Photo of the U.S. Securities and Exchange Commission (SEC) HQ by D. Ramey Logan.
Artist’s rendering of Sauron’s Ring by Peter J. Yost. Source: Wikimedia Commons
Back in 2020 we wrote that around 7,000 large companies had begun voluntarily reporting greenhouse gas emissions (GHG) and other environmental data to the non-profit Carbon Disclosure Project (CDP). The problem? More than 230,000 other companies had not. As the process was purely voluntary, there was little to be done.
But soon, with a tap of the SEC Chairman’s gavel, all public companies may be compelled to do so, and more. The SEC’s new proposed rule will mandate scope 1, 2, and (with exceptions) scope 3 GHG reporting. It will also require a full accounting of other climate-based investor risks and “how climate risk will affect their strategy, outlook, financial statements and business from the near-term to the long-term.” The rule would take effect quickly, in fiscal 2024 or 2025, though there are some built-in extensions for smaller reporting companies (SRC).
“We believe,” the SEC explains, “that the current disclosure system is not eliciting consistent, comparable, and reliable information that enables investors both to assess accurately the potential impacts of climate-related risks on the nature of a registrant’s business and to gauge how a registrant’s board and management are assessing and addressing those impacts.”
Drum sextant and compass, at the Sjøfart Museum, Oslo, Norway.
Photo by Fanny Schertzer. Source: Wikimedia Commons
As a result – if enacted – public companies must, for the first time, measure and report their specific GHG outputs and climate-related business risks. In another first, they will do so using a consistent reporting framework, a concern that has dogged voluntary reporting since its inception.
“The SEC has been calling companies out for saying in their ESG or sustainability reports, ‘climate is a big risk, it’s a massive impact on our business,’ but not saying that in their [IRS form] 10-K,” said Phil Clawson, Director, Sustainability & Social Impact at AMN Healthcare in Dallas. Indeed, the commission has complained of such discrepancies and this action is, in part, intended to align them.
But aside from better informing investors, this will make it easier for companies to do things the sustainability community has long been screaming for: quickly formulating and working towards meaningful science-based targets (SBT); planning effective sustainability strategies; and bringing sustainability into C-suites and boardrooms for keeps.
Photo by Rido81
Meanwhile, it will translate into long nights for those responsible for compliance, especially for thousands of firms who haven’t voluntarily done such analyses before. And as proposed, there’s little time to prepare. The SEC’s “reasonable amount of time to comply,” begins in about a year and a half.
As such, there’s likely to be a scramble to gather and collate appropriate data. While there are several companies and platforms specializing in such measurements, the brunt will fall on Chief Sustainability Officers (CSOs) and equivalent positions. Therein lies another challenge: last year, the Weinreb Group listed only 95 CSOs in the United States. The 4,000 public  companies that will fall under the SEC’s new rule, currently ill equipped, will be hungry for talent at that position.
Capacity will be strained and, historically, budget requests for sustainability projects have been tough to get approved. However, sustainability director Clawson chuckled, “though additional resources will be necessary to comply with the rule as currently envisioned. – technology, auditing, help with data capture and quality – it’s easier to make a business case for it if it’s mandated by SEC.”
Photo by Immo Wegmann / Unsplash
Indeed, the detailed measurement and analysis needed may be what finally causes business to, as we wrote in 2019, bring sustainability onto the top floor. As TechTarget points out, without trained professionals in these positions, “the reporting task will fall to a business’s legal counsel or the chief financial officer.” Such people are competent in their lanes, but measuring various global warming potentials (GWP) of GHGs across company operations, and surfacing the risks posed to global supply chain by climate change, are not the stuff of financial statements or legal briefs.
In part for this reason, the rule would also hold directors responsible for compliance. It would even require that companies identify, by name, the specific “board members or board committees responsible for the oversight of climate-related risk.” To this point, climate expertise has not been common in the boardroom and most companies will need some creativity to meet that rule.
