SEC Proposes Environmental Disclosures to Aid Investors

The SEC has proposed two new climate disclosure rules that will help investors compare environmental strategies across the SEC registrants and invest in companies that align with their personal sustainability values.

The U.S. Securities and Exchange Commission (SEC) has proposed two new rules that would increase the transparency of environmental impacts on investments. On March 21, the SEC announced the first rule, “The Enhancement and Standardization of Climate Related Disclosures for Investors,” which aims to set a baseline for the minimum reporting requirements of climate related risks. 

Investors will benefit from having access to accurate and comparable climate related information across all SEC reporting companies. The proposed rule would apply to all SEC registrants, both foreign and domestic, after a phase-in period which would take effect based on the filer status of the company. 

The SEC has published a tentative deadline for filers that assumes a December 2022 adoption of the rule. As such, the rule would apply to large, accelerated filers as early as fiscal year 2023 and as late as fiscal year 2025 for smaller reporting companies. 

How Climate Disclosures Will Work

If the rule is adopted by the SEC, companies would be required to include: 

  • Material impact of climate risks on the business. 
  • Governance plan and risk management strategies for climate change. 
  • Direct and indirect greenhouse gas emissions, some filers will need their metrics. to be attested. 
  • Financial statements that consider the impact of extreme weather events.  
  • Climate goal targets and transition plan if applicable. 

The disclosure of greenhouse gas emissions (GHG) is by far the most controversial aspect of the proposed rule. GHG emissions can fall into one of three categories: 

  • Scope 1, which are direct emissions generated from owned assets.
  • Scope 2 which are indirect emissions from energy usage.
  • Scope 3 which are indirect emissions related to the company’s operational activities. 

All SEC registrants will have to provide metrics for both scopes 1 and 2. The controversy stems not from scope 1 or 2 emissions but from the calculation of scope 3 emissions. 

“It can be complicated and daunting for a company to calculate the impacts of Scope 3 emissions, but despite what some claim, it is certainly possible,” says Scott Tew, VP of Sustainability at Trane Technologies. “Most companies have calculated and reported scopes 1 and 2 for a long time and although scope 3 is viewed as typically outside a company’s “control” there are certainly areas of scope 3 that are fully within the company’s control and this underlies the basis for some of the SEC’s future expectations.”

The current methodologies for calculating Scope 3 emissions are ever-evolving, and companies are concerned with the liability risk of reporting inaccurate metrics. The SEC has implemented a safe harbor policy along with a separate phase in period for Scope 3 emissions to alleviate liability concerns. Small reporting companies will be exempt from providing their Scope 3 emissions.  

ESG Disclosures Get Detailed

On May 25, the SEC proposed the second rule, “Environmental, Social, and Governance (ESG) Disclosures for Investment Advisers and Investment Companies,” to protect investors from greenwashing. The market has become saturated with investment funds claiming to be sustainable. 

Green Washing

Unfortunately, investors have no way to discern legitimate sustainability funds focused on ESG principles from the phony, greenwashed funds. This proposed rule aims to remedy the situation by providing investors with a detailed disclosure outlining the ESG criteria or strategies of a company.

If ESG factors are an integral part of the investment fund, a more detailed disclosure will be required. The SEC has identified three types of ESG funds based on how integral ESG principles are to the fund. The three types of ESG funds are as follows:

  1. Integration funds: some ESG principles are combined with traditional, non-ESG principles to make investment decisions thus requiring an account of how ESG principles influence the fund 
  2. ESG-focused funds: investment decisions are predominantly dictated by ESG principles and require an overview of their ESG strategies 
  3. Impact funds: ESG principles dictate their investment plan, and they have an ESG target that requires data to show their progress  

Impact fund companies will also be required to disclose their GHG emissions if their fund has a targeted goal to reduce emissions. The SEC has proposed that companies have one year from the date of adoption to comply with the new ESG disclosures. 

If the proposal is adopted, companies may feel pressured to create an ESG plan to be more competitive. People interested in sustainable investing are rapidly divesting in companies that contribute to climate change and have no plans to scale back their emissions.  

Between the two proposed rules, SEC registrants are preoccupied with the climate disclosures rather than the ESG disclosures. This is likely due to the fact that all SEC registrants are impacted by the first rule while the second rule is limited to companies employing ESG principles. 

The cost of compliance is also much higher for the first rule in comparison to the second. Although corporations will most likely contest the proposed rules in court, the adoption of such rules would be beneficial not only to investors but to the planet as well.