For years, investors have struggled to compare the impact that companies have on the climate, as well as the risks climate change poses to them. This is why in March 2022 the United States the Securities and Exchange Commission (SEC) proposed the Climate Disclosure Rules. These new requirements aim to increase transparency in publicly traded companies by requiring them to disclose climate-related risks to their business and greenhouse gas emissions in public disclosure filings.

Investors have been pressuring the SEC to introduce guidelines regarding environmental, social and governance (ESG) transparency since 1968. This would mean publishing reports and disclosing information about companies’ climate impacts, treatment of workers, and social effects. Demand was met with guidelines for ESG disclosure in the 70s, but companies were obliged to disclose ESG information only to government agencies like the Environmental Protection Agency. Reporting to investors has remained largely voluntary, with companies choosing from a variety of decentralized standards like the Global Reporting Initiative standards.

Reporting voluntarily is common among many corporations - all the biggest names do it to some degree (Microsoft, PepsiCo etc.). However, according to a 2021 survey by Boston Consulting Group, only 9% of companies measure their emissions comprehensively, 81% don’t measure parts of their internal emissions (emissions directly from their operations (Scope 1 and 2)), and 66% don’t measure their external emissions (emissions from their value chain - Scope 3) at all. Scope 3 emissions account, on average, for 75% of a company’s emissions and 99.98% of emissions in the financial services sector.

Scope 1 covers direct emissions from owned sources, like burning something to create a product.

Scope 2 covers indirect emissions from the generation of purchased electricity that’s used by the company.

Scope 3 includes all other indirect emissions in a company’s value chain, like the gasses caused by shipping a product or ultimately when a consumer throws it away and it’s burned in a landfill.

Therefore, there are significant differences in the rigor with which some companies approach measuring and reporting their emissions, as well as large disparities between the real and reported impacts on the environment and society that companies have. This makes investing responsibly very difficult: most companies are impossible to compare or trust.

The rules proposed by the SEC aim to fix this. They include a requirement for all publicly traded companies to report their Scope 1 and 2 emissions. Scope 3 emissions also have to be reported if they make up a large portion of total emissions or if the company’s emission targets include Scope 3 emissions. They’d also mandate that publicly traded companies be transparent about the management and the potential impacts of climate change-related risks. Such risks could include an increase in extreme weather or potential climate change legislation.

These changes would empower investors to compare companies with confidence. SEC Chair Gary Gensler explained, “Our core bargain from the 1930s is that investors get to decide which risks to take…climate risks can pose significant financial risks to companies, and investors need reliable information about [them] to make informed investment decisions.”

The proposal does face some criticism. Most filers would have to start reporting on the fiscal year 2024 (filing in 2025), and many think this is too quick of a turnaround. It takes time to establish the capability to measure emissions according to the SEC’s rules, so some analysts argue that companies need more time to prepare to report emissions.

The most important issue raised is the unclear rule about Scope 3 emissions reporting. No figure is given for how significant Scope 3 emissions have to require reporting. As mentioned earlier, Scope 3 emissions make up the largest proportion of most companies’ emissions, so it is important that there be no uncertainty about whether they need to be reported or not. At the same time, however, some argue that requiring companies to report Scope 3 emissions is a step too far, since they are very difficult to measure.

It is also uncertain whether the proposal would survive in the courts, especially given the Supreme Court’s ruling in June which limited the power of the EPA. The SEC’s case is stronger than the EPA’s as their proposal is done in the name of protecting investors. Nevertheless, the proposal could still be stalled up in Congress, which rejected climate disclosure proposals in 2018, 2019, and 2021. With the recent midterm results that split control of Congress and the increased political conflict surrounding climate change, the SEC might be hard pressed to make the proposal, and especially its Scope 3 requirements, become reality.

If they were passed, the rules would not only improve the information available to investors, but they would also help combat climate change on a large scale. Young investors are especially conscious of the impact of their investments, responsible investing is set to continue to grow in popularity, and many firms are shifting their portfolios to greener companies to hit their net-zero targets. Investors want to minimize the risk and emissions associated with their investments. Corporations would have to address their emissions and their exposure to climate-related risks in a meaningful way to continue to succeed. Transparency would be a big step towards real climate action.

Photo by Marcin Jozwiak on Unsplash.