A summary: SEC Climate Rules
🎤 The [SEC] won't let me be or let me be me so let me see…says every sustainability reporting advocate right now…
Hot off the press… it’s not a new album, it’s the long-awaited Climate Disclosure Rules from the US Securities and Exchange Commission (SEC) that has finally been adopted.
...we are not mandating Scopes 1 and/or 2 emissions disclosures from all registrants. Rather, under the final rule, if either or both of those categories of GHG emissions are material, and the registrant is an LAF or an AF other than an SRC or EGC, it must disclose its Scopes 1 and/or 2 emissions metrics.”
Read on…
The Background
Back in March 2022, the SEC proposed draft rules to enhance and standardise the climate-related disclosures provided by public companies. These rules were originally planned to be finalised in 2023, requiring public companies to report from 2024. However, they faced opposition from companies concerned about the burdensome requirement for scope 3 disclosure. The proposed rules would have required companies to disclose their Scope 1 and Scope 2 emissions, and Scope 3 for larger companies if deemed material or if the company had stated emission reduction goals that included Scope 3.
In October last year, many investors voiced their support for scope 3 disclosure, which they see as key to assessing company risk. Sustainability advocates have also called for mandatory reporting, in line with where the rest of the world is heading. But others have been expressing their doubts around scope 3 making the final cut in the rule. This week the SEC officially confirmed that scope 3 disclosure requirements wouldn’t be adopted and scope 1 and 2 would be required if considered material.
Let’s take a look at what the new approved Climate Disclosure Rules say.
Key Takeaways
Who does it apply to:
The SEC climate rules apply to companies in the United States that fall under the jurisdiction of the SEC. The SEC has proposed a phased-in approach impacting Large Accelerated Filers (LAFs), as defined by SEC as companies with a market value of $700M+, and Accelerated Filers (AFs) with market value of $75M+ (definitions).It’s estimated around 2,800 US companies and about 540 foreign companies with business in the US will have to report (source).
When will it apply?
The final rules will take effect 60 days after being published in the Federal Register. The dates for compliance with the rules will be phased in for all registrants, with the compliance date dependent on the registrant’s filer status.The first disclosures, which are focused on climate related risks and its impact on financials, are required from financial years beginning 2025.GHG Emission numbers, which fall under Item 1505 in the adopting release paper, will be required for financial years beginning 2026.
What are the sections relevant to carbon accounting?
The sections relevant to carbon accounting in the adopting release paper start from Section H GHG Emissions Disclosure (Item 1505) from page 222 onwards. The paper reflects on the previously proposed rules, the consultation comments, and the requirements for the final rule (Find the table of contents on page 5 for ease of navigation).
The final rules, per subsection H.1.3 from page 244 onwards, have stated:
“...we are not mandating Scopes 1 and/or 2 emissions disclosures from all registrants. Rather, under the final rule, if either or both of those categories of GHG emissions are material, and the registrant is an LAF or an AF other than an SRC [Smaller Reporting Company] or EGC [Emerging Growth Company], it must disclose its Scopes 1 and/or 2 emissions metrics.”
❓What does this mean?
Companies only need to disclose their Scope 1 and/or 2 emissions if deemed material to disclose, but how do you determine what is ‘material’?
The rules have provided some guidance on page 246:
“... we intend that a registrant apply traditional notions of materiality under the Federal securities laws when evaluating whether its Scopes 1 and/or 2 emissions are material. Thus, materiality is not determined merely by the amount of these emissions. Rather, as with other materiality determinations under the Federal securities laws and Regulation S-K, the guiding principle for this determination is whether a reasonable investor would consider the disclosure of an item of information, in this case the registrant’s Scope 1 emissions and/or its Scope 2 emissions, important when making an investment or voting decision or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.”
Examples were given as what situations may be considered as material:
- “...where a registrant faces a material transition risk that has manifested as a result of a requirement to report its GHG emissions metrics under foreign or state law because such emissions are currently or are reasonably likely to be subject to additional regulatory burdens through increased taxes or financial penalties, the registrant should consider whether such emissions metrics are material under the final rules.
- “A registrant’s GHG emissions may also be material if their calculation and disclosure are necessary to enable investors to understand whether the registrant has made progress toward achieving a target or goal or a transition plan that the registrant is required to disclose under the final rules.” (Pages 246-247)
❓What does this mean?
It’s interesting to see it written in law that “materiality is not determined merely by the amount of these emissions” and that “the guiding principle for this determination is whether a reasonable investor would consider the disclosure of an item of information important when making an investment or voting decision…”
This will be interesting - for all the fear around compliance costs, one might wonder how much cost is introduced from needing to interpret applicability over the coming years and the inevitable cases that follow. Is a reasonable investor going to expect a company to understand their emissions if they have a net zero target that appears in marketing materials? Reputational risk would seem relevant here.
There will be a spotlight on companies and their approach to materiality assessment to evaluate the significance of their emissions. We will likely see this as a major discussion point as organisations assess the rule.
In subsection H.3.b - Presentation of the GHG Emissions Metrics and Disclosure of the Underlying Methodologies and Assumptions (Page 250 - 256), the rule provides a few notable guidance:
- “a registrant that is required to disclose its Scope 1 and/or Scope 2 emissions must disclose those emissions in gross terms by excluding the impact of any purchased or generated offsets” - Page 250
❓Why is this important?
