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Can the SEC Climate Rule Spur a Culture of Voluntary Disclosure?

Climate accountability may benefit from the interaction of the SEC rule with California legislation.

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The Security and Exchange Commission’s recently adopted regulations on greenhouse gas emissions and climate-related financial disclosures mark a significant step toward availability of public information for investors in the future. The new regulations are currently mired in litigation. However, we believe that the pressure in the US from these rules and California’s Climate Corporate Data Accountability Act, or CCCDA, as well as its Climate-Related Financial Risk Act (collectively the California’s Climate Accountability Package) will spur the US to move toward the European Union in its climate disclosure regime, depending on the elections this November and the outcome of litigation.

By setting standards and fostering transparency, the SEC is driving toward a future where companies prioritize environmental sustainability alongside financial performance. By embracing the SEC’s requirements—both mandatory and sometimes even standardizing voluntary reporting—along with aligning with stricter standards like those of California, companies can attract responsible investors as well as demonstrate their commitment to a sustainable future.

Accountability: SEC Targets Scope 1 & 2 Emissions, and California Goes Further

The SEC and California each play a significant role in driving transparency and accountability in GHG emissions reporting, particularly focusing on scope 1 and scope 2 emissions. The SEC’s forthcoming rule mandates disclosures primarily for large public companies for whom scope 1 and 2 emissions are deemed material. California’s Climate Accountability Package goes further, requiring both public and private US companies doing business in California and generating over $1 billion in gross annual revenue to disclose their scope 1, scope 2, and scope 3 GHG emissions to the state of California on an annual basis.

California’s broader scope may push more companies to comply with SEC rules than the group to which the SEC rules specifically apply. This disclosure would signal to investors and stakeholders a commitment to environmental sustainability as part of financial performance.

Climate Transparency Improves on Reporting of Climate-Related Financial Impact

The SEC rule extends beyond emissions to address climate-related financial impacts, particularly those resulting from severe weather events and natural conditions. Under this rule, companies must disclose in their financial statement separate details on expenses and losses, as well as capitalized costs and charges related to severe weather events and other natural conditions based on specified quantitative thresholds.

In parallel, California is also advancing standardized reporting on climate-related financial risks through the Climate-Related Financial Risk Act. This legislation mandates large businesses in California to biannually disclose climate-related financial risks and mitigation strategies, including risks from severe weather events and transitional impacts. However, unlike the SEC, California does not specify a quantitative threshold for reporting. Thus, the SEC threshold may serve as the basis to standardize reporting in California.

How the SEC and California Are Setting the Bar: Mandatory Targets and Goals Disclosure

In addition to reporting on emissions and financial impacts, companies are expected to disclose targets and goals for emissions reduction and carbon neutrality. The SEC requires disclosure in annual reports and registration statements of climate-related goals and targets if the goal or target has materially affected or is reasonably likely to materially affect the registrant’s business, results of operations, or financial condition.

California’s legislation requires both public and private US companies doing business in California and generating over $1 billion in gross annual revenue to disclose not only all current emissions but also their plans for achieving carbon neutrality and reducing GHG emissions. Together with the SEC standard of material impact, it will foster a culture of target-setting and disclosure.

SEC and California Rules Enhance Credibility of Climate Disclosures

The SEC has also provided some rules and standards to boost the credibility of climate disclosures. Under SEC rules, a registrant required to provide scope 1 and scope 2 emission disclosures must include an attestation report from a GHG emissions attestation provider. An attestation report is a written statement from an independent third party, like a CPA or auditor, that gives their opinion on whether an organization’s financial statements or other information are accurate and reliable. Providing reports at a limited and reasonable assurance level enhances the credibility of reported data. If the company voluntarily chooses to provide assurance about its emissions disclosures before the SEC requirements take effect, it must follow certain standards mandated by the SEC. These include a description of the assurance standard used, and the level and scope of assurance services provided.

These standards for voluntary assurance apply during the transition period, or the period before the requirements take effect, for required filers as well as to entities not required to file GHG emissions, such as smaller reporting companies and nonaccelerated filers that are exempt from reporting GHG emissions. Thus, assurance reports may end up getting adopted beyond the universe of required companies because of the broad-reaching impact of disclosure requirements.

Similarly, California’s CCCDA mandates that businesses verify their reported emissions through independent third-party assurance providers. Together, these two layers of assurance requirements imply that climate data now requires the same level of care and attention as financial data, as inaccuracies can result in fines and reputational harm.

Paving the Way for More Transparent Reporting

As the world grapples with the urgent need to address climate change, regulatory bodies are increasingly stepping up to set standards for climate disclosures so that investors have the information to impose accountability. The SEC has implemented a new rule that could pave the way for more transparent reporting on GHG emissions and climate-related financial risks. While these regulations target specific companies, their interaction with California legislation may increase their impact, potentially ushering in a new era of voluntary reporting and standardized disclosures. Such a change presents an opportunity for climate-conscious investors to have valuable information and data.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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