“In our case there are no actual experts on the board,” said Clawson. “We’re growing board expertise, training board expertise.” His company isn’t alone: a 2018 survey found that “of the 1,188 Fortune 100 board members, only 6% had environmental credentials,” while the National Association of Corporate Directors (NACD) calculates the majority of directors fall short, with just 24 percent of public company and 13 percent of private company directors participating in educational activities related to ESG in the last 12 months.”
Photo by Vaughn Smith / Pixabay
Between C-suites and boardrooms, it should be a lively couple of years for execs with sustainability chops.
The rule drew its approach primarily from two extant sources: the Greenhouse Gas Protocol (GHG Protocol), “a leading accounting and reporting standard for greenhouse gas emissions;” and the Task Force on Climate-Related Financial Disclosures (TCFD), “a climate-related reporting framework that has become widely accepted by both registrants and investors.”
For many firms, scope 1 and 2 emissions are relatively straightforward affairs, which is handy with disclosure dates as close as 2023. Scope 3, however, is considerably tangled. The proposed rule acknowledges this with 2024 disclosure for scope 3, and SRCs – non-investment, non-subsidiary companies with small public floats or revenues under $700 million – have more time for 1 and 2 and are, currently, exempted altogether from scope 3.
Scope 3 emissions and climate risk are closely related in that both are dependent on factors a firm cannot directly control. The Port of Vancouver, as we reported last spring, was heavily affected by a climate-change exacerbated atmospheric river: the port Los Angeles was overwhelmed in 2021 by post-pandemic resupply; and this year, political chicanery caused massive trucking delays – hence extra emissions – at the Texas-Mexico border. Teasing out such risks – like potential damage to facilities, supply chain disruption, and sea-level rise – and reporting coherently on them within short time constraints, can be daunting. It could cripple the capacity of ESG staff while work is ongoing, and annually thereafter.
Photo by Twenty20 Images
According to the proposed rule, companies will be required to report on scope 3 emissions only when they are found to be material to the company. ‘Material to’ is a tad fuzzy but both the rule and Supreme Court precedent define it as representing issues with a “substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision.”
Calculating such emissions, as they ripple through an entire value chain, is perhaps the most challenging aspect of the proposed rule, an enormous undertaking. It is particularly so for huge multinationals. Coca Cola, for instance, lists more than 16,000 suppliers, manufacturing in 23 nations, and 225 global bottling partners (as of 2020). Proctor and Gamble tops 75,000 individual suppliers while Walmart boasts over 100,000. The complexity only increases when considering relationships of large banking and financial firms. Here, downstream emissions may include all investment activities not to mention insured emissions such as insurance and reinsurance underwriting portfolios: anything that represents material risk to investors.
Not surprisingly, the SEC’s proposal has received intense scrutiny from all sides. Indeed, the Commission was compelled to extend their public comment period while everyone from investor groups, congress, the sustainability community, the energy industry, and corporate interests weighted in.
Executive by Monkeybusiness / Smokestack by Ian Montgomery
The Wall Street Journal reported that “companies are tearing into the proposed rule” because, “it poses heightened legal liability, hefty costs and reporting burdens.”
Some argue that the rule is unneeded because climate risk disclosures are already required or that there is a “climate-industrial complex” that is being supported by the proposed requirements. In fact, one of the five commissioners, Trump Appointee and Federalist Society member Hester Peirce, made both of those arguments in her statement of opposition.
However, it is far from certain that these arguments will prevail. When it comes to the idea that climate risk disclosures are already sufficient, the world’s largest investor, Blackrock, has stated that climate-related risks have been “notoriously hard for investors to grasp,” while companies lag in grappling with the idea of “stranded assets,” such as 80% of Exxon’s business-as-usual petroleum investments.
(Since the “climate-industrial complex” argument is primarily a political one, its success depends more on the political fortunes of climate deniers and those who oppose action on it. While it’s always possible they will regain influence, to halt the new rule, that would have to happen before it takes effect.)
