Disclosure of Greenhouse Gas Emissions and Climate-Related Financial Risk: A FAR Sighted Rule

Context and a brief history of federal climate regulations

At the beginning of his administration, President Biden announced a new GHG target for the United States: to reduce net GHG emissions by 50%-52% below 2005 levels by 2030. The Administration has also centralized executive branch organizations to identify and coordinate climate-related actions, and issued directives with a view toward decisions that support meeting the Administration’s GHG reduction targets. Because of Congressional challenges and the failure of previous legislative attempts to address climate impacts of human economic activity due to emissions of greenhouse gases (GHG) previous federal action has focused on regulation of the emissions under existing legislation and voluntary programs.

A 2007 Supreme Court decision found that the Environmental Protection Agency (EPA) has authority to regulate GHG emissions from motor vehicles as air pollutants under the Clean Air Act and EPA issued rules to limit GHGs from various sources including emission controls on power plants and vehicles and building codes. State and local governments have been active, highlighted by the Regional Greenhouse Gas Initiative (www.rggi.org) of the Eastern States created in 2006 and the California Air Resources Board (CARB) established by Governor Reagan in 1967 implemented a spate of voluntary and required actions since 2010 to limit emissions. These state level initiatives have established GHG markets to enable industry to more efficiently manage emissions within state and regional caps. ?On June 30, 2022, in a reversal of narrow but important scope, the U.S. Supreme Court delivered its ruling on West Virginia v. Environmental Protection Agency (EPA), that limited the EPA’s authority under a provision of the Clean Air Act to regulate greenhouse gas emissions from the power sector, which is the second largest industry emitter.?Even with that ruling, the market is moving away from high emission energy sources like coal based on falling prices of substitute fuel sources.

Twenty-five years ago, the first international treaty setting targets to reduce GHG emissions was adopted in Kyoto, Japan, under the auspices of the United Nations. It was superseded by the 2016 Paris Agreement to cover all nations, which has now been adopted by the Biden Administration expanded the coverage of Kyoto to cover all nations. European nations have been the most aggressive adopters of the Paris Agreement during this time, but the US has been notable for its lack of implementation at the federal level. Instead, administrations going back to George W. Bush in 2007 have issued Executive Orders to close the gap. The Obama administration continued to issue Executive Orders but did not require the reporting or management of emissions by its suppliers. The Federal Acquisition Regulations (Part 23) covering Environment, Energy and Water Efficiency, Renewable Energy Technologies, Occupational Safety and Drug-Free Workplace implemented related regulations but did not cover the reporting and management of GHG emissions by suppliers.

As the world's largest buyer, the federal government seeks to use the power of its purchasing to reduce the GHG emissions in its supply network. In doing so, it is closing the gap between voluntary actions of the private sector to require responsible supplier behavior by federal suppliers. The Biden Executive Orders related to tackling the climate crisis provide the policy framework and guidance for implementing new FAR regulations regarding the central issue of GHG reporting and management by suppliers. Federal Chief Sustainability Officers in each Department and Agency provide the expertise to know the technical and business management requirements to implement the Executive Orders and provided the expertise to inform the proposed rule.

The work in support of the proposed rule was informed by decades of work by the Environmental Protection Agency (EPA), the Department of Energy (DoE), and a variety of Non-governmental Organizations, including the World Resources Institute, Greenhouse Gas Protocol, and CDP created and used by the world's concerned corporations.

The Central Pillar of Climate Policy: GHG Emission Metrics and Targets

The wave of federal climate Executive Orders (EOs) lags significantly behind the international community, the states and the private sector. The EPA and DoE assisted NGO's like the WRI in establishing shared methods for measuring GHG emissions, establishing GHG targets and reducing emissions. The administration is using procurement regulations to multiply the impact of its substantial procurement spending as the world’s largest buyer. The Council on Environmental Quality (CEQ) and the Office of Management and Budget (OMB) are providing government-wide execution leadership and management guidance.

