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The SEC, in a long-awaited move, put climate risk front and center in a proposed overhaul of corporate reporting that would affect the 4,000 or so companies listed in the United States and allow investors to more easily compare companies to each other.
The SEC is proposing that companies begin disclosing in their annual reports and elsewhere how they manage climate-related risks. The proposal also calls for companies to disclose the gamut of their greenhouse gas emissions, including the thorny, hard-to-track scope 3 emissions in their supply chains, if the latter are significant. (Scope 1 refers to a company's direct emissions, and scope 2 refers to emissions related to its power use.)
The SEC's move comes as Russia's invasion of Ukraine has created alarm about the world's reliance on Russian energy and prompted some leaders to consider expanding their sourcing of fossil fuels. As a result, the world is "sleepwalking to a climate catastrophe," U.N. Secretary-General Antonio Guterres warned, adding that instead of limiting global warming, "the problem is getting worse."
In addition, the SEC is considering a requirement that companies disclose how their boards and managers handle climate-related risks, identify how climate-related risks would materially affect their financial statements over the short and long terms, and report any transition plans they have adopted. You can read a fact sheet about the proposal here.
The proposed disclosures are already similar to the ones that are recommended by popular frameworks like the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. The proposal is open for comment until at least May 20, 2022.
"The proposal is much broader than most expected since the SEC is specifically requiring the disclosure of scope 3 emissions, which include indirect emissions that occur in a company’s value chain, that is those generated by suppliers and partners," says Jasmin Sethi, associate director of policy research at Morningstar. Such data would be valuable for investors to make informed decisions but will be "challenging for companies to gather and report" because they're loaded with a vast number of inputs for manufacturing, transportation, and so on.
The proposal is likely to be challenged by companies and states amid arguments about what information a "reasonable investor would consider material for investing or voting," says Sethi.
For example, West Virginia's attorney general has threatened to sue the SEC if it forced companies to disclose environmental data, while the Kentucky attorney general has expressed opposition to the initiative.
In addition, some large corporations are concerned about the breadth of disclosures that will need to be filed and the potential that such broad disclosures may subject them to liability, says David Adams, an attorney at Clifford Chance who specializes in regulatory and enforcement matters.
The proposal was applauded by shareholder advocates. In a statement, Mindy Lubber, CEO of Ceres, the climate advocacy nonprofit, said, "The thoughtful climate disclosure proposal announced today would allow investors and companies to better tackle climate-related financial risks across investment portfolios and global supply chains and seize the opportunities that come with acting on those risks." It would also bring U.S. disclosures closer to "the emerging global norm."
Green Century Capital Management president Leslie Samuelrich says the proposal that companies disclose their greenhouse gas emissions "represents a major step forward. We believe climate vulnerabilities and value chain emissions constitute material information, and investors need reliable, comparable disclosures in order to assess issuers' exposure to physical and transition risk."
Because scope 3 emissions are so difficult to track, the proposal recommends letting smaller companies delay reporting them until fiscal 2026. That could create a sticking point for larger companies, because smaller companies are part of the supply chain, says Alex Osborne-Saponja, an associate director on Sustainalytics' climate solutions team. For U.S. small- and mid-cap companies, including those that populate the Russell 2500 Index, even scope 1 and scope 2 disclosures are rare, according to RBC Capital Markets.
Nevertheless, the SEC proposal, if enacted in its current form, “will help improve transparency and comparability of corporate climate disclosures,” says Sara Mahaffy, ESG strategist at RBC. The majority of companies in the S&P 500 already provide some data on scope 1 and scope 2 emissions, although Scope 3 disclosures are less frequent.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.