As environmental friendliness becomes more important in business, whether it’s in regulation or the court of public opinion, it also becomes more important in investing. Today’s investors are becoming more environmentally conscious and are interested in investing in companies that pose minimal risk and mitigate the potential for regulatory issues to impact their performance.
To help speed along environmentally healthy investment, the SEC looks to create a task force on climate-related financial disclosures and mandatory SEC carbon disclosure. Below, we explore the carbon disclosure project (CDP) proposal and the reporting standards that’ll come along with it.
What Is SEC Carbon Disclosure?
The Securities and Exchange Commission (SEC) carbon disclosure is a proposed rule change requiring certain businesses to make climate-related disclosures in their SEC registration statements and periodic filings and financial reports. However, the SEC’s proposed rule would only apply to climate risks that could reasonably impact a company, its operations, or its financial condition.
These disclosures would also include a greenhouse gas emissions disclosure system.
The proposed CDP report would include:
A registrant’s climate-related risk management and other relevant risk management processes
How identified climate-related risks have or will likely have short-, medium, or long-term material impact on its business and consolidated financial statements
How the identified climate-related risks have affected or will reasonably affect strategy, business model, and outlook
The impact of severe weather events, other natural conditions, and transition activities on the line items of the business’ consolidated financial statements
A business’ climate change risk management and transition risks as well as their potential financial impacts based on existing climate-change strategies, transition plans, greenhouse gas protocols, or publicly announced climate-related targets
If the proposed rule becomes official, the SEC will install phase-in periods for registrants. Each compliance date will depend on whether the registrant is a large accelerated, accelerated, or non-accelerated filer.
Do Companies Have to Disclose Carbon Emissions?
While the Environmental Protection Agency (EPA) requires companies that emit over 25,000 metric tons of carbon dioxide (CO2) to report greenhouse gas emissions (GHG emissions) annually, the SEC has no reporting requirements for companies. However, the SEC has strongly advised companies to do so in the past.
As a part of the SEC’s proposed climate disclosure rules, though, companies would be required to disclose Scope1, Scope 2, and Scope 3 GHG emissions. Let’s explore what each scope is.
What Are Scope 1 Emissions?
Scope 1 emissions are a business’ direct GHG emissions. For example, if a factory uses coal to heat and melt metal or other elements to create its products, the emissions created from burning the coal is a Scope 1 emission.
What Are Scope 2 Emissions?
Scope 2 emissions are indirect GHG emissions from purchased energy. For example, a company purchases electricity from the electric company and uses it to run the building. The emissions involved in creating the electricity the business uses is a Scope 2 emission.
What Are Scope 3 Emissions?
Scope 3 emissions are a business’ upstream and downstream GHG emissions from its value chain. This is a broad-ranging scope that covers everything not covered under Scope 1 or Scope 2. These are emissions created by activities and facilities not owned or controlled by the company. For example, employees commuting to work create GHG emissions from their vehicles and emissions created in the supply chain, and these are Scope 3 emissions.
The SEC proposal would place Scope 3 emissions in a “safe harbor.” This means they may not be wholly accurate, but the SEC will not consider it fraudulent so long as the disclosure was estimated in good faith.
How Do Corporations Harm the Environment?
Corporations can impact the environment in various ways, whether directly or indirectly. Carbon emissions are some of the biggest issues surrounding corporations, as just 100 of the world’s largest companies make up 71% of global emissions.
As mentioned above, these emissions can come in three ways: Scope 1, Scope 2, and Scope 3. While Scope 1 and 2 are within a company’s control, Scope 3 is generally not within their direct control. To make matters worse, Scope 3 emissions are the majority of all corporate emissions.
Scope 3 emissions can be anything from an employee commuting to work to a delivery truck dropping off a product to an end user. It can even be as granular as the electricity an end user consumes to power a product.
Beyond GHG emissions, corporations impact the environment in several other ways.
Many corporations may emit silica dust, which can result in terminal lung diseases when inhaled. You can find silica dust in various industries, including construction, glass production, dental labs, foundries, and more. Another toxic dust is asbestos, which is known to cause mesothelioma.
Corporations produce waste, whether it’s simply trash or more serious byproducts from manufacturing. Occasionally, waste product mismanagement or an accidental leak can pollute public waters, rivers, lakes, and streams.
These leaks can lead to severe illnesses, neurological issues, and even death in the public water system. In the rivers, lakes, and streams, this can harm or kill wildlife.
Many companies also work with dangerous chemicals. When contained, they are often not harmful. However, leaks, such as an oil leak into waterways, can make public water undrinkable — leading to water security issues — and can harm the local wildlife. Also, companies that use pesticides may spray harmful chemicals that lead to respiratory diseases and even death.
Numerous companies can affect deforestation, particularly in the palm oil, pulp and paper, timber, beef, soy, and cocoa industries. These companies have destroyed millions of hectares of rainforest in The Amazon, Indonesia, and other countries.
This deforestation can lead to more significant environmental impacts, such as increased GHG, soil erosion, flooding, loss of wildlife habitat, and more.
Does the SEC Have Legal Authority?
Yes, the SEC has regulatory legal authority to propose and enact new regulations, as long as it is in the public interest or for the protection of investors. When creating new rules, the SEC will develop a concept release that eventually leads to a proposal. The proposal and concept release are available for public review and comment, and the SEC uses the public comment to adjust the proposal.
