What Does the Securities Exchange Commission Have to Do with Climate?

And – perhaps more importantly what does that mean to your business???

As the scrutiny related to carbon emissions and climate change increases, the investment community grows more concerned, as do regulators. New disclosure requirements will change the investment landscape as it relates to climate risk. Even if you are not a publicly traded entity, these may well affect your company, especially if you are in the business-to-business (B2B) arena. In other words, if your activities tie into other companies’ supply chains, you may have exposure.

On March 21, the Securities Exchange Commission (SEC) issued its 469-page?proposed rules related to climate disclosure risks, formally entitled “The Enhancement and Standardization of Climate-Related Disclosures for Investors.”??The basic essence of these rules – if adopted – will be that publicly traded companies will have to publicly disclose their exposure to potential risks related to climate change.??

In justifying its actions, the SEC stated “We are proposing to require disclosures about climate-related risks and metrics reflecting those risks because this information can have an impact on public companies’ financial performance or position and it may be material to investors in making investment or voting decisions.”

The Why:?On March 10, Chairman Gary Gensler explained the rationale behind this initiative?in a two-minute video on Twitter.??

The SEC was founded over 85 years ago, during the midst of the Great Depression, with the mission?of “protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.” For years, the SEC has required publicly traded companies to regularly disclose information related to financial performance, such as revenues, profits, and leadership (including compensation).?

As Gensler explained in his video, “The basic bargain is this.??Investors get to decide what level of risk they wish to take.” Today, with the pending threat of a changing climate, new and substantial risks have emerged. So, he commented, investors “representing literally tens of trillions of dollars are looking for more consistent and comparable information” in order to make informed decisions.??

https://twitter.com/GaryGensler?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1502001539577176064%7Ctwgr%5E%7Ctwcon%5Es1_&ref_url=https%3A%2F%2Fwww.greenbiz.com%2Farticle%2Fsec-consider-climate-disclosure-rules-us-companies

Investors, he noted, “want to know how climate-related risk will affect the companies they own.”??This could relate to either physical risk (such as infrastructure) or efforts companies are undertaking to lower risks associated with emissions. Ultimately, he argued this information, “helps investors put their money in companies that fit their needs.”

How Far Should the Definition of Risk Extend?

Some of these climate-related risks are fairly obvious. The major oil and gas companies that make the majority of their revenues from hydrocarbon extraction and refining face some clear challenges in a carbon-constrained world.?

More broadly,?an estimated $17 trillion?– or one-third of U.S. investments being professionally managed, fall under the Environmental, Social, and Governance (ESG) umbrella (see our post-March 8, 2022 “The E in ESG” for more on the topic, Link Here), so investors in these companies will benefit from this action.??

Under this rule, risks related to major emitters of direct greenhouse gas emissions (Scope 1 emissions – also covered in our “E in ESG” post), such as smelters, cement manufacturers, and other “smokestack industries” will be easier to assess. Carbon emissions – and related risks associated with electricity and steam consumption (Scope 2 emissions) will be made clear.??

The real challenge – and much of the pushback from various opponents of this proposed rule - lies in the Scope 3 indirect emissions.??These are the emissions associated with either upstream supply chain activities or downstream product use (such as automobiles) and disposal.??

The upstream Scope 3 investment risks are far more difficult to quantify since they involve casting a much broader net across entire upstream and downstream networks. Large companies may have hundreds, or even thousands, of suppliers. For many organizations, Scope 3 emissions may comprise the lion’s share of all associated greenhouse gas impacts, and Scope 3 risk exposure may be quite material. For example, governments in an increasingly carbon-constrained world may eventually implement future carbon taxes.??These, in turn, could significantly raise supply chain input costs. For example, industries utilizing carbon-intensive steel or cement could see large increases in their bills of materials.

The costs, and likely legal challenges:?There are clearly costs associated with this approach.??The level of detail required may be excruciating and costly to account for, so the SEC has indicated it will limit Scope 3 emission accounting to a level that is considered “material.”??

Already, a?number of organizations (such as the U.S. Chamber of Commerce and politicians have signaled their opposition?to the rules, which are now open for public comment. In fact,?one dissenting SEC Commissioner also went on record?claiming that the proposed rule will,?“undermine the existing regulatory framework that for many decades has undergirded consistent, comparable, and reliable company disclosures.”?

However, other powerful entities - such as the?Investment Company Institute (ICI, which represents global investors) have generally hailed the rule – with the ICI commenting, “Having consistent, comparable, and reliable data makes it easier for fund managers to better assess current and future sustainability-related risks on behalf of the millions of investors who invest in their funds.”

Your company’s Scope 1 is somebody else’s Scope 3:?Even if you are not in a publicly-traded company if you are in the B2B space, chances are you are in the supply chain of a publicly-traded company that will increasingly care about your carbon emissions. Irrespective of the horse-trading that will occur prior to the final ruling, it’s now clear that companies will have to take their climate risks more seriously.

The SEC action is not likely to immediately translate into new reporting requirements for your company overnight. However, the long-term implications suggest it may be time to get started in thinking about your carbon accounting and investigate the resources available to your business. The EPA has a?guide to greenhouse gas management for small businesses, and there are a number of companies that offer assistance and?software for emissions reporting?that may merit investigation. It’s also worth talking with your peers about what they are doing. Every company will be facing this issue sooner or later, so information sharing will become critically important in finding the best ways forward.

Action items:

1)???Evaluate your Scope 1 (direct emissions), and Scope 2 emissions

2)???Assess your Scope 3 emissions

3)???Evaluate your potential exposure to Scope 3 emissions of publicly traded companies, especially where you may fit into their supply chains.

4)???Begin looking into the companies and emissions-tracking software that exist in the market that may be of assistance.

Sustainably yours,

Matt Ward and Joyce Bone –?Founders,?SolMicroGrid