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What the SEC climate disclosure rule may mean for investors

Securities and Exchange Commission Chair Gary Gensler testifies before the Financial Services and General Government Subcommittee on July 19, 2023 in Washington. 
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The Securities and Exchange Commission is poised to issue a final rule on Wednesday that would require companies to beef up disclosures around climate risks — a level of transparency that should help investors assess a company’s value in a warming world, said experts.

At a high level, the rule — initially proposed in March 2022 — would expand investors’ insight into the threat that climate change poses to publicly listed companies and how businesses contribute to a warming planet.

Climate disclosures would be made in annual filings companies make to the SEC, such as a Form 10-K, and in registration statements filed before an initial public offering.

“I think climate disclosures have largely become table stakes for the investment community,” said Lindsey Stewart, director of investment stewardship research at Morningstar.

Current climate disclosures are ‘uncommon’

Ships on the Panama Canal on August 21, 2023. The Panama Canal Authority had reduced maximum ship weights and daily vessel transits to conserve water amid historic drought. Shipping experts fear such events could become the new normal as rainfall shortfalls highlight climate risks.
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Such data points are currently spotty.

Publicly listed U.S. companies make climate disclosures on a voluntary basis, and they remain “uncommon in all but a few sectors,” according to S&P Global.

Corporations will likely be required to disclose short- and long-term physical risks, such as the impacts of hurricanes, droughts, wildfires, extreme heat and sea level rise, Stewart said.

They’d also likely report “transition” risks from legal or regulatory changes, new technology and business practices that aim to adapt to a hotter world, he said.

Corporations would also be required to report their total greenhouse gas emissions, both created directly by a company and indirectly along its supply chain. The depth of that carbon reporting may be diluted from the SEC’s initial proposal in March 2022 due to blowback and to insulate the rule from legal challenges, experts said.

Overall, transparency around climate risk may be essential for investors to gauge if a company’s stock is worth holding or if its stock price is reasonable, experts said — for example, is it too expensive given high exposure to climate risk, or perhaps fairly priced considering it’s well positioned?

“Investors want to be able to accurately price those risks and opportunities as they look medium and longer term at their investments,” especially retirement investors who may have a timeline decades in the future, said Rachel Curley, director of policy and programs at the U.S. Sustainable Investment Forum.

Climate change is a ‘momentous risk’ to capital markets

A damaged gas station is taped off after Hurricane Idalia made landfall in Cedar Key, Florida, on Aug. 30, 2023.
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The U.S. now experiences a billion-dollar disaster every three weeks, on average; during the 1980s, that happened every four months, according to the Fifth National Climate Assessment, issued last year by the White House.

The economic toll due to factors like agricultural loss, tourism impact, falling real estate values, and property and infrastructure damage is expected to grow.

Allison Herren Lee, a former SEC commissioner who voted in favor of the SEC’s initial rule proposal in 2022 called climate change “one of the most momentous risks to face capital markets since the inception of this agency.”

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Many other nations — including Chile, China, Egypt, European Union member countries, India, New Zealand and the United Kingdom — already require climate reporting by public companies, according to the Climate Governance Initiative.

In October, California Gov. Gavin Newsom signed a law that requires large companies active in the state to give a detailed accounting of their greenhouse gas emissions, starting in 2026.

Challenges are ‘likely’

Congressional and legal challenges to the rule “are likely,” Jaret Seiberg, financial services and housing policy analyst at TD Cowen, wrote Thursday in a research note.

Last year, a group of House and Senate Republicans sent a letter to SEC Chair Gary Gensler criticizing the proposal, saying it “exceeds the [agency’s] mission, expertise, and authority.”

“Congress created the SEC to carry out the mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation — not to advance progressive climate policies,” according to its three signatories, Rep. Patrick McHenry, R-N.C., Sen. Tim Scott, R-S.C., and Rep. Bill Huizenga, R-Mich.

Carbon emissions accounting is contentious

Smoke from a coal-fired power station. 
Chris Ratcliffe/Bloomberg via Getty Images

One particularly contentious area involves the depth of greenhouse gas reporting, experts said.

The SEC proposal outlined three tiers of emissions disclosures: Scopes 1, 2 and 3.

Scope 1 emissions are direct. They’re caused by operating the things a company owns or controls: for example, by running machinery to make products, driving vehicles, or heating buildings and powering computers, according to the World Economic Forum.

Scope 2 emissions are indirect. They’re created by the production of energy that an organization buys, the WEF said. Companies can cut Scope 2 emissions by installing solar panels or using renewable energy rather than using electricity from fossil fuels, for example, it said.

Scope 3 emissions are also indirect but broader: They include emissions “up and down [a company’s] value chain,” according to Deloitte. For example, they may “be emitted by a company’s suppliers of raw material, or when a consumer uses a company’s products,” S&P Global wrote.

I think climate disclosures have largely become table stakes for the investment community.
Lindsey Stewart
director of investment stewardship research at Morningstar

The SEC proposal mandates reporting about Scopes 1 and 2 emissions.

However, companies would have some discretion to report Scope 3 emissions. They’d be required if investors would be reasonably likely to consider such information “material” or if a corporation set a carbon-reduction goal that includes Scope 3 emissions, Curley said.

For many businesses, Scope 3 emissions account for more than 70% of their carbon footprint, Deloitte estimates.

“Emissions-wise, Scope 3 is nearly always the big one,” it said.

However, Scope 3 emissions are “tougher to calculate and politically more contentious,” Seiberg wrote. He expects the final SEC rule to include Scope 1 and 2 emissions but exclude Scope 3; the latter will likely be left to a future rulemaking, he said.

U.S. companies may have to disclose such emissions according to California or international standards, experts said.

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