Janet Ranganathan, Executive Vice President of Strategy, Learning and Results at the World Resources Institute, breaks down the US SEC’s draft climate disclosure rule.
In March 2022, the US Securities and Exchange Commission (SEC) unveiled a draft rule requiring publicly traded companies to disclose climate-related risks and greenhouse gas (GHG) emissions. If fully implemented, the rule would help investors and companies better manage growing financial risks and liabilities linked to their GHG emissions.
The draft rule is based on the globally accepted framework of the Task Force on Climate-related Financial Disclosures (TCFD). It follows an extensive request for information during which 70% of investors called for TCFD-based disclosure, including its recommendation to use Greenhouse Gas Protocol standards for disclosing corporate GHG emissions. The draft rule addresses climate financial risks already in the marketplace, and those that are rapidly emerging.
Discussion around the draft rule has led to some confusion about key elements of climate disclosure and GHG accounting. As Co-Founder of the Greenhouse Gas Protocol, the world’s leading GHG accounting standard for companies, I am debunking several myths around GHG accounting and the draft rule.
Myth 1: Climate change isn’t a financial risk
Climate change is a financial risk. This includes risks stemming from the transition to a low carbon economy. Commitments made by over 200 countries at the 2015 Paris Climate Agreement have led to the implementation of 2,570 climate laws and policies. For example, 45 national jurisdictions and 34 subnational jurisdictions have carbon pricing initiatives in effect or under consideration, and 16 US states have 100% renewable energy targets. By the start of 2022, over 80 countries representing nearly 75% of global emissions had made public commitments to achieve net-zero emissions. These policies are necessary, yet they can also create transition-related financial risks for companies.
The SEC, along with other financial regulators – such as the Financial Stability Oversight Council and CFTC Subcommittee – identified climate change as a financial risk, endorsed the TCFD framework, and acknowledged the importance of GHG management.
Climate regulation isn’t the only factor influencing financial risk. Advances in technology have driven down costs of low-carbon technology, such as renewable energy and electric vehicles, creating competitive risk to non-adopters. Companies are voluntarily setting GHG targets and asking their suppliers to reduce their own GHGs, adding product environmental labels, and demanding low-carbon products.
The SEC rule is a positive step for both companies and investors because it gives them a more complete picture of the financial risks they face.
Myth 2: No standards governing corporate GHG accounting and disclosure
The widely used GHG Protocol Corporate Accounting and Reporting Standard has existed for more than two decades. The GHG Protocol provides a family of greenhouse gas accounting and reporting standards that began with the ground-breaking Corporate Standard, launched in 2001. The standards are developed through multi-stakeholder partnerships of businesses, NGOs, governments and others, convened by WRI and the World Business Council for Sustainable Development. Over 90% of Fortune 500 companies report to CDP using GHG Protocol. The GHG Protocol standards provide the rigour and consistency needed to underpin a mandatory disclosure rule.
Myth 3: Scope 3 disclosures are too new to include in the SEC rule
The draft SEC rule would require disclosure of Scope 3 emissions in certain circumstances. Scope 3 disclosures are not new – they have been around for more than 20 years.
The GHG Protocol Corporate Standard defines Scope 1 (direct GHGs from sources owned or controlled by the reporting company), Scope 2 (indirect GHGs caused by the consumption of purchased electricity), and Scope 3 (other indirect GHGs, including those related to goods bought and sold by a company that occur at sources in the company’s value chain).
Scope 3 was introduced in 2001 in the first edition of the GHG Protocol Corporate Standard. GHG Protocol subsequently published a Corporate Value Chain (Scope 3) Accounting and Reporting Standard (Scope 3 Standard) to ensure completeness and consistency in the way companies account for and report on emissions from their value chain activities.
Myth 4: Few companies report Scope 3 emissions
Scope 3 emissions reporting has become commonplace. In 2020 around 40% of S&P 500 companies reported Scope 3 emissions. In addition, over 1,400 companies have approved science-based targets and submitted a full Scope 3 inventory for validation.
Other Scope 3 adopters include CDP, the Climate Registry, and the International Standards Organisation’s ISO 14064-1. The International Accounting Standards Board is expected to issue standards by the end of the year. China is testing mandatory disclosure. The UK is phasing in TCFD-style mandatory disclosure over the next three years. And the EU is working out its environment taxonomy. Corporate GHG reporting, including Scope 3, will likely be a requirement in all these initiatives.
