California Takes Heat Off SEC

As the Golden State passes ground-breaking climate disclosure laws, all eyes are on the SEC’s next move amid fierce Republican pushback to its forthcoming rules.  

Democrat Senator Scott Wiener likens California’s legislature to the videogame Mortal Kombat when describing the pressurised environment in which he successfully steered one of two landmark climate disclosure bills in September. 

“The opposition was like a misinformation propaganda machine. We were having to combat that with accurate information about what carbon disclosures are, why they’re important and why we need to move in that direction,” Wiener says, speaking on a 26 September webinar held by carbon accounting firm Persefoni.  

A strong target of attack in Wiener’s Greenhouse Gases: Climate-Related Financial Risk Act (SB 253) is its mandatory requirement of Scope 3 reporting – greenhouse gas (GHG) emissions linked to a company, but outside its operations, such as its customers or supply chain.  

The move is significant, given that Scope 3 is currently heavily underreported by companies, but almost always represents their largest source of GHG emissions. It’s also notoriously difficult to quantify, given the reliance on data outside a company’s control and the current lack of expertise on how to calculate Scope 3 robustly – a situation ripe for political pushback during SB 253’s passage through California’s Assembly in the era of anti-ESG.  

Wiener notes how members of California’s Assembly claimed to calculate Scope 3, a supermarket like US’ Target, which sells grills, would have to call the grill manufacturer and get a list of everyone who bought it from their stores, call them up, and find out how often they’re using the grill. “They were literally saying stuff like that to members,” he explains.  

To ease tensions, Weiner noted that when refining the SB 253, he and colleagues were careful to provide a degree of “flexibility” to Scope 3 reporting to ease implementation, with companies able to rely on secondary data, including the use of industry average, proxy, and other generic data. 

Reporting on Scope 3 under SB 253 will also be delayed until 2027, giving companies one extra year to prepare when the law comes into effect in 2026, whereby reporting on Scope 1 and 2 will be required.  

The new law applies to any corporation both publicly traded and privately held that does business in California with gross annual revenues of US$1 billion+, with approximately 5,500 companies falling under its scope. 

The inclusion of private companies under SB 253 is hugely significant, and a first in the US, as is the mandating of the Task Force on Climate-Related Financial Disclosures (TCFD) reporting under its sister law the Climate Corporate Data Accountability Act (SB 261).  

But the largest impact of the new laws in California is the knock-on effect it will have on the US Securities and Exchange Commission’s (SEC) highly anticipated climate disclosure rules, which are expected to land this month after several delays. 

Follow the pack 

During a house oversight hearing last month, SEC Chair Gary Gensler noted the potential for California’s climate disclosure laws to support the agency’s efforts to introduce similar rules, which face stiff opposition from industry lobby groups.  

Kristina Wyatt, who served as a Senior Counsel for Climate and ESG to the SEC until last year, says while the agency has its own mandate and processes “it would be foolish to ignore the reality of the situation”.  

“When [the SEC] proposed the climate rule it was not clear that GHG emissions would become mandatory reporting items around the world,” says Wyatt, noting that with the passage of the EU’s Corporate Sustainability Reporting Directive (CSRD), the International Sustainability Standards Board’s (ISSB) inaugural sustainability standards and the California’s adoption of SB 253 – “the dye has been cast”.  

According to Wyatt, who now acts as Senior Counsel at Persefoni, new mandatory climate disclosure rules are “essentially consistent” in requiring Scope 3 reporting through the Greenhouse Gas Protocol, the standard-setter for measuring and managing GHG emissions.“ It would be hard for the SEC to not be criticised as a laggard if it is an outlier and doesn’t follow suit.” 

SEC under attack 

Further, the passage of SB 253, says Wyatt, “changes the baseline” which will help the SEC when it does a required cost/benefit analysis of its climate disclosure rule. The SEC rule will be less costly because companies operating in California will be required to do similar disclosure. It will make the rule more “defensible when it’s challenged in court,” says Wyatt.   

The SEC is expected to face legal challenges to its climate disclosure rule, in a country where climate change denial is rife and a concerted anti-ESG effort is underway. Wyatt, however, suggests this will make little difference to the impact of the rule on companies.  

“Litigation is just a part of doing business with the SEC,” she explains, noting that the regulator has control over whether the rules are stayed pending litigation, with the agency unlikely to stay the rule.  

“Frankly, companies are going to be reporting in California, in Europe, in the rest of the world,” she says. “As a functional matter, it doesn’t make a huge difference. Companies are still going to be getting ready [to report] pending the resolution of litigation.”  

Another former SEC employee, Thomas Gorman, who served as a Senior Counsel in the Division of Enforcement, expects the agency to face up to four years of litigation once the climate disclosure rule is passed.  

“It’s a big step for the SEC, and personally I think that it is well within their legislative authority,” says Gorman. “They’ll try to get the rule in the best shape they can to withstand the challenges, but then they’re going to wind up in the courts.” 