Several business-lobbying firms also commented in opposition to the rule, including the largest of them all, Akin Gump. Though they echoed many of Peirce’s arguments, it was the dollars required to meet the SEC’s potential rule that they seemed to emphasize. “The tremendous compliance costs of the proposed rule,” Akin Gump wrote, “would compound the significant challenges that businesses are already facing from historic inflationary pressures, significant reductions in government reimbursement for services, and labor shortages.”
Will this financial argument win the day? A little math suggests it might not:
- The SEC has estimated costs will be around a half million dollars per year (from $490,000 – $530,000 in the first year and $300,000-$420,000 in subsequent years, depending on company size and SRC Applicant status)
- As noted earlier, the rule applies only to companies with over $700m in revenues
- Given that the average operating margin (EBIT) for the S&P is about 15%, a company with $700m in revenue would have just under $600m in expenses – $595m if margin were exactly 15%. Will increasing that by $0.5m to $595.5m be seen as a large enough cost to prevent finalization of the rule? It doesn’t seem likely
Corn trading pit, Chicago Board of Trade. Photo by Jeremy Kemp (1993). Source: Wikipedia
In a sense, objections to the rule serve to underline the SEC’s concerns about risk. Healthy corporations who are unwilling to pay for reporting on Scope 1, 2, and 3 emissions are potentially actually driving environmental risk for investors, by running gigantic operations without clarity on the extent or derivations of their emissions. As noted above, voluntary reporting and hounding by risk-averse investors have not motivated most companies to report.
Public advocacy group PIRG has recommended the proposed rule be strengthened, making the excellent point in their comments to the SEC that, “the climate disclosure rule is particularly important because Americans’ retirement accounts and other savings could be endangered if we don’t acknowledge potential threats caused by climate change and work diligently to address them.”
If enacted, this rule may set off the greatest data swap-meet in corporate history. Requests for scope 3 data alone will likely choke the switchboards and calculating these emissions will certainly strain data collection and analysis efforts.
Bell systems switchboard. Photo source: U.S. National Archives.
In a recent Deloitte survey (of 300 public corporations taking in at least $500 million in revenue) more than half (57%) indicated that data availability and quality remain their greatest challenges with respect to environmental, social, and governance (ESG) data for disclosure.
Indeed, there is a corporate concern with actual merit, even if it didn’t figure in most arguments to the SEC: if enacted, compliance for the first year may seriously stretch some companies’ already brimful capacity. Standard functions that eat up hours and strain sustainability staff – such as materiality assessments, project cost analyses, ESG policy management, and much more – could grind to a standstill while the SEC’s initial asks are met. (There are, however, as we wrote last spring, potential ways to alleviate this strain.)
Photo by SeventyFour Images / Envato
Whether this proposed rule goes into effect in its current form or not, public companies must begin to undertake such activities. And private companies, though not required to, would benefit from doing so as well.
For one thing, increased regulatory measures such as a carbon tax and cap-and-trade pose significant financial risks, even to companies not yet required to report on scope 3 emissions. Then again, public companies may hound private ones in order to meet their scope 3 reporting obligations.
These requirements, in one form or another, are coming. Valutus tools VIEWSTM and E3EvolutionTM measure what’s approaching over the horizon, and how fast. The need for full-scope emissions assessments is clearly gaining momentum, and failure to begin now could prove financially devastating to any who remain ignorant of the extent of their exposure.
Meeting photo by Matthew Osborn / Unsplash. Elephant photo by Kaffeebart / Unsplash
Beyond measurement and disclosure comes an even greater need: to actually reduce emissions, which the SEC’s proposal doesn’t mandate. “Businesses will have to disclose how climate risk will affect their strategy, outlook, financial statements and business from the near-term to the long-term,” explained Michelle Hanlon, MIT Sloan professor of accounting, in MIT Management. They’ll also have to act on those insights.
That is where the real risk – and the real value – to both planet and ROI is generated. Actions to reduce climate risk bristle with potential value, and failure to perform them is destabilizing the planet. As my forthcoming book, The Value of Values, makes clear, incredible ROI – much of it submerged, invisible below the surface – is available from such actions. Now, with or without the SEC, is the time to begin.