In drafting the first regulation in support of Executive Order 14030, "Climate-Related Financial Risk" the Proposed FAR Rule on November 14 (2021-0015) the FAR Council primarily addresses the question of who to buy from based on reported climate related emissions of GHG. This proposed FAR Rule change implements a requirement to ensure certain Federal contractors disclose their greenhouse gas emissions and climate-related financial risk and set science-based targets to reduce their greenhouse gas emissions. The proposed FAR rule is similar in some ways to the regulation in FAR Part 9, Contractor Qualifications, by adding industry responsibility for GHG emissions as part of what will become required to qualify as a federal contractor.

Other FAR Rule changes are forthcoming and their combined impact on federal acquisition and the business of government must be effective, efficient, equitable and executable. The proposed rule FAR Rule on emission reporting, metrics and targets succeeds on these “4E” attributes of procurement regulations. The 4E criteria are addressed in turn below.

The 4E Attributes of the Proposed Rule

The proposed rule is well designed to achieve these goals and to provide a solid foundation on which to build a sustainable federal business that actualizes the climate?agency of the government. An important objective of that rule is to effectively mitigate the growing number and variety of destructive weather events that threaten the financial and economic livelihood of the nation. I believe it can be easily executed on both sides of the market and accelerate creation of new technologies to mitigate emissions and adapt to the new threats of the changing climate.

#1 Effective. The rule "begins with the end in mind" by prioritizing accountability for GHG emissions of federal suppliers and the reduction of their net emissions to achieve the goal of net zero emissions by 2050, which is currently estimated to prevent or mitigate the worst scenarios of destructive weather events and trends. The need for such public accountability and responsibility is at the foundation of the?failure of current rules to recognize the broad economic and financial damage associated with purely private calculus of benefits and costs of business decisions. Determining the sources of emissions is the first step in executing the policy. The proposed rule applies to 85% of estimated current emissions in the federal supply base, a fact that will make it highly effective in mitigating future emissions.

It is especially important that the?proposed rule employs the same GHG Protocol and CDP methods and measures of the “carbon” footprint of businesses that are already in wide use among major suppliers. This alignment is crucial to creating an effective rule that can be used and adopted globally, avoiding the ineffective development and potentially duplicative cost of federal unique standards.

EPA has been reporting a national?Inventory of U.S. Greenhouse Gas Emissions and Sinks?since the early 1990s (Inventory of U.S. Greenhouse Gas Emissions and Sinks | US EPA). The?annual report?provides a comprehensive accounting of total greenhouse gas emissions for all man-made sources in the United States, including carbon dioxide removal from the atmosphere by “sinks,” (e.g., through the uptake of carbon and storage in forests, vegetation, and soils) from management of lands in their current use or as lands are converted to other uses. The gases covered by the Inventory include carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride, and nitrogen trifluoride.

The national greenhouse gas inventory is submitted to the United Nations in accordance with the?Framework Convention on Climate Change. In preparing the annual emissions inventory report, EPA collaborates with hundreds of experts representing more than a dozen U.S. government agencies, academic institutions, industry associations, consultants and environmental organizations. EPA also collects greenhouse gas emissions data from individual facilities and suppliers of certain fossil fuels and industrial gases through the?Greenhouse Gas Reporting Program.

The EO 14030 and Draft Rule also references The Financial Stability Board (FSB) report on its Task Force on Climate-related Financial Disclosures (TFCD) published on October 13, 2022. (https://www.fsb-tcfd.org/) At the time of the report, over 3,900 companies and other organizations had pledged to support the TCFD. It includes references to the Science Based Targets Initiative as the basis for establishing emission targets (https://sciencebasedtargets.org/companies-taking-action). It establishes a structure for the TCFD that puts the metrics and standards of the proposed FAR Rule at the center of its management structure.

