industrial burning

In March 2022, the Securities and Exchange Commission (SEC) issued a proposal that would require publicly traded companies to disclose their greenhouse gas (GHG) emissions, their environmental risks, and what they are doing to mitigate those risks. Disclosures also must include how any company-identified climate risks could have a short-, mid-, and/or long-term effect on the firm’s operations or consolidated financial statements.

The proposed disclosure rule would have sweeping significance – not only for public firms but also for their non-public suppliers and possibly their customers.

Increasing environmental transparency

The SEC’s move follows years of investor demand for transparent and standardized reporting by public companies of their climate risks. Investors are increasingly interested in how companies are addressing environmental, social, and governance (ESG) issues and how ESG efforts are reported and measured. Creating a climate disclosure reporting regime establishes an even playing field for public firms and enables investors to make better-informed decisions. Everyone wins, right?

That depends on who you ask. The SEC proposal was followed by a stakeholder comment period (which ended June 17) during which the agency received more than 3,400 letters, many of them less than supportive of the proposed rule. According to reporting in the St. Louis Post-Dispatch, individual companies and trade groups from a wide array of industries, as well as the National Federation of Small Businesses, wrote to the SEC saying the rules put an undue burden on businesses.

The cost of quantifying carbon footprint

Much of the concern has to do with requiring public firms to provide detailed disclosures of their GHG emissions, which the rules break down into three “scopes.”

  • Scope 1 Emissions: GHG emissions from sources owned or controlled by a public company.
  • Scope 2 Emissions: GHG emissions resulting from the generation of the electricity purchased and used by a public company.
  • Scope 3 Emissions: GHG emissions that result from a public company’s activities but are outside the company’s control. Examples include emissions related to transportation services purchased from third parties, business travel, employee commuting, and third-party processing and use of the company’s products.

It is the Scope 3 Emissions disclosures that have most worried some businesses, many of them private. Critics suggest that Scope 3 reporting requirements could reach deep into supply chains, requiring smaller companies to make investments in gathering and reporting climate data in order to keep their larger, public customers happy.

In terms of direct impacts, Scope 3 would mostly affect large firms and only if Scope 3 emissions are material or if the company has established GHG reduction goals that include Scope 3 emissions. Public firms that meet the definition of a smaller reporting company are not directly subject to Scope 3 reporting requirements.

Giving investors what they want

In anticipation of legal challenges to the disclosure requirements, the SEC points out that the proposed rules are a direct result of investor demand. Due in part to this demand, the agency argues that many large public firms are already well down the path to disclosure compliance. The SEC further argues that the rules will pay off in the long run by standardizing what is now a patchwork of reporting standards that amount to investors being left with apples-to-oranges comparisons between companies.

While many large public companies have the resources to comply and may be compliant or close to it already, there is concern that smaller publicly traded firms may struggle. To help address this concern, the proposed rule’s phase-in period would vary depending on a company’s size and filer status, and they only apply to Scopes 1 and 2.

There are a lot of moving parts to the phase-in, but generally speaking, smaller firms will have more time to comply. Filing deadlines are based on the eventual date the proposed rule becomes effective. Companies affected by Scope 3 Emissions rules will have additional time to comply with them.

Keeping up with the EU

A recent development in the European Union (EU) is turning up the heat on US regulators and lawmakers to act on ESG. In June, members of the European Parliament and EU governments approved a provisional agreement for new ESG reporting rules for large companies.

Despite the heightened sense of urgency, a recent survey by Deloitte suggests US companies have their work cut out for them. In a poll of 300 finance, accounting, sustainability, and legal executives at public firms with revenue of more than $500 million, 57 percent said data availability and quality are their biggest challenges to ESG disclosure. Less than 25 percent of those surveyed said their firms have a dedicated work group for ESG issues, but 57 percent said they are working to establish one. More than 80 percent of respondents said additional resources would be necessary to produce compliant ESG disclosures.

The real-world impact of climate disclosure requirements

Small to medium-sized business owners already have a lot on their plate, and this proposed new SEC reporting requirement will be yet another to-do on their list.

Understanding the basics of how this new disclosure would work can help you have value-added conversations with clients and prospects that may themselves be publicly traded or that are third-party suppliers or contractors to publicly traded companies. It very well may be an issue that is keeping business owners up at night as they seek to determine how this requirement will impact their business and more specifically their bottom line.

>> Learn more about industries that might be impacted by this proposed SEC reporting requirement.

Image credit: Curtis Adams via Pexels

Subscribe to our blog: