The U.S. Securities and Exchange Commission (SEC) plans to issue final rules requiring publicly traded companies to disclose climate-related information, including an accounting of greenhouse gas (GHG) emissions and the risks climate change poses to their businesses. These new requirements are intended to provide investors with more consistent, comparable, and reliable information about how climate-related matters impact a company’s business and financial results over time.
The new rules will represent a sea change in climate reporting obligations. Some companies are more prepared than others for these changes. But, nearly all companies will need to understand how the rules will impact them and make changes to their climate policies and disclosure policies. Ultimately, these rules can help companies prepare for future climate risks in the same way they prepare for other financial risks.
What’s in the new rules?
The new rules will likely have two key components for public companies.
- GHG emissions: The rules may require public companies to disclose information about their direct GHG emissions (scope 1), indirect GHG emissions from purchased electricity and steam (scope 2), and, for many public companies, other indirect GHG emissions (scope 3)—including those within their value chain.
- Climate-related risks: The rules may require public companies to disclose information about their governance and management of climate-related risks and opportunities. For example, how would a company protect their buildings from the increased heat and flooding expected because of climate change? The rules may also require that companies disclose in financial statements the impact those risks and opportunities could have on their business.
How can companies prepare?
The new rules will significantly change the way many companies currently manage and report climate-related information. Here are five steps companies can take now, so they can hit the ground running when the rules are finalized and eventually go into effect.
1. Identify key leaders
It sounds basic, but an often-overlooked step is to identify who within the company needs to play a key role in tracking progress and ensuring accountability for this new set of mandated climate disclosures. Someone at a very high level—close to the C-suite, ideally—should be responsible for directing progress.
There also needs to be an entire reporting chain that goes down into the appropriate divisions. All companies are different, but reporting lines generally should include legal, investor relations, enterprise risk management, information technology, supply chain management, and operations in addition to the sustainability office.
2. Build bridges
In many companies, it’s likely that the sustainability team has had little or no regular connection with the finance department. That needs to change. Now that key sustainability measures are subject to public and financial disclosure, it’s important to build bridges between those two departments.
A chief sustainability officer, sustainability director, or other staff with responsibilities for the company’s climate change response should be talking regularly to the chief financial officer and their office. These necessary conversations may include how to integrate GHG emissions into the company’s financial disclosure statements, how to calculate GHG intensity measures that factor in revenue, and the costs of implementing measures to reduce emissions. In more general terms, the company needs to understand the financial risk that lowering its GHG emissions poses as well as the potential business opportunities created by transitioning to a low-carbon future.
Prosaic matters are important, too. Find out what format the CFO’s office needs the climate information to be in and make sure you provide it correctly.
3. Prepare a GHG emissions inventory
If a company isn’t currently calculating its GHG emissions, it should plan to start doing so as soon as possible. If a company has prepared a GHG emission inventory, it’s time to make sure that the inventory is fit for the purposes of disclosure. The SEC’s final rule might change the breadth of emission sources that are included within a company’s GHG inventory, the methods used to account for emissions, and the level of detail needed to document the inventory approach.
For example, many companies have historically selectively included scope 3 emission sources based on factors such as available data. Moving forward, companies may have to include scope 3 sources if they are deemed material or if they have set a scope 3 goal. Companies that have largely approximated emissions using average data—such as average building energy use or fleet vehicle miles traveled—will want to begin incorporating actual consumption values from utility bills and fuel purchases.
It’s important to remember that the GHG emissions inventory may be auditable moving forward, meaning the inventory would need to be reviewed or verified by a third party. As a result, companies need to step up in terms of the stringency of documentation as to where the data is coming from and what emission factors are being used to create the inventory.
4. Recognize risks
The risks from climate change can take numerous forms, including physical risks. If a company has ever had disruptions due to severe weather—flooding of facilities, employees unable to access the office due to storms, etc.—then they are likely to have at least some vulnerability to physical risks from the changing climate.
The SEC defines transition risks as having actual or potential negative impacts on a company's consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks. Another way to think about it is the risks associated with being part of a society that's transitioning to a low-carbon future. An example of transition risk is a fossil fuel company left with stranded assets (e.g., refineries) as it transitions to renewable energy. Each company will need to determine its exposure in these situations.
At its most basic, material transition risks will have to be reported under the new SEC rule. Where it gets complicated is how the SEC rule defines “materiality,” which generally refers to how each identified climate-related risk has had or is likely to have an impact on the business and consolidated financial statements. Disclosure may be required if the price of any risk is at least 1% of the cost of the associated line item. That percentage may get amended to a less stringent requirement, but regardless there is likely to be a threshold for required reporting on transition risks.
5. Take the long view, and the broad view
It’s important to focus on creating deep roots around climate disclosure that sets the stage for future success. This includes engaging the necessary internal stakeholders and leadership around a sustained process versus trying to figure out how to just follow the letter of the law.
Climate change necessitates a sustained and concerted response. Companies need to be thinking about the multi-decade long view rather than what to report this quarter. Part of that relates to establishing a learning process and recognizing that the company is going to get better at understanding and addressing climate risks as time goes by.
Taking the broad view acknowledges that companies have limited resources. Therefore, it might make sense to start by creating a high-level overview across the entire company versus a deep dive in a particular line of business. What are the biggest issues that need to be addressed? Figure out where it will matter the most to understand climate risks and start there.
The broad view also includes recognizing climate-related opportunities where they exist. Depending on the business, new areas of growth in different sectors, technologies, or regions of the world may be possible. For example, we forecast double-digit percentage declines in the cost of clean energy across a range of technologies. A company that discloses that its energy costs will decline may become more attractive to investors.
The most important insight we have is not to treat climate-related disclosures like a book that must be written but then merely sits on a shelf. It’s an essential resource that describes a company's impact on the environment and the environment’s impact on a company. It looks at fundamental risks to your business and identifies areas of concern. Understanding and acting on that risk analysis is what will allow your company to comply with the SEC’s new rules while also making the business more resilient, less vulnerable, and part of the climate change solution.