#2 Efficient. By eliminating most reporting requirements for the large number of small and significant suppliers, the rule achieves the macroeconomic goal of getting the most "band for the buck" of industry compliance investments in mitigating GHG emissions. The proposed rule explicitly recognizes and preserves the head start provided by the efforts of other governments and voluntary commitments of many large, multinational corporations to reduce their net emissions. It capitalizes on decades of investments in reporting standards and avoids the temptation to reinvent the wheel. It simplifies the reporting for “Significant” federal suppliers by limiting their reporting to the easier to estimate Scope 1 and Scope 2 emissions resulting from company operations. Except for resellers who specialize in selling to the federal marketplace as intermediaries, this reporting aligns the relative costs of reporting with the amount of damage attributable to federal suppliers.?By dividing suppliers into the three size categories based on federal sales, Major, Significant and Small, the proposed rule is set up to?normalize measurement and reporting requirements by size. Importantly, there is?no reporting requirement for the smallest firms. Only the Major suppliers are required to provide estimates of complex Scope 3 emissions, which include the upstream supply chains of suppliers, the Significant suppliers must provide only Scope 1 and 2 emissions, which are much more readily estimated. This structure for reporting reduces the overall industry cost of compliance, and concentrates it on the larger firms that are more likely to be doing it already and are the largest emitters on average in each industry. The structure of the proposed Rule greatly enhances its efficiency.

#3 Equitable.?By placing the largest reporting burdens on those that are the largest contributors to federal climate impacts, the proposed rule also avoids a regressive distributive effect. Those that are best able to absorb the costs of compliance have the greatest burden, which is desirable on equity grounds. Because the reporting requirement adds the indirect emissions of the upstream and downstream activities, it demands the most sophisticated methods and models. This requirement is?similar to what these larger companies are already reporting through the internationally accredited CDP and?standard GHG Protocol.

Larger firms who are not already reporting using those standards will incur the largest relative new reporting costs under the proposed rule. They are also likely to be those firms who realize the greatest financial benefit from the Green to Gold phenomenon, Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage. By becoming efficient users of resources, firms achieve cost savings as argued in the Benefit section of the rule discussion. A more recent, and broader coverage of the private sector benefits of climate responsibility is in the more recent book Net Positive, by Polman and Winston.

Walmart is an example of a large business that has enthusiastically pursued a climate policy that aligns with the proposed FAR rule. Walmart's climate policy is summarized by the company as follows:

"....Walmart has committed to science-based targets for emissions reduction, including achieving zero emissions in our operations by 2040 and engaging suppliers through our Project Gigaton (tm)?initiative to reduce or avoid supply chain emissions by 1 billion metric tons by 2030. We aim to galvanize collective action across the retail and consumer goods sector through our advocacy, supplier engagement, philanthropy and innovation in product supply chain practices, while taking steps to strengthen the resilience of our business against the effects of climate change."

Walmart and thousands of other large companies have been active members and users of the Greenhouse Gas Protocol (https://ghgprotocol.org/corporate-standard) also referenced in the Draft Rule.

A less desirable aspect of the proposed rule is that for some it doesn’t go far enough. While there is certainly much more to do, the proposed rule strikes a sound balance between what is already known to be executable in the near-term and the eventual extent of what is required both within government and by industry suppliers. I anticipate that much of industry will continue to outpace the new rule.

#4 Executable. There are several types of execution challenges associated with the proposed rule.?First is the knowledge of the federal acquisition workforce. The large majority of the workforce knows little about climate and sustainability issues or how they are already participating in them. Educating the federal buying community on what it can and should be doing is a critical first step in executing the proposed rule. In doing so, it increases the burden on an already stressed workforce. They will need the knowledge of how to assess the responsibility of providers and how to use the flexibilities of Part 1 of the FAR in pursuing the goals of reducing emissions by 65% by 2030 and achieving net zero emissions by 2050. They need to learn the climate related procurement vocabulary of entities, concepts, principles and relationships. In addition to the National Contract Management Association, many federal organizations have key roles to play in that education process. They include especially the Federal Acquisition Institute (FAI) and the Defense Acquisition University (DAU).

Beyond education, the acquisition workforce must be enabled to adapt Procurement processes to the needs of climate policy. The proposed rule is familiar territory, it implicitly sets reporting requirements and standards for bidding on federal contracts. It is similar in that regard to other “Responsibility Determination” requirements.

Like the diversity, inclusion and equity policies, the proposed rule provides the basis for establishing climate related provider preferences, which are evidenced by climate responsible behavior along the lines of the imperfect, well intended, Responsible Business Alliance and similar industry groups. Future federal procurement rules can also be expected to apply to the lifecycle of key phases of the procurement process from performing market research through establishing source selection criteria, including evaluating the GHG impacts of proposed solutions to mission problems. These future rule changes will influence the answer to government acquisition teams’ question of how to buy.

Another challenging area for executing the proposed rule has to do with developing supplier relationships and mutually beneficial agreements with them. The desired buyer-supplier relationships should be constructive, consistent, and considerate of both party’s goals, constraints, and incentives. To build such relationships with respect to the broader climate scope, the government buyers and industry suppliers should engage with each other to develop bi-lateral market intelligence to discover and adapt so-called "requirements" that enable better contracts in the climate dimension. By cultivating this knowledge, buyers and suppliers are able to identify, prioritize and pursue the most impactful and efficient opportunities to discover and reduce emissions.

For example, government buyers can seek to reduce emissions in contractual outcomes by implementing one or more of the following strategies in its industry engagements:

1. Bring new value to suppliers.

The government can provide new value to suppliers in several ways—for example, by serving as a gateway to new markets or reducing the supplier’s risks.

2. Change what and how the government buys.

The government can consolidate its purchase orders, rethink its purchase bundles, or decrease purchase volume and substitute other goods and services.

3. Create a new supplier.

This is a high-risk option, but it can transform the government’s prospects. The government has essentially two paths: It can bring in a supplier from an adjacent market or encourage vertical integration with complementary suppliers.

4. Play hardball to penalize uncooperative suppliers.

As a last resort, the government can cancel current orders and future business or threaten litigation.

One of the most challenging execution problems is effective flow down of the GHG reporting through the layers of the supply network of first tier suppliers. As industry has discovered, a hands-off, trust-based approach is not reliable without an enforceable verification strategy that ensures a cascade of sustainable practices that flows smoothly throughout the supply network. Contractually committed first tier commercial suppliers have already had to recover reputational damage and loss of trust associated with publicized sourcing scandals brought about by lower-tier suppliers who, despite being aware of sustainability standards, have nevertheless gone on to violate them.

In this regard, Government procurement teams can proactively?encourage a number of steps to promote their supplier networks’ social and environmental responsibility:

? Establish government long-term sustainability and other policy driven goals.

? Require first-tier suppliers to set their own long-term sustainability goals.

? Include lower-tier suppliers in the overall sustainability strategy.

? Require a designated Contracting Officer’s Representative be accountable for extending the government’s climate sustainability program to first- and lower-tier suppliers.

? Adapt additional commercial best practices in managing supply networks

Success of the Proposed Rule. The success of the proposed rule is measured by its contribution to the goal of achieving desired milestones in the progress to the target of Net Zero Emissions by 2050. Measuring and managing the outcomes will have a powerful second-order effect of incentivizing investments in industry innovation. A key measure of the success of the proposed rule will be identifying the contribution of the rule to the invention and adoption of new technologies and solutions that shift production possibilities to reduce GHG emissions.

A second knock-on effect is to incentivize additional government Procurement Innovation through exercising FAR Part 1 authority or using Other Transaction Agreements. Those prospective business innovations on the part of government buyers can be more powerful than the individual technical innovations they bring about.

Exclusions. The proposed rule excludes certain preferred providers including: Alaskan Native, Universities, and others. These exclusions will tend to shift the buying behavior of the government even further toward these preferred suppliers. Other things equal, the greater the exceptions the less effective is the proposed rule.

Urgent and Important. There is much to do and learn about succeeding in the quest for net zero emissions. Establishing accountability and responsibility of federal suppliers for GHG emissions through this proposed rule is the essential first step to?a more comprehensive set of actions affecting what the government buys, how it buys it, and how the purchased services and products are managed to achieve the milestones of the target. Mitigating GHG emissions through the proposed rule will have broad-based impacts on many elements of society and the economy from the financial models for risk sharing in “natural” disasters to new and evolving occupations, implications for health care, and providing for the life, liberty and pursuit of happiness ensconced in the founders dreams.?

Tim Cooke, Ph.D.

CEO, Owner?

ASI Government, LLC?

Tim took the helm at ASI in 2015 and later led a management buyout of the company to continue its legacy of innovation and improved mission outcomes for federal buyers. ASI helped to create the category of acquisition advisory and assistance services during the federal acquisition renaissance of the late 1990s. For the past 26 years, ASI has helped missions achieve their outcomes by providing consulting,?training, and solutions for Defense, Civilian and IC agencies.