Earth Day Resonance
The first Earth Day occurred on April 22, 1970 after an environmental teach-in following the 1969 Santa Barbara oil spill morphed into a countrywide event that saw more than 20 million people demonstrate in favor of environmental protection.
This groundswell of grassroots support helped inspire a major evolution in U.S. environmental policy.
That December, President Nixon signed an executive order creating the Environmental Protection Agency (EPA), which consolidated the federal government’s environmental responsibilities under one agency. And on New Year’s Eve, Nixon signed into law the Clean Air Act of 1970, which established regulation for air emissions from stationary and mobile sources. This environmental action at the federal level proved enduring; in October 1972, Nixon signed into law the Clean Water Act, establishing a regulatory structure for water pollution.
In three years, environmental policy in the U.S. was transformed. Environmental issues were now firmly in the mainstream thanks to growing support for environmental action highlighted by that first Earth Day. So perhaps it is fitting that the Securities and Exchange Commission’s (SEC) new proposed climate-related disclosure rule landed just before Earth Day 2022.
Another Evolution in U.S. Environmental Policy
As we approach the 53rd Earth Day, U.S. environmental policy is on the precipice of another revolution. Announced on March 21st, the SEC’s “Enhancement and Standardization of Climate-Related Disclosures” proposal would require domestic and foreign registrant companies to disclose climate-related information in their public filings.
According to the SEC, the proposed rule is meant “to enhance and standardize climate-related disclosures” made by issuers to ensure that investors have complete and consistent climate-related information. Much of the rule will be familiar to companies that already follow the Taskforce on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol, as the SEC took inspiration from them when developing its proposal.
The issues covered by the proposal are wide-ranging, but some elements stand out:
- Identifying, Assessing, and Managing Climate-related Risks: Companies would be required to disclose their processes for identifying, assessing, and managing climate-related risk and whether these processes are integrated into their risk management processes.
- Impacts of Climate-related Risks: Companies would be required to disclose how any identified climate-related risks have impacted or are likely to impact their business and consolidated financial statements over the short-, medium-, or long-term.
- Scenario Analysis: Companies would be required to disclose the scenarios they use to assess climate-related risk and the parameters, assumptions, analytical choices, and projected principal financial impacts if they utilize scenario analysis to evaluate the resilience of their business to climate-related risks.
- Scope 3 Reporting: Companies would be required to disclose their indirect GHG emissions from activities in their value chains (Scope 3) in absolute terms and in terms of intensity if these emissions were material or if the company had set a related target or goal.
- Targets and Goals: Companies would be required to disclose information on climate-related targets and goals they have set, including:
- The scope of activities and emissions covered, the time horizon, and interim targets.
- How they intend to meet the target or goal.
- Data to indicate whether they are making progress toward the target or goal.
- The amount of carbon reduction represented by carbon offsets or the amount of renewable energy represented by renewable energy certificates (RECs) if used as part of the plan to achieve the target or goal.
The proposed rule includes phased compliance schedules for companies of different sizes. The table below outlines these schedules for the SEC’s 10-K filer definitions. Large Accelerated Filers have worldwide public float over $700M and Accelerated Filers are generally between $250M and $700M. Smaller Reporting Companies (SRCs) and Non-Accelerated Filers are defined by a combination of public float and annual revenue.
|GHG Scope 1 and 2; management narratives; financial metrics and financial metrics audit compliance; targets and goals||GHG Scope 3||Limited assurance for Scopes 1 and 2||Reasonable assurance for Scopes 1 and 2|
|Smaller Reporting Company||3 years to comply||Exempt||Exempt||Exempt|
|Accelerated and Non-Accelerated Filer||2 years to comply||3 years to comply||3 years to comply||5 years to comply|
|Large Accelerated Filer||1 year to comply||2 years to comply||2 years to comply||4 years to comply|
What this Evolution Means for Business
Back in February, I outlined four steps for companies to consider as they prepared for the release of the proposed SEC rule. Now, with the proposed rule published and the public comment period underway, I examine five likely implications of the rule for business.
1. Climate-related reporting enters the mainstream
Climate-related reporting, long a voluntary practice, now enters the mainstream of corporate reporting. This continues a trend among regulators and stakeholders of placing greater emphasis on Environmental, Social, and Governance (ESG) factors when considering the financial health of the economy and the long-term profitability of companies. While the rule will likely undergo alteration before finalization, companies should prepare now. One-step would be to assess your current climate-related reporting against the proposed rule’s requirements to identify any gaps and devise a plan to close them.
2. The importance of TCFD and Greenhouse Gas Protocol reporting is further validated
As mentioned above, the SEC used the TCFD and Greenhouse Gas Protocol frameworks to shape the recommended climate-related disclosures outlined in the proposed rule. Already widely used by companies to guide climate-related reporting, the use of these two frameworks by the SEC further validates their credibility and utility. With the SEC explicitly mentioning that the proposed disclosures are similar to TCFD and Greenhouse Gas Protocol guidance, companies that already disclose in accordance with them will be ahead of the curve.
By building on the TCFD and the GHG Protocol, the SEC followed stakeholder recommendations to leverage existing reporting guidance and frameworks. I expect comments on the proposal submitted to SEC will include further recommendations to align the rule with existing frameworks. – Tom Curry, Partner, Corporate Sustainability and Climate Change, ERM
3. Scenario analysis to the forefront
According to the TCFD 2021 Status Report, scenario analysis was the least reported aspect of the TCFD’s recommended disclosures, with only 13 percent of the public companies analyzed including such information in their reporting. With the SEC’s proposed rule set to introduce requirements for reporting on scenario analysis, this risk assessment method will no longer be able to be bypassed. For those companies already utilizing scenario analysis or planning to, it will be critical to explain how you conduct these assessments in future climate-related reporting.
4. Scope 3 reporting requirements still up for debate
In the lead up to the release of the SEC’s proposed climate-disclosure rule, one of the most debated issues was how it would approach Scope 3 reporting. Would it require all companies to track and report these emissions, or would it limit Scope 3 reporting to companies whose Scope 3 emissions met a certain threshold? In the end, the proposal required companies to report on Scope 3 emissions if they are material or if a company has set a related target or goal. Regardless of what’s in the final rule, it is clear that U.S. companies are already tracking and reporting on these emissions. For example, an April 2022 ERM review of 30 leading U.S. power companies found that over 50 percent already report their Scope 3 emissions and that 30 percent have set some sort of target to reduce them.
5. Climate-related targets and goals to come under increased scrutiny
As net zero commitments and other climate-related targets and goals proliferate, it has become more difficult for stakeholders to assess progress against them, and there is concern about potential greenwashing. According to one analysis, the net zero targets of 25 of the world’s most valuable companies are not as robust as advertised. The proposed SEC rule requirements will likely bring more scrutiny to climate-related targets and goals by making it easier to determine the scope of a company’s ambitions and how they plan to achieve them.
A Welcome Evolution
From the original to the 53rd, Earth Day has been part of the evolution of environmental policy in the U.S. and across the world.
Today, climate change has superseded the air and water issues that defined the ‘environmental decade’ of the 1970s. While the SEC’s proposed rule will bring significant change to the corporate reporting landscape, it also presents significant opportunity for businesses to demonstrate the strengths of their climate actions at a time of intensifying climate change impacts. For investors and society as a whole, this should be a welcome evolution.