By ESG Analyst Louise-Marie Sur
The Previous Standard
Perhaps once perceived as just one segment amongst a plethora in a company’s required financial reports, ESG audits are increasingly seen as a fundamental benchmark of corporate responsibility by regulators and investors. As a result, their requirements have become increasingly rigorous. Pressured by jurisdictions further along on this trend, the SEC released a revised climate-disclosure plan in 2022 requiring large-cap companies to disclose their direct emissions (Scope 1 and 2) and indirect emissions (Scope 3) on all SEC filings and annual reports. The inclusion of Scope 3 quickly became a point of contention for investors and firms urging that emission reports spanning a company’s entire supply chain was an unrealistic demand to achieve with certitude. Many expressed their concern that the decision placed a disproportionate share of the burden on companies whose internal audit structures do not meet the level of sophistication requisite to absorb the additional reporting responsibilities. Amidst their acknowledgement of these valid concerns, the SEC maintained the tradeoff between its inclusion and the overall accuracy of reports worthwhile given Scope 3 emissions account for an estimated 75% of most companies’ total emissions, touching the 90th percentile for companies in financial services, transport, capital goods, materials, agricultural commodities, and energy sectors. To compensate for the added responsibility, the decision included a clause holding larger companies with higher emissions and more robust reporting capabilities to a higher standard. Additionally, to enforce the integrity of business’s climate-related promises, a public scope-specific disclosure was required from those vowing to reach a net decrease in emissions by a certain date.
The Decision
On March 6th, 2024, the SEC revised its original climate regulation proposal to standardize Scope 1 and 2 emissions. Now, companies are required to be overt about how climate change impacts their operations, how their operations contribute to the trend, how a transition to renewable energy sources might hinder their margins, and how climate strategy coincides with their risk management practices. Two main requirements established by the 2022 revision—the added responsibility for larger firms and required backing behind any net reduction promised—hold, but the new plan has eliminated the need for large companies to report their Scope 3 emissions.
The SEC’s Goal
Ultimately, the SEC’s revisions are intended to create a streamlined audit scheme that best serves investor interests and regulator responsibilities. Proponents argue the revision will provide investors with a clearer picture of climate-related material risks, facilitate cross-company comparison, and standardize variation metrics between companies in similar industries. Studies have shown that climate-related information impacts investor willingness to pay for an asset, and ultimately their decision to invest. Providing them with this information in a concise manner would allow for climate-related costs to be more readily integrated into the valuation scheme of a firm, and lead investors to make more climate-conscious portfolios. Moreover, the motivation to exclude Scope 3 emissions from these reports is to forgo the risk of muddying investment decisions and concluding inaccurate comparisons.
Practical Suggestions for Businesses
The added standardization for Scope 1 and 2 does place a greater amount of responsibility on the companies themselves. As a result of this standardization, practices that were once viewed as added bonuses are becoming requisite, forcing companies to devise a mechanism for which various levels of the company organization must integrate and articulate sustainability strategy. In their detailed outlines of the new plan, all Big-4 firms—Deloitte, KPMG, PWC, and EY—have suggested large-cap companies hire ESG controllers to bridge the gaps within the operation and ensure they meet the SEC’s requirements. The controller’s responsibility would be to educate firm levels and aid in the establishment of a climate governance framework that they can adhere to. Additionally, to assess the current reporting framework, pinpoint where discrepancies lie between what they currently provide and what is demanded of them under the new regulation, and what employee up-skilling, data management, and potential talent outsourcing are needed to bridge these gaps. Ultimately, an ESG controller would empower companies with confidence that regulatory bodies, investors, and stakeholders have all precise information on how these climate-related metrics might impact their bottom line. This is a potential added cost that companies have no choice but to absorb, but positive report results could be rewarded with higher company valuation and greater investor confidence.
