On Monday, March 21, 2022, the Securities and Exchange Commission (SEC) issued a proposed rule intended to standardize climate-related disclosures. What does it mean for climate tech companies, and what does it mean for climate action more generally? This post will explain why it matters, share some of the details of the proposed rule, and conclude by providing some broader context.
First, a note of caution: this is a proposed rule that will be modified over time, be challenged in court, and does not apply to companies that are not publicly listed. So, you have a lot of time to prepare.
Standardization is Coming
While this rule is only relevant for publicly traded companies, I envision this eventually ends up as the de facto standard for private companies of considerable scale as well. From an investor’s perspective who may hold public and private companies, it is easier to just use one standardized set of information and metrics for all of them. Regardless, it is useful to understand how reporting and regulation is changing in the space you are in, even if it doesn’t apply to you right now.
If you’re a climate tech company in the business of greenhouse gas accounting measurement services, tools, and consulting, this is a good day for you: this rule should dramatically increase the demand for these services. That said, it will also mean additional competition from many different types of companies interested in offering these services (from financial software companies to large consultancies and beyond).
What’s the What
This rule is intended to standardize climate risk reporting. It’s aligned with commonly utilized frameworks like the Task Force on Climate-Related Financial Disclosures. Of course, this is a proposed rule, so it is not yet an actual regulation. In terms of scope, this rule would apply only to public companies.
For the largest companies, reporting Scope 1 and Scope 2 associated emissions intensity metrics would be required starting in fiscal year 2023; Scope 3 reporting would start in fiscal year 2024. Scope 1 and 2 emissions will eventually be required to be independently verified as well. For smaller public companies, Scope 1 and Scope 2 emissions reporting would begin in fiscal year 2025; there would be no requirement for Scope 3 disclosure for smaller public companies.
Reasonable, Timely, and Useful
I would describe what the rule proposes as reasonable, timely, and useful. Reasonable because the SEC requires disclosure of risks to a business; climate risk is undoubtedly one of those risks. Also, it phases in over time, with differing levels of requirements for businesses of different sizes. And, it represents something of a compromise: no Scope 3 emissions reporting requirement except for the largest companies.
Given the amount of focus on the issue, it is timely to standardize what is being communicated to make it easier for both investors and companies to know what will be asked of them.
The information is useful as it will help enable investors to understand the climate risks that exist in their investments. As Axios put it on Monday, “The rule, which has been under discussion since last year, aims to provide some clarity for investors by enabling them to determine the climate risks lurking in their portfolio.”
More than Reporting Emissions
And this rule is not just about reporting emissions: it also includes the potential impacts of climate events and climate related risk. For example, a real estate company whose holdings are in areas with increased hurricane and flooding activity, or a coffee company whose beans are grown in locations that may not support coffee bean cultivation in the future. These are the sorts of things investors are likely to care about, regardless of how they feel about climate policy and politics more generally. This is important, because it has implications far beyond whether or not a fossil fuel company has a lot of emissions associated with it.
This is Important
I think this is one of the most important climate policy changes of the last decade. Why? The standardization of expectations and requirements going forward: this standardization will make it easy for investors and companies to analyze these disclosures, quantify risk, and adjust their portfolios accordingly.
Capital markets are already considering these issues, and now this data standardization will make it easier for investors to act by providing more transparency. This action will lead to capital flows being redirected, sometimes in ways that have significant impacts for the businesses involved.
A few other interesting details:
- While many companies will be excluded, Scope 3 reporting will be required for the largest energy companies (like oil and gas supermajors) as Scope 3 emissions make up most of their total emissions (technically Scope 3 reporting is only required if it is material to a company’s business or if the company has set a scope 3 emissions reduction target, but it would be surprising if this did not include any major energy company).
- The requirement to share information on emissions and plans for emissions reduction without including offsets and renewable energy credit purchases. This would allow investors to understand what the core emissions intensity of the business is (similar to how a key business metric is a company’s earnings, prior to adjustments for depreciation, interest payments, and taxes, to better understand the profitability of the core business).
- In addition to reporting emissions and emissions reduction plans, the proposed rule also requires companies to share internal carbon prices (and other key assumptions) they use for future planning – this should provide very useful information for investors today.
Not everyone will be happy: by exempting Scope 3 for smaller public companies, it avoids reporting requirements on some companies.
All in all, while this is just a proposed rule that would only partially apply to a subset of companies, its impact is likely to be much more comprehensive than its fragmented nature suggests. This means more clarity around the business assumptions companies are using, a richer understanding of what climate risks certain businesses may be exposed to, and a big, big, big market for companies which are helping companies measure, report, and improve on their emissions profiles.