Let March Madness Begin! The SEC Finally Announces its Climate Disclosure Rule
Securities and Exchange Commission Finally Announces Climate Disclosure Rule
While some people have been eagerly anticipating college basketball’s March Madness, others have been anticipating the SEC’s long-awaited climate disclosure rule, which was finally announced today. As discussed previously (in a climate-related disclosures blog post from a year and a half ago), this rule is highly contentious and will probably face legal challenges.
The SEC appears to be acknowledging the risk of litigation in rolling back what must be reported under this new rule. The European Union requires that corporations disclose their Scope 1, 2, and 3 emissions, and the proposed SEC rule had similar requirements. The final rule, however, does not require disclosure of Scope 3 emissions and even Scope 1 and Scope 2 emissions reporting has been scaled back. The EPA defines Scope 1 emissions as “direct greenhouse (GHG) emissions that occur from sources that are controlled or owned by an organization (e.g., emissions associated with fuel combustion in boilers, furnaces, vehicles).” Scope 2 emissions are also those controlled by the organization itself and include “indirect GHG emissions associated with the purchase of electricity, steam, heat, or cooling.” Scope 3 emissions, on the other hand, are those emissions generated by activities and assets that are not owned or controlled by the reporting business, but that the reporting business indirectly affects in its value chain (aka “value chain emission”). Notably, these Scope 3 emissions often represent the majority of the reporting business’s total GHG emissions.
While this more limited scope may reduce litigation, there is still a high probability that the SEC’s ability to mandate this type of reporting at all will still be challenged in court. The reality, however, is that regardless of what happens with this rule, savvy investors recognize that a company’s exposure to climate risks can have a serious impact on the company’s current value and future potential. Among the many challenges commercial real estate face, for example, is increased insurance costs due to climate change. The financial industry also faces another potential housing bubble, thanks to overvalued properties that don’t take into account climate-risk related problems (such as flooding and sea level rise). And depending on how a business sources the supplies it needs (or materials it sells), climate change can seriously impact the healthy functioning of such supply chains. Construction projects too can face a myriad of risks if developers and contractors (along with their architects and engineers) aren’t incorporating resilience to climate-change-related risks into the design and build of their projects.
In addition, regardless of what happens long term with the SEC’s new rule, there are already a number of other governments regulating these same issues. Just last fall, California passed both S.B. 261, a climate financial risk disclosure bill, and S.B. 253, a greenhouse gas emission reporting bill. While there will presumably be litigation over the scope of these bills (they apply to businesses operating in California with at least $1 billion in annual revenues), they do not face the same uphill legal battle as the SEC rule. Other states, such as Colorado and New York, are also considering various climate-change-related financial disclosures. Many states are dipping their toes into the disclosure realm by requiring homeowners to disclose flooding risks. While a far cry from SEC financial disclosures, these state-mandated disclosures are an acknowledgment of the financial impact that extreme weather events and climate change can have on an investment central to many American’s financial portfolio.
As mentioned above, the E.U. mandated GHG emissions reporting when the European Union’s Corporate Sustainability Reporting Directive went into effect last year. This directive updates and strengthens rules regarding what social and environmental information needs to be reported, along with specific rules regarding reporting requirements for sustainability issues. This new European Union sustainability law could be waived for U.S.-based companies if the SEC rule survives legal challenges and is deemed adequate by E.U. regulators. Given the SEC’s decision to eliminate Scope 3 reporting from the rule, however, the likelihood that E.U. regulators will deem it adequate has been reduced.
While the scope and viability of the SEC’s disclosure rule will be litigated for the next few years (at least), businesses should begin evaluating what they are doing and how they can assess, evaluate, and report their climate-change-related risks and impacts if needed. With rules being implemented at both the state and international levels, and sophisticated investors and insurance companies already directly demanding this kind of information already, few businesses will be able to completely escape climate-change-related disclosures for very long.
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