The five-commissioner SEC will then meet to review public and industry input on the proposal and make additional changes until it reaches a final proposal. The commissioners then vote whether or not to enact the final rule by a simple majority.
Does the SEC Have Legal Authority to Adopt Climate Change Disclosure Rules?
In the same way it has the authority to adopt securities regulations, the SEC has the legal authority to adopt climate change disclosure rules. The proposed rules must be in the public interest and aimed at protecting investors.
What Is SFDR Sustainability?
The Sustainable Finance Disclosure Regulation (SFDR) is essentially the European Union’s (EU) version of the SEC carbon emission disclosure. It requires companies to disclose various environmental, social, and governance (ESG) metrics at the entity and product level.
The EU introduced SFDR on March 10, 2021, to improve market transparency for sustainable investment products, to prevent greenwashing, and to increase transparency around financial market participants’ claimed sustainability.
The goal is to help investors better understand the impacts of their investments on the environment and spur their decisions toward more environmentally positive securities, such as renewable energy and other emissions reduction steps. And shifting investments could also push corporate decision-making toward business strategies focusing on environmental friendliness and climate action.
While SFDR doesn’t directly impact non-European Economic Area (EEA) members, a company will likely have to comply with these low-carbon-economy reporting regulations if it does business within the EEA.
What Is Carbon Footprint Reporting?
As mentioned earlier, the EPA requires companies producing more than 25,000 metric tons of carbon dioxide to deliver annual GHG emissions reports. The official name for this reporting is the Greenhouse Gas Reporting Program (GHGRP), though it’s informally called carbon footprint reporting.
As of August 2022, the EPA requires roughly 8,000 individual facilities to produce annual reports on their carbon emissions — or carbon footprint — every October. A company’s total carbon footprint includes all Scope 1, Scope 2, and Scope 3 emissions produced annually.
How Does Carbon Accounting Work?
Like financial accounting helps a business determine how much revenue and profit it’s creating, carbon accounting lets a company track the carbon emissions it’s producing. Companies can divide carbon accounting into two categories: physical and financial.
Physical carbon accounting measures direct and indirect carbon emissions a company creates. Financial carbon accounting puts a market value on the company’s carbon emissions.
Is Carbon Accounting Mandatory?
No, carbon accounting is not mandatory in the literal sense. However, it can be helpful for companies with net-zero carbon goals or those looking to assign carbon emissions responsibility to certain parts of the value chain.
Carbon accounting is also helpful for companies that produce more than 25,000 metric tons of carbon emissions and must report annual GHG emissions to the EPA.
What Are Carbon Allowances?
The EPA issues carbon allowances to corporations, and each allowance permits the company to emit 1 metric ton of carbon dioxide or other GHG. These aren’t to be confused with carbon offsets, which are carbon emission reductions through specific programs.
The EPA limits the number of carbon allowances to reduce overall GHG emissions. However, companies can buy, sell, and trade carbon allowances.
How Do I Apply for an Emissions Allowance?
The EPA will offer allowances to corporations for free or via an auction, such as the EPA’s Acid Rain Program SO2 Allowance Auction. If your company isn’t offered an allowance or lost out in an auction, you can also purchase carbon emissions allowances through a brokerage.
These brokers connect carbon allowance buyers and sellers and help facilitate large transactions. For smaller transactions, companies can go directly to other corporations or groups to purchase them.
What Is Regulation S-K?
Regulation S-K is an existing rule within the SEC that requires businesses to disclose material qualitative descriptors of their business. Within Regulation S-K are several items that opponents of this new disclosure say overlap the proposed rule changes, such as:
Item 303 of Regulation S-K, MD&A: This item requires businesses to disclose material events and uncertainties likely to cause reported financial information not to align with future operating results or financial conditions.
Item 101 of Regulation S-K, Description of Business: This item requires a description of the business, including each reportable segment. It also requires companies to disclose the material effects compliance with environmental laws and regulations could have on capital expenditures.
Item 103 of Regulation S-K, Legal Proceedings: This item requires a description of environment-related material pending legal and administrative or judicial proceedings if certain conditions are met.
Item 105 of Regulation S-K, Risk Factors: This item requires the disclosure of material factors that make an investment in the registrant or offering speculative or risky. This could also include climate-risk disclosures, emissions data, environmental data, and other climate-related information.
Who Does Regulation S-K Apply To?
Regulation S-K applies to companies registering their securities with the SEC to sell them to the general public. So, any public company that sells stocks and other securities on the open market to investors will fall under Regulation S-K disclosure rules.
The SEC Carbon Disclosure Rule Isn’t Official Yet
While the SEC’s carbon emission disclosure requirements are still just proposals, there is a chance they’ll eventually become a reality. In this case, many publicly traded companies will need to prepare to have emissions disclosures to go along with their financial disclosures.
Understanding what to expect from the carbon disclosure project (CDP), such as the various scopes of emissions and phase-in dates, will put your company ahead of the learning curve.
If you’re interested in moving toward limiting your environmental impacts or becoming a carbon-neutral company and preventing any potential climate-related risk issues in future reporting, check out Terrapass’ carbon-offsetting products to help meet your reduction targets.
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