Today let’s return to the SEC’s proposed requirement that companies disclose their climate risks, and specifically the greenhouse gas emissions that arise from a company’s operations and supply chain. Tracking and reporting such information could be quite difficult — so what’s the rationale here, and how might companies get started to fulfill such a requirement?
The SEC explains its intentions for GHG emissions across 40 pages of its proposed rule, and at first glance the requirements seem straightforward enough. Companies would need to report GHG emissions according to three “scopes.”
- Scope 1: direct emissions from operations that are owned or controlled by your company, such as a factory or a sales center;
- Scope 2: indirect emissions from the generation of electricity, steam, heat, or cooling that your business purchases for its operations;
- Scope 3: any other indirect emissions that happen in the upstream or downstream activities of your supply chain.
All of these emissions would need to be calculated according to the GHG Protocol, a group that provided standards for corporations to measure greenhouse gas emissions. And while carbon dioxide is the foremost gas you would need to track, the SEC identifies five other greenhouse gasses, too: methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, nitrogen trifluoride, and sulfur hexafluoride.
One bit of good news is that the Environmental Protection Agency already requires large industrial businesses to report Scope 1 emissions using that same GHG Protocol — so if your company makes such EPA reporting, you’d be able to use that same data to satisfy SEC reporting as well.
Except, the EPA only requires Scope 1 reporting. Your business would still need to report Scope 2 and potentially Scope 3 emissions as well, so you’d likely still need to develop new processes to capture that data. Plus, plenty of businesses aren’t subject to that EPA reporting rule, and haven’t even started on Scope 1.
Details of GHG Disclosure
As currently proposed, the SEC rule would require businesses to disclose their GHG emissions in several ways.
First, companies would need to disclose their gross GHG emissions, regardless of any carbon offsets you might purchase to push net emissions lower. Why? Because the value of those offsets might differ from one jurisdiction to another, or vary over time. Disclosing gross emissions would allow investors to assess “the full magnitude of climate-related risk posed by a registrant’s GHG emissions” and how the company plans to manage those risks, the SEC said.
Second, companies would need to disclose both their aggregate GHG emissions and the disaggregated amounts for each of those six gasses mentioned above — and you’d need to report those totals individually for Scope 1, 2, and 3. Again, why? Because governments might target the reduction of specific greenhouse gasses (say, methane). In that case, investors would be able to make better decisions if they knew how much of that gas a company was emitted.
Third, companies would need to express the emissions for each scope in a unit of measurement called the “carbon dioxide equivalent,” abbreviated as CO2e. That’s the basic unit of measurement in the GHG Protocol, to help people understand the global warming potential for each greenhouse gas. So you’ll need to identify your emissions for each of the six gasses and report each one; and convert them into CO2e numbers so people will have a better sense of your company’s overall contribution to global warming.
As we noted in our previous post about the SEC proposal, not all companies would need to disclose all this information — but most companies would need to disclose most of it. Smaller reporting companies (those with market cap below $250 million) would be exempt from reporting Scope 3. Other filers would only need to report Scope 3 if those emissions are material, or if you set an emissions reduction target that includes Scope 3 in your goals. Everyone else would be subject to all requirements according to the following timetable.
That’s a lot of disclosure to make, and it brings us to a perfectly fair question.
Why does the SEC want everyone to do this?
Rationale for Emissions Disclosure
The SEC’s premise is that investors want to know a company’s GHG emissions so they can make better decisions about whether to invest in that company. That premise will certainly be challenged in court when the SEC adopts a final rule, but for now let’s accept it as valid — because from that premise, several points about the disclosure requirements start to make more sense.
For example, why does the SEC want companies to report Scope 3 GHG emissions from their upstream and downstream operations? Because in some industries, Scope 3 emissions are the lion’s share of all a company’s GHG emissions.
That’s the case in auto manufacturing: the GHG emissions created by customers driving a car are far larger than the GHG emissions created by companies making the car. So if an automaker only disclosed its Scope 1 and 2 emissions, that wouldn’t give investors a true sense of how much that automaker contributes to global warming.
In theory, a mid-sized automaker might generate more total GHG emissions than, say, a large professional services firm — but investors could only know that if you include Scope 3 in the reported totals. Hence the need for Scope 3, even though calculating that number is likely to be a real bear.
The SEC also wants all these disclosures so investors can better understand whether, and how, companies will transition to low-emission operations in the future.
This seems to be an emerging theme with the SEC: that all those pronouncements companies are making about achieving net-zero operations by 2030, or 2040, or whenever — you’ll be expected to show your progress on those promises. For example, we’ve already seen questions from SEC staff in comment letters to companies, asking the filer to square its disclosures in the 10-Q with its promises in whatever corporate sustainability report the filer is publishing.
The next logical step, then, would be to let investors hold companies accountable for those promises, by requiring companies to report their GHG emissions year after year. If one company seems woefully behind schedule on its move to net-zero operations while its competitors are racing toward that goal, that’s useful information to investors. They could dump the laggard’s stock, or agitate for strategic changes, or take some other action. Regardless, that disclosure would help investors make better decisions; hence the proposed rule.