainability Accessed September 25, 2023
4. Bloomberg Law, “SEC Climate Rules Pushed Back Amid Bureaucratic, Legal Woes,” https://news.bloomberglaw.com/securities-law/sec-climate-rules-pushed-back-amid-bureaucratic-legal-woes Accessed September 25, 2023
