Breaking Down the SEC Climate Proposal: A Focus on GHG Emissions Disclosures

Recent years have witnessed remarkable advancements in climate regulation, spearheaded by Europe and the UK, as they recognize the significance of companies disclosing their greenhouse gas (GHG) emissions and climate-related risks in financial reports.

In line with these global regulatory trends and in response to mounting investor pressure, the US SEC proposed new rules, in March 2022, that would mandate three categories of disclosure from U.S. public companies: a narrative discussion of their climate-related financial risks, reporting of greenhouse gas emissions, and a note in the financial statements addressing the financial impacts of climate change. The proposal is currently under consideration and expected to be finalized by the end of 2023. While the implementation timeline will be announced by the SEC at the time of its adoption of the final rules, it appears likely that larger companies will begin reporting their climate-related data in their 2024 10K filing, due in 2025.

The push for increased climate disclosure stems primarily from financial stakeholders, specifically investors, who seek transparency to inform their investment decisions. The new rules would also provide greater clarity for reporting companies.

The proposed SEC Climate Disclosure Rule emphasizes comprehensive reporting of GHG emissions, encompassing scope 1, scope 2, and, in certain cases, scope 3 emissions. These disclosures are crucial for understanding a business's exposure to climate-related financial risks and the measures to identify, assess, and manage them. In this blog post, we will explore the specific requirements for GHG emissions disclosures outlined in the SEC proposal and the steps businesses can take to prepare.

Understanding the SEC Proposed Climate Rule

The proposed disclosure requirements mark a critical step forward in the standardization of climate-related disclosures. The intent of the rule is to provide investors with the information they need about the climate-related financial risks they face in a clear and consistent manner. 

The proposed rule requires three distinct components of disclosure to be incorporated into your SEC filings:

GHG Emissions Disclosure Requirements

The proposed rule would require publicly listed companies to disclose their greenhouse gas (GHG) emissions for the most recent fiscal year and for historical years covered in their consolidated financial statements. The rule would require reporting of carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), nitrogen trifluoride (NF3), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6).

While the rule follows GHG Protocol standards for emissions reporting, it provides some flexibility that allows companies to choose their own calculation method. However, companies are required to provide details about the methodology, significant inputs, and assumptions used for their GHG emissions metrics.

The proposed rule outlines specific requirements for the manner of disclosing emissions, including reporting emissions disaggregated by each GHG gas and in the aggregate, disclosing emissions in absolute terms without considering purchased or generated offsets, and presenting GHG intensity. GHG intensity is a ratio that expresses the impact of emissions per unit of economic value, such as metric tons of CO2e per unit of total revenue or per unit of production for the fiscal year. Excluding offsets from emissions reporting allows investors to assess the full climate-related risk posed by a company's emissions.

Scope 1 and 2 Requirements

The proposed rule would require all registrants to disclose their scope 1 emissions and scope 2 emissions. They are categorized and defined as follows:

• Scope 1 GHG emissions: Direct emissions from sources that are owned or controlled by the reporting company. This includes emissions from sources like combustion of fossil fuels in company-owned vehicles and on-site industrial processes.
• Scope 2 GHG emissions: Indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant

To provide decision-useful information, it will be necessary to aggregate and disaggregate greenhouse gas emissions by each constituent gas, such as carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), and others. 

Additionally, the GHG emissions for all scopes would be required to be calculated in terms of carbon dioxide equivalent (CO2e), which is the unit of measurement used by the GHG Protocol. Scope 1 and scope 2 emissions should be calculated from all sources within the registrant's organizational and operational boundaries, as stated in the SEC Climate Disclosure Proposal. Scope 1 emissions must then be reported separately from scope 2 emissions. The data should be calculated in gross terms, excluding purchased or generated offsets from the calculation.

Lastly, the proposed rule would require the gross sum of scope 1 and 2 emissions, as well as the sum of its scope 1 and 2 emissions in terms of GHG intensity, based on revenue, production, or another relevant intensity metric. 

Accounting for Scope 3

The proposed rule would not mandate all registrants to disclose scope 3 emissions - smaller reporting companies, or SRCs, would be exempted, for example. For larger companies,  scope 3 emissions would need to be disclosed if they are deemed "material" or if the registrant has set a GHG emissions reduction target that includes scope 3 emissions. The SEC advises reporting companies to err on the side of investor protection when determining materiality of scope 3 emissions.

Scope 3 emissions, as defined in the proposed rule, encompasses all indirect GHG emissions not otherwise included in a company’s scope 2 emissions, which occur in the upstream and downstream activities of a reporting company’s value chain.

The proposed rule also identifies certain upstream and downstream activities within scope 3, consistent with the GHG Protocol:

If scope 3 emissions are disclosed, they should be disclosed separately from scope 1 and 2 emissions, but in the same manner — in absolute terms (disaggregated and aggregated) and by GHG intensity. Reporting companies would be required to identify the categories of upstream or downstream activities included in the calculation of scope 3 emissions. Registrants must disclose data separately for each category it deems significant in addition to the total emissions.

Registrants must also provide details about the data sources used to calculate scope 3 emissions, including emissions reported by third parties in their value chain (verified or unverified), data from specific activities reported by value chain parties, and data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources, including industry averages of emissions, activities, or economic data.

Given the complex nature of scope 3 emissions measurement and the scrutiny of controls over 10-K filings, it is advisable for organizations to manage all climate-related data in a secure IT-controlled system. This ensures greater integrity, accuracy, and traceability of climate-related information.