Conflicting Sentiment
Although this move appeals to the outspoken desire of many companies to have Scope 3 emissions dropped from reporting requirements, the additional clause forcing firms to divulge their contribution to climate change has opened Pandora’s box of contention. With outspoken support from energy companies and business lobbies, this decision has faced a legal challenge from a 10-state coalition arguing that the ruling was “illegal and unconstitutional”. When asked to speak on the matter, these interest groups expressed their suspicion that the decision was politically calculated and the ultimate burden would unjustly trickle down to investor and consumer levels. Directly following the challenger’s announcement, the executive vice president of the US Chamber of Commerce demonstrated their alliance, asserting the decision is the SEC’s attempt to “micromanage how companies made decisions” and will only serve to undermine investor risk tolerance.
A total of nine lawsuits were filed in six appellate courts, with one having been granted an administrative stay on the decision, essentially forcing the SEC to maintain the status quo as an interim solution until the decision’s constitutionality is decided.
By contrast, many environmental groups, including Earthjustice and the Sierra Club, are expressing their concern that the adjustment is not going far enough. They fear the decision provides a ‘greenwashing’ loophole for companies to be less overt about their actual emissions and for potentially inaccurate reports to be approved by the SEC. This apprehension might be slightly offset given that the SEC is not the only regulation agency setting rules that companies must comply with. In fact, firms must continue reporting Scope 3 emissions to remain in compliance with the European Union’s Corporate Sustainability Reporting Directive (CSRD) and California’s S.B. 253 & S.B. 261 if they desire to continue their operations in those jurisdictions.
Status Quo
For now, businesses just hold tight.
Until the stay is lifted, the decision will sit on the appellate court’s stack, waiting for its fate to be determined. In the meantime, businesses are advised to prepare estimations on the new clauses if the appeal is overturned, and all the new climate-disclosure regulations pass.
References
Associated Press. (2024, March 6). SEC approves landmark rule requiring some companies to report emissions, climate risks. TIME. https://time.com/6881955/sec-rule-climate-risks-emissions-companies/
Bill Text – SB-253 Climate Corporate Data Accountability Act. (2023, October 9). https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=202320240SB253
Bill Text – SB-261 Greenhouse gases: climate-related financial risk. (2023, October 9). https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=202320240SB261
Cleveland-Peck, P., & Tokar. (2024, March 18). U.S. appeals court temporarily halts SEC Climate-Disclosure rules. Wall Street Journal. Retrieved March 26, 2024, from https://www.wsj.com/articles/u-s-appeals-court-temporarily-halts-sec-climate-disclosure-rules-456f2f4c?mod=Searchresults_pos1&page=1
Corporate sustainability reporting. (2023, January 5). Finance. https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en
Deloitte. Executive summary of the SEC’s landmark climate disclosure Rule (March 6, 2024; updated March 26, 2024). https://dart.deloitte.com/USDART/home/publications/deloitte/heads-up/2024/sec-climate-disclosure-requirements-ghg-emissions-executive-summary
Hadziosmanovic, M. (2022, June 4). Trends Show Companies Are Ready for Scope 3 Reporting with US Climate Disclosure Rule. World Resources Institute. https://www.wri.org/update/trends-show-companies-are-ready-scope-3-reporting-us-climate-disclosure-rule
Mindock, C. (2024, March 22). Challenges to SEC’s climate rules sent to conservative-leaning US appeals court. Reuters. Retrieved March 26, 2024, from https://www.reuters.com/legal/challenges-secs-climate-rules-sent-conservative-leaning-us-appeals-court-2024-03-21/
PricewaterhouseCoopers. (2024, March 7). SEC climate disclosure rules and your company. PwC. https://www.pwc.com/us/en/services/esg/library/sec-climate-disclosures.html#:~:text=On%20March%206%2C%202024%2C%20the,business%20or%20consolidated%20financial%20statements.
PricewaterhouseCoopers. (2024, March 7). SEC adopts climate-related disclosure rules. PwC. https://viewpoint.pwc.com/dt/us/en/pwc/in_briefs/2024/2024-in-brief/ib202402.html
Staffin, E., Baldwin, K., Nelson, E., Van Orden, M., & Securities and Exchange Commission. (2022). The enhancement and standardization of Climate-Related disclosures for investors. In SECURITIES AND EXCHANGE COMMISSION. https://www.sec.gov/files/rules/final/2024/33-11275.pdf