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The Securities and Exchange Commission (SEC) today has issued the final Climate Disclosure Rule.
This rule will require public companies to provide detailed climate-related disclosures in their registration statements and annual reports and will be rolled out in a phased approach based on the size of the public company.
In this blog post, we will cover the background and rationale of the SEC that brought forth this rule, a brief overview of the final climate disclosure rule, and finally share a CEO’s perspective on how these rules will benefit investors and advisors in the short and long term and specifically what benefits YourStake sees from these enhanced climate and emissions disclosures.
Background and Rationale of the SEC in the release of the new Climate Disclosure Rule
The SEC's decision to enhance climate-related disclosure requirements stems from the growing recognition that climate-related risks can have a significant impact on a company's financial performance in the short and long term. Investors, including institutional investors and investment advisors, have increasingly sought more consistent, comparable, and reliable information about these risks to inform their investment and voting decisions.
However, the current state of climate-related disclosure has often been fragmented, inconsistent, and insufficient to meet investors' needs. This direct issue was the original thesis for YourStake’s NoScore ESG approach to data.
In recent years, companies have been disclosing information related to climate risks in different documents and formats. As of 2022, around 74% of companies listed in the S&P 500 have reported climate-related risks, while almost 90% of companies in the Russell 1000 have also disclosed data regarding these issues. However, these disclosures still lack an overall schema that is consistent and comparable.
To address these issues and promote transparency, the SEC has determined that standardized and enhanced disclosure requirements are necessary. By requiring public companies to provide detailed climate-related information in their SEC filings, the Commission aims to improve the consistency, comparability, and reliability of this information for investors. Furthermore, providing these disclosures in commission filings brings enhanced liability that provides important investor protections.
Overview of the Final Climate Disclosure Rule from the SEC
The SEC's final climate disclosure rules introduce a series of amendments to Regulation S-K and Regulation S-X, which govern the content and format of non-financial and financial disclosures, respectively.
The key elements of the final rules include as stated in the final rules:
Scope 1 and Scope 2 emissions: Large accelerated filers (LAFs) and accelerated filers (AFs) that are not otherwise exempted must disclose information about material Scope 1 and/or Scope 2 emissions.
Transition plans, scenario analysis, and internal carbon prices: Registrants must provide specified disclosures regarding their activities, if any, to mitigate or adapt to a material climate-related risk, including the use of transition plans, scenario analysis, or internal carbon prices.
Material climate-related risks: Registrants must disclose climate-related risks that have had or are reasonably likely to have a material impact on their business strategy, results of operations, or financial condition.
Actual and potential impacts of climate-related risks: Registrants must disclose the actual and potential material impacts of identified climate-related risks on their strategy, business model, and outlook.
Mitigation and adaptation activities: If a registrant has undertaken activities to mitigate or adapt to a material climate-related risk, they must provide a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions directly resulting from such activities.
Board and management oversight: Registrants must disclose any oversight by the board of directors of climate-related risks and any role by management in assessing and managing material climate-related risks.
Risk management processes: Registrants must disclose processes for identifying, assessing, and managing material climate-related risks and whether and how these processes are integrated into their overall risk management system.
Climate-related targets or goals: If a registrant has set climate-related targets or goals that have materially affected or are reasonably likely to materially affect their business, results of operations, or financial condition, they must disclose information about these targets or goals, including material expenditures and impacts on financial estimates and assumptions.
Assurance reports: LAFs and AFs required to disclose Scope 1 and/or Scope 2 emissions must provide an assurance report at the limited assurance level, with LAFs moving to the reasonable assurance level after an additional transition period.
Financial statement disclosures for severe weather events and natural conditions: Registrants must disclose, in a note to the financial statements, the capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, subject to applicable one percent and de minimis disclosure thresholds.
Financial statement disclosures for carbon offsets and RECs: Registrants must disclose, in a note to the financial statements, the capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of their plans to achieve disclosed climate-related targets or goals.
Impact on estimates and assumptions: If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events, other natural conditions, or any disclosed climate-related targets or transition plans, they must provide a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements.
A CEO's Perspective: The SEC's Climate Disclosure Rules and Their Impact on The Industry, Financial Advisors, and YourStake
I believe the SEC's new climate disclosure rules represent a significant step forward in promoting transparency and enabling informed decision-making.
Expected Impact on Carbon Disclosure
I anticipate that the SEC's climate disclosure rules will lead to full disclosure of Scope 1 and 2 emissions by public companies within a couple of years of the initial rollout, likely by 2028. Although the SEC has previously called for climate disclosures when material through comment letters dating back to 2009, these new rules set clear expectations around when and how to report, counterbalancing the disincentives that have prevented transparency thus far.
Companies have been reluctant to include carbon disclosures in their Annual Reports due to concerns about potential misstatements arising from the lack of standardization in carbon calculations. As a result, carbon disclosures have been siloed into voluntary sustainability documents, which often function as marketing tools with uneven, unreliable, and cherry-picked metrics. The SEC's rules will help to address this issue by providing a framework for consistent and comparable disclosure.
Moreover, with the European Union's Corporate Sustainability Reporting Directive (CSRD) setting carbon reporting requirements on a similar timeline (FY25), I believe U.S. companies will be pushed to de-facto conclude that carbon is material. European investors in U.S. markets will have a compelling case to argue that carbon disclosures, which are mandatory in the EU, are also material in the U.S. for peer companies.
The SEC's Balanced Approach
The SEC's approach to the climate disclosure rules is consistent with its principles-based approach to guidance, rather than imposing command-and-control prescriptive requirements. While some may view the final rules as a step back from the initial proposal to make disclosures completely mandatory, I believe that giving companies the freedom and responsibility to determine materiality will pre-empt backlash while still leading to similar levels and quality of disclosure in practice.
Furthermore, by dropping the requirement for Scope 3 emissions disclosure, the SEC can position this ruling as a compromise. However, I believe that the Scope 1 and 2 disclosure requirements are a productive stepping stone towards more comprehensive climate-related disclosure in the future.
Implications for YourStake
At YourStake, we have always had a core competency in collecting and streamlining public datasets, and we have been careful about the rigor of 'wild west' sustainability report disclosures. The more apples-to-apples disclosures, the better.
We have consistently pulled the existing structured data disclosures around carbon from the SEC, and we can reiterate just how scarce the current level of disclosures is – often in the single-digit percentages. This underscores the need for more comprehensive and standardized disclosure requirements.
It is worth noting that carbon-based portfolio analysis and construction is often criticized, and for good reason. The underlying data is still really bad, and estimation methodologies used to extrapolate gaps in disclosure usually lead to poor decisions. As the SEC's climate disclosure rules are implemented and more companies provide consistent and reliable carbon data, we expect the quality of carbon-based portfolio analysis to improve significantly.
I believe we continue to be well-positioned to leverage the enhanced climate disclosures resulting from the SEC's rules to provide our clients with more accurate, comprehensive, and decision-useful sustainability data. We will continue to monitor the implementation of these rules and adapt our data collection and analysis processes to ensure that we are providing the most up-to-date and reliable information to support informed investment decision-making.
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