IN-DEPTH: The SEC Climate Rule is here
After two years in the making and being subject to some 24,000 public comments, the Securities and Exchange Commission’s (SEC) Climate Rule was finally unveiled on March 6 amid intense media glare and approved in a 3-2 vote. But neither side of the ESG divide seems entirely content with the final ruling.
First announced in March 2022, the rule was promoted as a solution to bring decision-useful information into the hands of investors and to hold companies to account on their climate-related risks and opportunities.
The final rule contained several revisions when compared to its initial rendition, however, with SEC Chair Gary Gensler citing the need to prioritize decision-useful information for investors and reduce the cost of compliance for issuers.
The final rule
The Enhancement and Standardization of Climate-Related Disclosures Rule requires registrants to disclose climate-related risks that may have a material impact on the registrant’s business strategy, operations, or financial conditions, as well as activities taken to mitigate or adapt to climate-related risks, including the use, if any, of transition plans, scenario analysis or internal carbon prices.
Companies will also be expected to report on board oversight of climate-related risks and processes for identifying, assessing and managing related risks.
The most significant revision to the ruling, and the most contested aspect, is its approach towards greenhouse gas (GHG) emissions reporting. The draft version required Scope 1 and 2 emissions reporting as standard, with Scope 3 emissions reporting, derived from corporate value chains, required where considered “material.”
However, the final rule exclusively requires large accelerated filers (LAF) and accelerated filers (AF), with market caps of more than $75 million, to provide Scope 1 and 2 reporting, and only where deemed “material,” starting in financial year 2026. Scope 3 emissions, derived from a company’s supply chain, will not form part of the reporting requirements, as had been widely speculated prior to the final vote.
“Overall, the rules are a mixed bag for investors. It’s better than having no rule at all and will provide consistency, but many may feel it doesn’t go as far as it should,” Michael Littenberg, partner at law firm Ropes & Gray told Diligent Market Intelligence (DMI) in an interview. “Many institutional investors will bemoan the exclusion of a Scope 3 emissions disclosure requirement, although there are divergent views in the investor community regarding the usefulness of that information.”
Initial responses
The general consensus among ESG-focused shareholder advocacy groups is that the rule does not go far enough but is still a step in the right direction.
As You Sow’s Decarbonization Lead Abigail Paris described the rule as an “important advancement,” but said allowing companies to determine the materiality of their emissions will create “significant subjectivity, diminishing confidence in reporting.”
Leslie Samuelrich, president of Green Century Capital Management, said that while the fund is disappointed that the final rule excludes Scope 3 reporting, it is buoyed by the fact that “most issuers will report the very basics – their Scope 1 and 2 emissions.”
While some investors mourn the watering down of the rule, Paul Barker, parnter at Kirkland & Ellis, told DMI that the SEC was walking a fine line between balancing the needs of shareholders while also trying to avoid any chance of the rule being shot down in court.
The 2022 West Virginia v Environmental Protection Agency (EPA) ruling serves to highlight the challenges climate-related policymaking can face in the courtroom, with the U.S. Supreme Court denying authority for the EPA to regulate corporate emissions, on the basis the agency has no authority to impose emissions regulations.
“The Supreme Court held that a clear statement from Congress is necessary for an agency to be able to issue regulations of ‘vast economic and political significance,’” Barker said. “Given this broader legal context, the SEC has sought to mitigate the risk of a successful challenge to its final rules in the courts.”
“The number of times the term ‘materiality’ appeared in the rule was surprising. The SEC was really driving home the point that, unless the issue at hand is material, disclosure is not required,” said Loyti Cheng, head of environmental practice at Davis Polk & Wardwell.
Despite the SEC’s cautious approach, the rule is already set to face legal action. Within two hours of the rule’s announcement, 10 Republican-led states, including Georgia and Alabama, already moved to challenge the new rule in the 11th U.S. Circuit Court of Appeals.
Scope 3 is the new norm
Regardless of the SEC’s exclusion of Scope 3 emissions, investors and global policymakers seem resolute in their expectation that value chain emissions disclosure should become the new standard.
In the time the SEC has taken to finalize the rule, both the EU and California have implemented policies to mandate Scope 3 disclosure. Voluntary standards such as the International Sustainability Standards Board’s (ISSB) framework also encourage Scope 3 reporting.
“The big companies, where most of the carbon is coming from across all three scopes are, in my view, going to adopt the ISSB’s standards on a voluntary basis and [Europe’s] Corporate Sustainability Reporting Directive (CSRD) ones as well, if they have to. Both require more than what the SEC came out with,” Robert Eccles, visiting professor of management practice at The University of Oxford, told DMI.
“Many registrants already provide voluntary climate-related disclosures that go well beyond the requirements of the SEC’s new rules,” said Littenberg. “Robust voluntary disclosures will undoubtedly continue to be made.”
At DMI’s Proxy Season Preview event last month, panelists also emphasized the importance of Scope 3 disclosures. “If you can put your estimations in a corporate sustainability report and explain how you got there and how you’re looking to improve, that goes a long way in our conversations,” Edward Apsey, co-head of ESG engagement and stewardship at CIBC, said.
“If there is some hope that companies can declare victory if the SEC cuts out Scope 3, it won't change the investor demand for that data and some jurisdictions somewhere will still require it of you,” said fellow panelist Jake Rascoff, director, climate financial regulation at Ceres. “Companies will be subject to mandatory disclosure somewhere if they are multinational firms of any notable size.”
