How to prepare now for the SEC’s climate disclosure rules
The U.S. Securities and Exchange Commission (SEC) last week announced the adoption of long-awaited final rules requiring publicly traded companies to disclose climate-related information, including an accounting of greenhouse gas (GHG) emissions and the risks climate change poses to their businesses. The final rules differ significantly from the draft, but still represent a sea change in climate reporting obligations.
These new rules will take effect relatively quickly. Most large accelerated filers—those companies with a public float of $700 million or more—will be required to disclose fiscal year 2025 climate-related information in their annual filings in 2026.
Some companies are more prepared than others for these changes. But all affected companies will need to understand how the rules will impact them and potentially make corresponding changes to their climate policies and disclosure policies. Ultimately, these rules can help companies prepare for future climate risks in the same way they prepare for other financial risks.
What’s in the new rules?
The new rules have two key components for public companies.
GHG emissions: The rules require public companies to disclose information about their direct GHG emissions (scope 1) and indirect GHG emissions from purchased electricity and steam (scope 2) if they are material—essentially, whether a reasonable investor would consider the disclosure or omission important when making an investment or voting decision.
Climate-related risks: The rules require public companies to disclose information about their governance and management of climate-related risks that have or are reasonably likely to materially affect their operations. For example, how would a company protect their buildings from the increased heat and flooding expected because of climate change? The rules also require that companies disclose any transition plan they have for managing material climate-related risks, focusing on strategies to reduce these risks.
How can companies prepare?
The new rules will significantly change the way many companies currently manage and report climate-related information. Here are five steps companies can take now.
1. Identify key leaders
It sounds basic, but an often-overlooked step is to identify who within the company needs to play a key role in tracking progress and ensuring accountability for this new set of mandated climate disclosures. Someone at a very high level—close to the C-suite, ideally—should be responsible for directing progress.
There also needs to be an entire reporting chain that goes down into the appropriate divisions. All companies are different, but reporting lines generally should include legal, investor relations, enterprise risk management, information technology, supply chain management, and operations, in addition to the sustainability office.
2. Build bridges
In many companies, it’s likely that the sustainability team has had little or no regular connection with the finance department. That needs to change. Now that key sustainability measures are subject to public and financial disclosure, it’s important to build bridges between those two departments.
A chief sustainability officer, sustainability director, or other staff with responsibilities for the company’s climate change response should be talking regularly to the chief financial officer and their office. These necessary conversations may include how to integrate GHG emissions into the company’s financial disclosure statements, how to calculate GHG intensity measures that factor in revenue, and the costs of implementing measures to reduce emissions and climate risks. In more general terms, the company needs to understand the financial risk that lowering its GHG emissions poses, the risks that physical and transition risk pose, and the potential business opportunities created by transitioning to a low-carbon future.
Prosaic matters are important, too. Find out what format the CFO’s office needs the climate information to be in and make sure it is provided correctly.
3. Prepare a GHG emissions inventory
If a company isn’t currently calculating its GHG emissions, it should plan to start doing so as soon as possible. If a company has prepared a GHG emission inventory, it’s time to make sure that the methods used to account for emissions are a fit for the purposes of disclosure. As an example, by having a full and documented understanding of the data, methods, and emission factors used to prepare the emission estimates that comprise your company’s GHG inventory.
While many companies have historically selectively included scope 3 emission sources, there is no requirement to disclose scope 3 in the final rules. Companies that have largely approximated emissions using average data—such as average building energy use or fleet vehicle miles traveled—will want to begin incorporating actual consumption values from utility bills and fuel purchases.
It’s important to note that the GHG emissions inventory will be auditable moving forward, meaning the inventory needs to be reviewed or verified by a third party. The rules require limited assurance starting from the third year after the initial reporting compliance date for both large accelerated filers and accelerated filers; reasonable assurance is mandated only for large accelerated filers, starting from the seventh year after initial reporting. As a result, all companies need to step up in terms of the stringency of documentation as to where their data is coming from and what emission factors are being used to create the inventory.
4. Recognize risks
The risks from climate change can take numerous forms, including physical risks. If a company has ever had disruptions due to severe weather—flooding of facilities, employees unable to access the office due to storms, etc.—then they are likely to have at least some vulnerability to physical risks from the changing climate.
The SEC defines transition risks as having actual or potential negative impacts on a company's consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks. Another way to think about it is the risks associated with being part of a society that's transitioning to a low-carbon future. An example of transition risk is a fossil fuel company left with stranded assets (e.g., refineries) as it transitions to renewable energy. Each company will need to determine its exposure in these situations.
Under the final rules, companies must report the impacts of physical and transition risks under certain conditions. They must disclose the financial effects of severe weather events when the total related costs reach at least 1% of the annual pre-tax earnings or losses, with a minimum threshold of $100,000. For capitalized expenses, the disclosure threshold is set at 1% of the companies’ total shareholder equity or deficit, with a minimum threshold of $500,000.
5. Take the long view and the broad view
It’s important to focus on creating deep roots around climate disclosure that sets the stage for future success. This includes engaging the necessary internal stakeholders and leadership around a sustained process versus trying to figure out how to just follow the letter of the law.
Climate change necessitates a sustained and concerted response. Companies need to be thinking about the multi-decade, long view rather than simply what to report this year. Part of that relates to establishing a learning process and recognizing that the company is going to get better at understanding and addressing climate risks as time goes by.
Taking the broad view acknowledges that companies have limited resources. Therefore, it might make sense to start by creating a high-level overview across the entire company versus a deep dive in a particular line of business. What are the biggest issues that need to be addressed? Figure out where it will matter the most to understand climate risks and start there.
The broad view also includes recognizing climate-related opportunities where they exist. Depending on the business, new areas of growth in different sectors, technologies, or regions of the world may be possible. For example, we forecast double-digit percentage declines in the cost of clean energy across a range of technologies. A company that discloses that its energy costs will decline may become more attractive to investors.
The most important insight we have is not to treat climate-related disclosures like a book that must be written but then merely sits on a shelf. It’s an essential resource that describes a company's impact on the environment and the environment’s impact on a company. It looks at fundamental risks to your business and identifies areas of concern. Understanding and acting on that risk analysis is what will allow your company to comply with the SEC’s new rules while also making the business more resilient, less vulnerable, and part of the climate change solution.
The authors would like to thank Pieter Krans for his contributions to this article.
