Katherine O’Malley
Associate Editor
Loyola University Chicago School of Law, JD 2025
With every wildfire, catastrophic storm, and record-breaking heat, climate change is at our front doors. But what can help mitigate some of these effects? Regulations. Holding big polluters responsible for their carbon emissions is a crucial way to mitigate the effects of carbon emissions. Although many big companies voluntarily disclose some of their climate data, the pressure can come from investors, not the government. In an effort to enhance and standardize public companies’ climate data, the Securities and Exchange Commission (SEC) proposed a controversial Climate-Disclosure Rule in April 2022.
Corporate world emissions: Scope 1, 2, 3
The SEC’s proposed rule requires reporting companies to disclose risks that are “reasonably likely to have a material impact on its business or consolidated financial statements, and GHG [greenhouse gas] emissions metrics that could help investors assess those risks.” Furthermore, the proposed rule incorporates the GHG Protocol’s concept of “scopes” of emission to define the type of emissions companies need to report on. Scope 1 emissions are direct GHG emissions from sources owned or controlled by the company, whereas Scope 2 emissions are indirect emissions from purchased electricity. Scope 3 emissions are upstream and downstream activities within a company’s supply chain. For example, the production of a company’s raw materials and the use and disposal of its products are all considered Scope 3 emissions.
The inclusion of Scope 3 emissions is the most contentious aspect of the proposal for many reasons. For starters, calculating emissions from upstream and downstream activities is an extremely complex and challenging task that relies on approximations. Furthermore, Scope 3 emission reporting requires each company in the value chain to estimate their total emissions from the same activity, generating data duplications. Approximations and duplications coupled with the complexities of reporting this type of emissions lead to a high risk of measurement error. When this rule aims to enhance accuracy and standardization, relying on approximation for Scope 3 seems counterproductive. Yet, simply ignoring Scope 3 emissions because they are costly and hard to measure cannot be the solution. These emissions account for the largest source of greenhouse gas emissions. Investors care about ESG reporting, so regulating these major contributions to greenhouse gases could significantly influence businesses to lower their emissions.
Due to the expensive burden of reporting Scope 3 emissions, the proposed rule contemplates allowing certain companies to be exempt from disclosing Scope 3 emissions. Companies with “greater revenue and/or public float” may be better positioned to report on Scope 3 emissions compared to smaller/newer companies.
Reactions to the SEC’s involvement
This proposed rule received a record-breaking 15,000 public comments. Critics of the rule state that the SEC is overreaching their domain and that the SEC should allow market-driven voluntary disclosures to occur instead of enforcing strict disclosure rules that could disrupt the market. Hester Peirce, an SEC commissioner, stated in contention with the proposed rule, “[w]e are not the Securities and Environment Commission.” The head of the SEC, Gary Gensler, noted, “[t]he SEC has no role as to climate risk itself. But we do have an important role in helping to ensure that public companies make full, fair, and truthful disclosure about the material risks they face.”
Critics claim the costs associated with this type of extensive reporting on climate data are enormous. For example, executives estimate that the new SEC proposed rule would cost at least $750,000 in compliance in its first year.
Big investors call for the importance of standardization because decoding the current voluntary disclosures to compare between companies is difficult and time-consuming. Proponents claim that the standardization will actually save investors money.
Public or private companies? California does not discriminate
The SEC’s proposed rule only affects public companies. Meanwhile, California plans to pass a bill requiring Scope 3 disclosures by any public or private business that operates within the state and generates more than $1 billion in revenue. Gavin Newsom, governor of California, has until October 14th 2023 to either sign or veto the bill; if he does not act, the bill will automatically become law.
With every week comes another extreme weather event. Even if these events could be the new normal, any effort towards lessening the effects of climate change should be pursued. When companies push back on expensive regulations, we must take a step back and realize why we need such expansive regulatory efforts.