In 2022, the Securities and Exchange Commission (SEC) proposed a new rule that would require public companies to disclose detailed information regarding their climate risks. The rule marks a significant expansion of existing reporting requirements and, in many cases, represents unknown territory for America’s largest companies. The proposal comes as investors, environmental advocates, and many policymakers are intensifying their demands for companies to disclose their environmental impact.
Notably, the importance of the rule goes beyond mere accounting regulation, as policymakers and voters of all political persuasions are increasingly reporting that an organization’s commitment to environmental responsibility contributes to their level of respect for the organization. In fact, Penta’s comprehensive policymaker research (formerly Ballast Research) —which gathers feedback from over 1,200 officials and senior staff across Capitol Hill, the White House, and Federal Agencies—reveals that 92% of Democrats and 70% of Republicans value companies’ ability to demonstrate environmental responsibility.
As part of the rule, public companies would be required to report existing climate targets and transition plans, climate-related risks that are “reasonably likely” to have a material business impact, and certain climate-related financial data in public disclosure filings. Additionally, the rule would mandate the disclosure of Scopes 1 and 2 greenhouse gas emissions, which are produced directly and indirectly through a company’s operations, as well as Scope 3 emissions, which are emissions generated by a company’s suppliers and customers using its products.
In response to the proposed rule, the SEC received over 5,000 comments submitted by individuals, companies, and trade associations, demonstrating the significant impact that the rule may have on businesses. Above all, the business community expressed the most concern with the proposed requirements for Scope 3 emissions disclosure, citing technical challenges, such as the possibility of double counting emissions; a lack of standardized process for measuring, accounting, and reporting emissions; companies having limited control over supplier or customer actions; and barriers that companies face to accessing the necessary data from external partners.
Some environmental advocates have also argued that requiring Scope 3 emissions disclosures may inadvertently stall real climate progress by diverting attention toward regulatory compliance and discouraging companies from setting public targets to reduce emissions. As a result, these groups recommend focusing on areas of disclosure that currently have the greatest confidence and accountability, a sentiment that is echoed by many in the business community. By focusing on reducing Scope 1 and 2 emissions, companies would inherently be contributing to reducing Scope 3 emissions elsewhere in the supply chains.
The SEC is currently drafting the final rule, which is expected to be released early this year. While the final rule is expected to preserve most provisions contained in the draft rule, including Scopes 1 and 2 disclosure requirements, the provisions for disclosing Scope 3 emissions could see significant revisions due to legal and political pressure.
Below are the three most likely scenarios for Scope 3 emissions requirements in the SEC final rule, ranked based on their conformity to the draft rule.
Scenario 1: The initial SEC draft rule is enacted with no changes to Scope 3 disclosure following the comment period.
The SEC has clearly signaled that increased transparency and disclosure around Scopes 1, 2, and 3 emissions is a priority. It would not be surprising if the agency published the rule as is, requiring companies to fall in line despite the changes recommended in comments by corporations, trade associations, and financial services firms.
If the SEC moves forward with the draft rule with few or no changes, it would reflect a substantial expansion of the SEC’s scope and could present major technical challenges for publicly-traded companies. Companies that do not currently estimate emissions using voluntary frameworks, like the Greenhouse Gas (GHG) Protocol, would be forced to develop and implement reporting processes. The timeline for these changes would be fast, as disclosures would be required in 2024 or 2025. These changes, which may necessitate hiring additional staff or securing independent audits, would place a significant financial strain on many businesses. In fact, the SEC estimates that the rule will cost $420,000 a year in additional disclosure expenses for small public companies, and $530,000 a year for larger firms. Furthermore, filing false or incorrect Scope 3 estimates could expose companies to expensive shareholder class-action litigation due to limited liability protections. The costs of these lawsuits could dwarf the additional disclosure costs.
However, any such move by the SEC is likely to attract legal challenges. Following the publication of the proposed rule, SEC Commissioner Hester Peirce released a dissenting statement arguing that the agency does not have the legal authority to mandate such sweeping disclosures. Several law firms have also identified multiple potential legal challenges to the Scope 3 section of the rule, including violations of the First Amendment and the Administrative Procedure Act.
One thing to watch: Many companies may be keen to join legal challenges to the SEC rule. However, these companies will need a strong communication strategy to reconcile their legal opposition to the rule with robust sustainability commitments made by most public companies.
Scenario 2: The SEC makes Scope 3 disclosures voluntary.
In light of public responses by companies, trade associations, and major banking and asset management firms, the SEC could amend the final rule to make Scope 3 emissions disclosures voluntary. Companies would only be required to disclose Scope 3 emissions if they have set public climate targets. While the rule would still heavily regulate the voluntary disclosure of Scope 3 emissions, continuing to mandate independent assurance, this scenario would limit pressure on public companies who have not set measurable goals for Scope 3 emissions reduction.
This outcome would reflect an acknowledgement of existing challenges to accurate data collection and reporting, such as barriers to accessing and controlling the emissions data of supply chain partners. This decision would also be favorable to many stakeholders who support expanded disclosure requirements, but have advocated for more time to develop the processes, personnel, and technology needed to comply.
One thing to watch: Exclusively requiring companies that set forward-leaning climate targets to disclose Scope 3 emissions has the potential to backfire. If these companies do not feel confident in their technical abilities to measure and report emissions, they could be discouraged from setting forward-leaning climate targets altogether.
Scenario 3: The SEC does not impose any Scope 3 regulations.
While enacting Scope 3 disclosures would be a watershed moment for the SEC, the agency may ultimately respond to corporate, legal, and policymaker pressure by removing the provision from the final rule. In this case, the final rule would exclusively focus on Scope 1 and 2 disclosures, requiring filings from all public companies. This outcome would significantly reduce the costs to firms, especially those that already report Scopes 1 and 2 emissions.
However, the regulation will still have a significant impact, as it would standardize the process for Scopes 1 and 2 emissions reporting and increase mandatory climate disclosure requirements facing companies and financial institutions.
One thing to watch: In the absence of mandatory Scope 3 disclosures, companies will be forced to choose whether they continue to estimate and report emissions using voluntary frameworks. Ultimately, choosing to voluntarily disclose Scope 3 emissions may allow companies to differentiate themselves to investors, customers, and other important stakeholders in the marketplace.
No matter which direction the SEC decides to take, the final climate risk disclosure rule will pose significant challenges for how companies communicate any contrast between their sustainability goals and push back on climate disclosure rules. Given the complexity of the regulatory and communications environment, companies must develop robust strategies to identify and educate their stakeholders on their next steps after the release of the final rule.