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Economy

It's Time for a Little Disclosure on Climate Change in the Corporate World

Much backlash and litigation is expected over the SEC's recent move. But until then, the move to establish and release the draft rules is in itself a landmark step – not just for the US, but internationally as well.

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On March 21, the United States Securities and Exchange Commission made a ground-breaking announcement. It proposed rules to enhance and standardize climate related disclosures for investors. According to their statement, this rule would “require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks…”

This means that some of the largest international corporations such as ExxonMobil and Apple would need to release data about their exposure to climate challenges such as sea level rise, and what plans if any, they have to publish information about emissions from the use of their products. This rule is still a draft, and likely to remain that way for some months. Yet, this publishing itself may be a sign of things to come. Here are three reasons why:

One, it begins to address greenwashing. According to the University of Oxford, 21% of the world’s largest public companies have declared “net zero” commitments. Only some of these have established roadmaps for how they will achieve the targets. And there is massive capital looking to finance the net zero transition. According to Bloomberg New Energy Finance, 2020 saw a record $501 billion invested in energy transition sectors and over the last five years, $2 trillion of debt has been issued in the same sector – of which $730 billion was in 2020 alone. What would the GHG basis for such capital allocation be?

Exactly what this net zero means is unknown, or at best, uneven as there is no common definition. Numerous organizations starting with the Climate Disclosure Project, a pioneer and still leader in this space since 2002, have been supporting and advocating for disclosure of emissions. The basis for all such disclosure is the Greenhouse Gas Protocol, a tool built twenty years ago which has now become the rule book for defining “scopes” of emissions.

As a reminder, scope I are emissions from direct combustion of, say, fossil fuels; scope II (indirect) are emissions from the purchase of electricity, steam, heat and cooling; and scope III are emissions from elsewhere in the value chain – such as the traveling of employees. Among the SEC’s key requirements is for companies to disclose their scopes I and II emissions, and those generated by their generators and partners, if material. In my experience, most companies are comfortable reporting emissions of scopes I and II, but become uneasy when it comes to scope III. Here’s why: take for example, a consultant flying to a client meeting. The emissions from burning aircraft fuel would constitute scope I emissions for the airline, and scope III for the producer of the jet fuel. They could also be counted as scope III by the consultant’s client. And/or her travel insurance. And/or the airport. And/or the leasing company that leases the aircraft to the airline. The list can go on and on, because scope III largely means emissions from the value chain not captured in scopes I and II. Where does the reporting end?

For some companies, scope III constitute the largest part of their footprint. For hydrocarbon companies, scope III is especially serious: 90% of Shell’s total emissions fall under scope III. For this very reason, it becomes necessary to find a way to address these emissions – the starting point of which is (managed) disclosure. Many in the international community have been working to find ways to allocate responsibility appropriately – and to that extent, this proposed rule of the SEC is a powerful step in the right direction. The SEC puts the onus on companies to determine what they believe to be “material” scope III emissions.

Two, the rule recognises that the effects of climate change present economy wide risks which need to be disclosed, just like other categories of risks that affect businesses and investments. Climate change presents physical risks such as extreme heat or drought, and non-physical or transition risks that arise from shifts in the economy as a result of transitioning to a low carbon system. Both present risks to the investor, and the only way to require the disclosure of such risks is through the regulator. There has been, and remains, a fair degree of opposition around this – centered around to what extent emissions-related data falls under the jurisdiction of market regulators such as the SEC. This opposition is international – and not limited to the US SEC.

It is, however, changing, perhaps not fast enough. For example, the Network for Greening the Financial System already comprises of 108 members – all central banks and financial supervisors – who have come together voluntarily, and for now, they share best practices for climate risk management in the financial sector.

And three, the rule begins to give investors the leverage to force changes in business practice – a movement that has resulted in the adoption of GHG reduction targets by many companies that may not have done so on their own. The SEC Chair has indeed gone on record saying the regulator is responding to demand from investors who wish to have additional information to make informed decisions on which risks to take.

The American public has sixty days to comment on the proposed. Much backlash and litigation is expected and the adoption of the rules will likely be delayed by several months. But until then, the move to establish and release the draft rules that have been in the making for long, is in itself a landmark step – not just for the US, but internationally. Climate change affects us all – it creates risks and has economic consequences. And it is up to us – and the institutions we make – to decide to recognize them or not.

Mahua Acharya, MD and CEO of state owned Convergence Energy Services Limited, a subsidiary of EESL. Views are personal.