Climate change disclosures

Climate change disclosures

June 23, 2022 | By Keith Martin in Washington, DC

Climate change disclosures that the US Securities and Exchange Commission is proposing to require of public companies could have two indirect effects on power companies.

They could increase demand for corporate power purchase agreements with physical delivery of renewable electricity.

They could also lead corporations to require power suppliers to quantify seven types of greenhouse gases emitted to generate the electricity.

The SEC proposed extensive new climate disclosures in late March that US and foreign companies that raise equity or debt in the US capital markets will have to make in annual reports and capital-raise registration statements in the future. The agency hopes to reissue them in final form by year end.

They do not apply to private companies whose only capital raises are Rule 144A or similar debt that does not require filing SEC registration statements.

The new disclosure requirements will phase in over a four-year period. Assuming the SEC gets the final regulations out as hoped by December 2022, very large companies will be required to start disclosing information on their 2023 annual reports filed in 2024..

Smaller companies whose publicly-traded shares have a market value of less than $250 million or that have annual revenues of less than $100 million and either no publicly-traded shares or publicly-traded shares worth less than $700 million will have until 2026 to start disclosing the information. The first disclosures will be required in their 2025 annual reports.

Disclosures by other companies will start with 2024 annual reports.

Some of the more difficult greenhouse gas reporting — disclosure of so-called scope 3 emissions — by each category of company will take effect a year later.

Companies will be required to make detailed disclosures of not only their own greenhouse gas emissions, but also emissions associated with the electricity, steam, cooling and heating they purchase and, in some cases, for their full value chains.

Large public companies are adding multiple full-time positions to their finance staffs to work on climate change disclosures.

Many companies already make voluntary disclosures of emissions and reduction targets. Public companies are also already required to disclose material information to investors. However, the SEC said it is looking for “robust and company-specific disclosure” rather than boilerplate discussions about climate risks without any real analysis of the potential effects on their businesses.

The SEC wants a long list of future disclosures.

It wants companies to disclose how the board oversees climate risks, which management positions and board committees are responsible for identifying and managing risks, and how they do so.

Companies will be required to disclose all climate risks that have had or are likely to have a material effect on the business or financial statements. Risks are to be broken into short-, medium- and long-term risks, with the time periods of the company’s own choosing. The disclosure must be accompanied by an analysis of how the risks have affected or are likely to affect the company’s strategy, business model and outlook. Companies will be expected also to disclose what they are doing to mitigate the potential effects.

The risks fall into two categories: “climate-related events,” meaning extreme weather, changing weather patterns and natural conditions that pose physical risks, and “transition activities,” meaning risks tied to a change in the economy or business climate, such as the risk of new climate-related regulations, litigation, changing consumer tastes and investor preferences, reputational issues, demands from business partners or lenders, and long-term shifts in market prices. Physical risks need to identify affected locations and be divided between acute and chronic. The SEC wants to know the potential to affect particular line items in the financial statements.

It also wants to know the role that RECs and carbon offsets play for the company.

If the company has committed to a carbon reduction goal, the SEC wants it to report annually on progress.

It wants to know any carbon price that the company uses for internal planning, why the company selected the price and how the company expects the carbon price to change over time.

Companies are also free to disclose any climate-related opportunities to leaven what could otherwise be grim reading for investors. This could include cost savings from moving to renewable energy and opportunities to develop new products or services or to move into new markets related to the transition to a lower-carbon economy.

The SEC made this part optional to avoid forcing companies to disclose business opportunities.

Companies will have to disclose two, and possibly three, categories of greenhouse gas emissions. The SEC said such emissions could eventually affect a company’s access to financing and its ability to reduce its carbon footprint enough to comply with future regulatory, policy and market constraints.

The SEC wants both aggregate emissions and the emissions broken down into carbon dioxide equivalents for seven types of greenhouse gases: carbon dioxide, methane, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride.

It wants them expressed as emissions per unit of product or revenue to make it easier to make comparisons across companies.

Scope 1 emissions are direct emissions from operations that are owned or controlled by the company.

Scope 2 emissions are emissions from generating the electricity, steam, heat and cooling that the company purchases for use in its operations.

Scope 3 are indirect emissions from the upstream and downstream value chain of the company. Upstream means emissions from goods and services the company buys, transportation of such goods and employee travel and commuting. Downstream means emissions from use of company products, transportation of company products to market, disposal of the products after use and investments by the company in other companies.

Scope 3 emissions would have to be disclosed only if they are material or if the company has set a greenhouse gas emissions reduction goal that includes scope 3 emissions. However, smaller companies would be exempted from scope 3 disclosure.

Scope 3 emissions are material if a reasonable investor would consider the information important when deciding whether to invest. The SEC said some companies treat scope 3 emissions as material if they are at least X% of total emissions. For example, Uber Technologies uses 40%, the SEC said. However, it said scope 3 emissions could be material even if they are small where they are a significant risk to the business model; for example where there is a material risk of regulatory action to require curtailment of such emissions. Scope 3 emissions account for 75% of electric utility emissions, according to IHS Markit.

Large companies would have to get an accounting or engineering firm or other consultancy with emissions expertise to attest to the accuracy of the emissions figures.

Audited financial statements would have to include notes addressing three metrics related to climate change: financial impacts, expenditures, and financial estimates and assumptions.