Even oil and gas companies, like Shell, Total and Equinor, report their Scope 3 emissions, which comprise the majority of their GHG emissions (from the combustion of their products by customers).
Myth 5: Scope 3 emissions are irrelevant to financial risk
Scope 3 emissions are relevant to climate-related financial risk. They represent the majority of GHG emissions for most companies. CDP estimated that Scope 3 emissions account for three-quarters of a company’s emissions on average. Scope 3 emissions vary considerably by sector and can approach 100% of a company’s emissions (Scope 3 emissions were near 100% on average for companies in the financial services sector).
Disclosing Scope 3 emissions enables investors to gain a complete picture of a company’s GHG-related risks.
Mandates to replace internal combustion engines with electric vehicles, for example, pose significant risks to automotive manufacturers, oil and gas distributors, and refiners. Managing Scope 3 emissions is an opportunity for a company to reduce risks, innovate and gain competitive advantage.
“Supply chain GHG management can play a critical role in combatting a company’s climate transition risks,” said Matthew Banks, Associate Director of Guidehouse’s Energy, Sustainability, and Infrastructure segment.
A company that understands its supply chain GHGs is well placed to manage other supply chain financial risks. It’s no surprise that private companies such as Mars and IKEA have voluntarily set GHG reduction targets that include Scope 3 emissions. They recognise the need to proactively manage climate risks and are discovering opportunities to innovate in the process.
Myth 6: Double counting undermines the value of Scope 3 disclosures
The GHG Protocol standard addresses double counting. The way GHG Protocol has defined Scope 1, 2, and 3 ensures that they are mutually exclusive categories for the reporting company, so there can be no double counting of emissions within one company’s inventory.
Myth 7: Indirect GHG emissions are outside a company’s control
The assumption that indirect GHGs (Scope 2 and 3) cannot be influenced is incorrect. Companies can and do influence their indirect GHGs. Food manufacturers can reduce their supply chain GHGs by reformulating their products and shifting away from land- and GHG-intensive ingredients. Automotive and electrical appliance manufacturers can reduce their products’ GHG emissions by redesigning them to be more energy efficient.
Many financial risks and opportunities are outside of a company’s direct control – changing or challenging political climates, commodity pricing, or changing consumer preferences – but companies still share these with investors, because they are important. Financial statements, for example, include estimates of whether a firm’s debtors will pay their bills, which are outside a company’s control, yet still reported and audited.
The financial risks from GHG emissions do not end at a company “gate”. The SEC is right to include Scope 2 and 3 emissions in its disclosure rule.
Myth 8: Reporting Scope 3 is too difficult without primary data
Claims that companies aren’t reporting their Scope 3 emissions because it’s too difficult to collect data are misplaced.
Companies can use primary or secondary data sources when reporting Scope 3. Primary data originates from measures of specific activities within a company’s value chain, such as a supplier’s electricity consumption from producing materials for the reporting company. When primary data is not available, companies can use secondary data from other sources, such as published databases, government statistics, literature studies, and industry associations.
Companies often start with secondary data to compile a complete but less accurate inventory and move toward improved data quality over time, prioritising their most material emission sources.
T. Rowe Price noted in its 2020 Annual ESG report that nearly 75% of the 11,000 companies it tracks have estimated (secondary) data, noting that, “while relying on estimated data can sound disconcerting to some investors, it has utility because it helps us understand the order of magnitude of carbon emissions for our portfolios versus their benchmarks”.
The SEC’s existing procedures for addressing assumptions and uncertainties can inform GHG emissions accounting challenges. Primary data will be needed to track progress over time.
The proposed SEC climate disclosure rule can help improve the quality and availability of GHG data by increasing the number of companies reporting and the consistency and quality of data reported.
The SEC climate disclosure rule is an essential step to protect the interests of investors against GHG-related financial risk. But it’s not just investors – it will help companies better manage risks, too. By requiring GHG disclosures, the SEC rule will help companies manage and reduce GHG-related risks already on their books and prepare for new risks coming their way as the world rapidly decarbonises.
This article was originally published here on WRI.org.