There is growing awareness that climate change threatens the stability of financial markets and poses systemic risks to the US economy. For now, however, the country’s hundreds of publicly traded companies are not required to disclose the various ways in which the consequences of a warming planet could threaten their bottom line. Companies that address climate risks in their annual reports and other public documents do so voluntarily. As a result, many policymakers argue that climate-related disclosures are unreliable, inconsistent and not comparable across companies, leaving investors in the dark about the true risks on a company’s books.
These policymakers are beginning to make headway. On Monday, the Securities and Exchange Commission (SEC) took the first step in requiring companies to publicly disclose various climate risks. The long-awaited rule requires companies to explain how climate risks may affect their revenue and profitability in public filings they are required by law to file with the SEC. The independent federal agency, which aims to protect investors by regulating publicly traded companies’ share offerings, has also suggested companies must disclose any climate-related targets they have set (e.g. net-zero targets) on how climate risks are changing the line items in their financial reports and whether they are taking steps to minimize the impact of climate change on their operations.
Most importantly, the proposed rule will require disclosure of the volume of carbon emissions that result directly from a company’s operations, as well as emissions resulting from the generation of electricity and other forms of energy on which it relies, which are classified as Scope 1 and 2 are denoted Emissions, respectively. The rule also requires some disclosure of the more indirect Scope 3 emissions, a category that includes emissions resulting from the use of products that companies sell. Businesses have between one and three years to comply with the rule, if adopted.
“Corporations and investors alike would benefit from the clear traffic rules proposed in this press release,” said SEC Chairman Gary Gensler. “I believe the SEC has a role to play when there is such a demand for consistent and comparable information that can impact financial performance. Today’s proposal is therefore driven by the needs of investors and issuers.”
The US is catching up on climate-related financial rules. The European Union has already mandated similar disclosures and is in the process of tightening its climate risk rules. In recent years, there has been increasing recognition of how climate-related disasters wreak havoc on businesses. Electric utility PG&E is a prominent example of a public company being forced into bankruptcy due to wildfires fueled by climate change. As a result of such risks, investors and shareholders have lobbied company boards for more disclosure — even staging internal revolts when their efforts have met resistance. The United Nations Principles for Responsible Investment, a group that promotes environmentally friendly practices among investors, has more than 4,000 signatories.
The SEC has a mandate to protect investors by ensuring that public companies provide them with timely and accurate information about their business practices. The agency, which operates more independently than other federal departments reporting directly to the president, is tasked with maintaining “fair, orderly and efficient markets” – and environmental activists argue that climate-related risks fall squarely in its wheelhouse.
But those opposed to the rule say the agency does not have the power to issue regulations on climate change, an issue they believe should only be addressed by environmental regulators. Opponents include the American Petroleum Institute, the main lobbying organization for fossil fuel interests, which has raised concerns about practical issues that could arise from standardizing disclosure, and state officials like the West Virginia Attorney General, who claim the rule would require “explanations” on political issues that advance a political agenda.” Litigation against the rule is all but certain.
Companies have also been pushing the SEC to exempt Scope 3 emissions from the rule. Because Scope 3 emissions come from the entire supply chain, including purchased goods, smaller suppliers and customers, they are often outside of a company’s direct control. The proposed rule requires disclosure of those emissions if the company already has an explicit emissions reduction target that includes Scope 3, or if such emissions could be considered “material” from an investor’s perspective – that is, if a typical shareholder would be likely to classify such emissions as relevant to its financial interest in the company. Smaller companies are exempt from the obligation.
Alyssa Rade, chief sustainability officer at Sustain.Life, a tech company that helps companies track and report their emissions, said the new rule could put positive pressure on companies across supply chains to disclose their emissions.
“While smaller supplier companies may not yet have calculated their carbon footprint, increasing pressure from their largest customers is forcing them to take action,” she said in an email. “This is exactly the kind of market pressure that US regulators are exerting by including accounting for Scope 3 emissions in the new disclosure decision.”
The SEC is soliciting comments on the proposed rule for the next 60 days. After the comment period has passed, the agency is expected to review and possibly revise the rule in response.
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