The backlash in the US has been building since2019, according to NGO Influence Map, who highlighted in a briefing note that policy priorities outlined by US House Republicans in their July 2023 “anti-ESG” month include stopping the SEC’s climate disclosure rulemaking.  

Its briefing note also lists the industry associations that are lining up against the SEC, including the US Chamber of Commerce which asserts that the agency’s climate disclosure rule violates the First Amendment; the National Association of Manufacturers that argues the incoming rule represents “regulatory overreach”; while the American Petroleum Institute is calling for the regulator to reconsider its “overly burdensome and ineffective” climate disclosure proposal.  

Major members of these industry associations include tech giant Microsoft, who publicly supported the California climate disclosure bills, alongside the likes of Apple, Ikea and Salesforce.  

A figure well-versed in the types of legal and political attacks the SEC will face is California’s former Insurance Commissioner Dave Jones.  

During his tenure he introduced a requirement for insurance companies operating in the state to report on their oil, gas, coal and utility exposure. The move, in 2017, was the first example of this type of climate-risk related disclosure in the US, and globally.  

Jones tells ESG Investor he made the move as he was “concerned as a financial regulator about the transition risks that insurers and investors faced”.  

He faced stiff opposition from 12 Republican-led state Attorney Generals who sent him a letter threatening legal action for harming their state’s interests.  

Jones wrote back explaining the legal basis for the request and why it would be financial regulatory malpractice to not ask questions of insurer’s fossil fuel exposure, during a transition, due to climate change, away from the industry.  

“They never sued,” Jones says.  

“Sadly, the same phenomenon has occurred more recently, where Republican state attorney generals are injecting politics into risk consideration by investment managers, asset owners and financial institutions.”  

California is yet to face a lawsuit against its climate disclosure rules – but many expect it to given the current political climate.  

Jones, who is now Director at the Climate Risk Initiative at the UC Berkeley School of Law, drafted the first version of SB 261, that mandates TCFD reporting in California, with the UN Principles for Responsible Investment (PRI). Like SB 253 public and private companies fall within its scope, but the financial threshold of SB 261 of US$500 million+ in revenue is lower than that required of SB 253.  

Scope 3 complexity  

Experts who ESG Investor spoke with all stress the importance of Scope 3 reporting in California’s new laws.  

John Marchisin, Managing Director at consultancy firm AArete, says while being a company’s largest and most complex area of GHG emissions reporting, there’s “no science or guidance” towards measuring Scope 3.  

“It literally changes year to year,” he says. “There are multi-billion dollar resource rich global organisations that are just starting to try and understand their Scope 3 emissions. But when you don’t have a ruling or compliance requirements, you can do things at your own pace.”  

SB 253 should turbo charge activity, but Michael Littenberg, Partner at Ropes & Gray, notes the availability of timely Scope 3 data, despite flexibility within the law, remains a question mark.  

Organisations are currently trying to solve this through “brute force”, according to Marchisin. 

“The problem is the standards change every year,” he says, noting that last year there were 130 reporting calculation categories, with that number growing to 260 this year and expected to expand in 2024 as the methodology and accepted standards keep getting more refined.  

“That’s going to require not only calculating this year, but going back and recalculating previous years so we can have an accurate baseline that we’re measuring against.”  

But despite the difficulty of Scope 3 reporting, its critical to shareholders to understand the true climate-related risk of a company across its value chain, says to Danielle Fugere, President of US-based investor network As You Sow.  

“That information is relevant to investors, to know the quantity of emissions and whether year-on-year those emissions are declining,” Fugure tells ESG Investor.  

.“Over time, an investor can see whether companies are being responsive to climate change, or if there is a significant part of their emissions that they are not addressing.” 

Scope 3 reporting requirements under SB 253 should also make it harder for public companies to secretly spin off “dirty assets” to a connected private entity, as it would still have to report on this as part of its supply chain, says Jones.  

And of course, many private companies will fall under the scope of SB 253 and SB 261 – a move that goes further than the SEC’s climate disclosure rule and should change the conversation around private companies avoiding initial public offerings (IPOs) to avoid the regulatory burden, according to Marchisin.  

“It’s hard to overstate how important [the passage of SB 253 and SB 261] this is, particularly in an environment like ours, where climate change has become so politicised,” says Jones. “We’re in effect setting a national standard at a time when we’re still waiting for our US federal regulators to move ahead. California is big enough and impactful enough to continue to drive for progress in the US.”  

The next step for California, the world’s fifth-largest economy, is for its Governor Gavin Newsom to sign SB 253 and SB 261 into law – a move he confirmed at New York Climate Week in September.  

Continued pressure on climate is expected out of California, which is suing oil majors for climate deception. The lesser reported on proposed SB 252 bill which would require California’s major public pension plans California Public Employees’ Retirement System (CalPERS) and California State Teachers’ Retirement System (CalSTRS) to divest investments from the fossil fuel industry will be tabled again in 2024 after failing this year.  

Senator Wiener has suggested he’s not done after the success of SB 253 expressing his delight that California is again “taking the leadership mantle on climate”. 

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