Assurance of GHG Emissions

The proposed rule outlines the requirements for GHG emissions attestation. The scope 1 and scope 2 GHG emission disclosures will go through a phase-in period with limited assurance, followed by reasonable assurance. If a registrant voluntarily seeks assurance for scope 3 emissions, it will be subject to the same standards and requirements as scope 1 and scope 2 disclosures. Although specific attestation standards are not prescribed, certain minimum requirements must be met, including using standards that are publicly available, establishing them with due process, and allowing public comment.

The third-party assurance provider must be an expert in GHG emissions and conduct engagements in accordance with professional standards. They must also maintain independence from the registrant. The GHG attestation report will include details about the specific standard used, management's responsibility for the information, and the attestation provider's responsibility. Additionally, the registrant must disclose information about the attestation provider's licensure or accreditation, record-keeping obligations, and whether the attestation engagement is subject to an oversight inspection program.

The controls that companies apply to their climate data will help ensure that companies are applying the same level of rigor to  their emissions data as they do with their financial data. It demonstrates a commitment to transparency and accountability in disclosing accurate GHG emissions data and strengthens stakeholders' confidence in the reported information.

SEC Climate Disclosure Timeline

According to the proposed rule, the initial companies that would have to submit reports (specifically, the largest companies) were slated to begin doing so in 2024, reporting on 2023 data. This timeline was established based on the assumption that the rules would be officially adopted in 2022. However, since the rules weren't adopted in 2022 as expected, it's reasonable to assume that they won't come into effect until at least 2025, with the data reporting being based on 2024 numbers.

The plan is to implement a phased approach, as outlined in the proposal. This means that larger companies would be required to submit their reports first, while smaller companies would be given more time to prepare before they are obligated to comply with the reporting requirements.

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Preparing for the SEC Climate Disclosure Rule

The SEC's proposal heralds a new era of GHG emissions disclosures, prompting companies to take swift action. To ensure compliance with these emerging regulations, companies should focus their efforts on developing investor-grade reporting. This entails establishing effective controls over their climate data and bolstering their capacity to collect, manage, and report accurate GHG emissions data.

Develop a GHG Accounting Methodology 

Businesses are developing robust methodologies to meet the requirements. Here are key steps to ensure accurate and transparent reporting:

• Develop a repeatable and transparent data collection process: Companies need to establish a data collection process that is both transparent and repeatable, enabling accurate measurements and facilitating third-party verification. Documentation of the data collection process is essential to comply with the SEC proposal's disclosure requirements.
• Organize and control GHG emissions calculations rigorously: Employing the same rigor and technology infrastructure used in revenue and expense accounting, companies should treat GHG emissions calculations as a core function. Leveraging carbon accounting software that presents GHG emission calculations in an activity ledger gives companies confidence in the data they are reporting, and streamlines the auditing process. Auditors can review each activity line item and associated calculations, minimizing manual errors and ensuring data integrity. Just as financial accounting teams rely on financial enterprise resource planning (ERP) systems for revenue and expense accounting, carbon ERP systems automate activity data submission and calculations, enhancing efficiency and accuracy.
• Integrate GHG emissions into broader investor disclosures: To ensure consistency in both internal and external reporting, it is crucial to integrate GHG emissions data into the broader investor disclosure process. By incorporating GHG calculations and verifiable data, companies can build robust disclosure management processes and seamlessly integrate these metrics into their annual disclosures. Managing GHG emissions data within an IT-controlled environment allows for seamless integration with other environmental, social, and governance (ESG) disclosures and mandatory SEC reports like 10-K filings.

The Need For Internal Controls 

Under the SEC proposal, the inclusion of GHG emissions data in your 10-K filing brings a crucial need for robust internal controls. CEOs and CFOs must review the company's disclosure controls and procedures for preparing GHG reports. This requires organizations to approach GHG reporting with the same discipline applied to other aspects of their Form 10-K. Documenting the process of creating disclosures and assigning ownership of specific tasks is essential to mitigate risks, commonly referred to as "building controls." Just as audit and risk teams implement controls around revenue and expense numbers, the same practice should be applied to GHG accounting to ensure compliance and build traceability.

Investor-grade reporting empowers the automation of high-risk processes through accurate data collection, end-to-end transparency, and traceability. We recommend utilizing the same controlled environment employed for financial reporting to minimize risks and ensure auditability. This approach proves invaluable when undergoing third-party verification, facing investor scrutiny, or regulatory review. By utilizing carbon accounting software within a controlled IT environment, businesses can input source data, perform emissions calculations, and significantly reduce the risk of manual errors while maintaining an audit trail of every data point. 

How Persefoni Helps Businesses Prepare for the SEC Climate Disclosure Rule

Using carbon accounting software can be an efficient and reliable way to meet the GHG emissions requirements of the SEC's climate disclosure proposal. It reduces the cost and complexity of emissions calculations and ensures accurate reporting. In addition, software provides the reliability necessary to support the full spectrum of assurance needs.

Persefoni was specifically designed to help organizations solve anticipated regulatory requirements:

• Complete control over your data: All GHG measurements can be traced back to the calculation and source data used to determine the CO2e accounted for.
• Data accuracy: Calculations through the Persefoni platform are tied to appropriate emission factors, eliminating manual errors, and are verified by a controlled system with a SOC 1 attestation.
• Transparent disclosures: Calculations can be readily reviewed and validated by a third party. This transparency enhances the credibility and reliability of your GHG emissions disclosures.
  

By simplifying the process of calculating GHG emissions, Persefoni enables organizations to allocate more time and resources to address their business needs and effectively mitigate climate risks. Contact us today to learn more about how Persefoni can assist you in meeting the GHG emissions disclosure requirements of the SEC Proposed Climate Rule.