With the rise in greenwashing litigations and misleading claims of ‘carbon neutral’ such as Delta Air Lines claiming to be the "world's first carbon-neutral airline", it’s becoming clear the importance of disclosing gross emission numbers so that users can understand the emissions a company is emitting, and whether they are truly making any emission reduction efforts. Even if you are carbon neutral under whatever framework you follow (like Climate Active in Australia for example) when it comes to disclosures, everyone wants to know your emissions, not “we are carbon neutral”.
Learn more in What is the difference between net zero and carbon neutral?
- “the final rule provides that the registrant must disclose the method used to determine the organizational boundaries, and if the organizational boundaries materially differ from the scope of entities and operations included in the registrant’s consolidated financial statements, the registrant must provide a brief explanation of this difference in sufficient detail for a reasonable investor to understand.” (Page 252)
❓Why is this important?
As part of their climate disclosures, organisations may choose an approach for setting their organisational boundary that does not align with the consolidated structure in their financial statements. An example of where this situation can arise is where an organisation has chosen the operational control approach but has a complex ownership structure. Make sure you're clear on the organisational boundary, you can't just exclude subsidiaries that show up in your consolidated financial statements, for example, without a clear explanation of why.
- “the final rule requires a brief description of, in sufficient detail for a reasonable investor to understand, the protocol or standard used to report the GHG emissions, including the calculation approach, the type and source of any emission factors used, and any calculation tools used to calculate the GHG emissions. (Page 253)...
For example, with the required disclosures, an investor will be able to evaluate the registrant’s selected emission factor(s) in the context of its operations and assess whether changes in reported emissions over time reflect changes in actual emissions in accordance with its strategy or simply a change in calculation methodology. (Page 255)
...the final rule provides that a registrant may use reasonable estimates when disclosing its GHG emissions as long as it also describes the assumptions underlying, and its reasons for using, the estimates (Page 255)
❓Why is this important?
Long gone are the days where a quick ‘black box’ calculation of GHG emissions is sufficient. Transparency over the assumptions and estimates used will help users, in particular investors, better understand how the GHG numbers came about and allow for a better like-for-like comparison across companies.
💡Our tip? Get your accountants involved, this stuff is their bread and butter.
Lastly, noted in Subsection H.3.c - Exclusions from the GHG Emissions Disclosure Requirement (Page 256) are the words that “We are not adopting a provision that would require a registrant to disclose its Scope 3 emissions at this time.”
The rules justified that, despite not requiring this right now due to apparent compliance and cost burdens (one has to wonder the true cost of not requiring this in the medium and long term…), they’ll keep an eye on Scope 3 as “many registrants will be required to disclose their Scope 3 emissions under foreign or state law or regulation, Scope 3 calculation methodologies may continue to evolve, mitigating many of the concerns noted by commenters about the disclosure of Scope 3 emissions. While such developments may encourage more registrants to disclose their Scope 3 emissions in Commission filings, at the present time, because of the potential costs and difficulties related to Scope 3 emissions reporting, the disclosure of Scope 3 emissions in Commission filings will remain voluntary.”
❓What does this mean?
Even though the SEC rules have taken a back-seat approach, they are expecting other jurisdictions to take the lead and indirectly require US companies to disclose. It’s just not the SEC laying it down - this is why you often hear “who really cares what the SEC ruling says, if companies make assessing scope 3 emissions part of their procurement policies or do business overseas or in states that do mandate this, disclosing scope 3 may as well be mandatory.
What are the Assurance Requirements?
The final rules have required assurance over Scope 1 and 2 from 2029 onwards. Most other jurisdictions have indicated limited assurance over Scope 1 and 2 from 2024 (New Zealand and Australia) and 2026 (Europe’s CSRD) and moving towards reasonable assurance in the years 2026 - 2030.
What now?
Despite the rules having been scaled back more than many expected, the finalised SEC Climate Disclosure Rules are still a major milestone in the movement for companies to report on their impact beyond their financials.
Even though the final rules have excluded Scope 3 emission disclosures, and may allow some companies to exclude themselves from disclosing any emissions at all… For US businesses, the pressure to report won’t be from the SEC, they’ll be facing pressure from regulation and customers they do business with in different states or international markets.
Businesses that operate in markets that have already implemented reporting regulations will need to disclose their emissions if they are caught under those such as the California Climate Accountability Package or CSRD in the EU - which will require disclosure on their Scope 1, 2, and 3 emissions. And those businesses caught within these jurisdictions, will be asking their suppliers for their emission numbers as part of their Scope 3 reporting - so you might just be asked anyways for those numbers!
Next Steps
At least up-skill members of your team in GHG accounting (it may just reduce fees, access to our market leading online courses are just a click away).
Learn more about how Sumday works with public companies who have a compliance obligation through to the SMBs in their supply chain (it’s accessible to both!) contact us!
And as always, get your accountants involved! If they have no idea how to help you tackle this in an affordable way, go to another firm, there’s plenty willing to support you in the Sumday Advisor Directory.
We’re happy to chat more to help you navigate this space, just reach out 👋🏻
