The Securities and Exchange Commission recently proposed amendments to their existing disclosure policy that would require publicly traded corporations to disclose more information regarding climate change related risks, and how those risks may impact the company’s business and outlook (read, “bottom line and stock value”).  While the SEC regulates publicly traded corporations, privately held companies need to also track these proposed rule amendments:

• The SEC has been requiring reporting on climate change / greenhouse gas emission information since 2010, so this overall concept is not new. However, the proposed disclosures would expand these obligation by requiring the publicly traded corporation to disclose (among other things):
  • The company’s process for identifying, managing, measuring and managing climate change risks;
  • If the company uses (“best,” “worst” and “most-likely” case) scenarios to assess risk, what assumptions and analytical choices the company uses to reach these outcomes;
  • The Company’s “direct” and “indirect” emissions (the latter, from purchased electricity or other forms of energy); and, of particular significance; and – possibly of greatest significance,
  • The Company’s indirect emissions from upstream and downstream activities.

This last bullet is far-reaching and likely to be controversial due to its impact on upstream privately held companies that sell products or services to publicly traded companies.  Should this proposal be promulgated:

• Publicly traded companies will be obliged to make heightened demands upon their upstream vendors and suppliers to measure and disclose information re carbon dioxide (or other greenhouse gas) emissions associated with the sourcing, manufacture and transport of products to the SEC-regulated customer;
• Commercial counter-parties should anticipate new terms in contracts that would require such disclosures from private companies – including possibly indemnification for misstatements about carbon emissions;
• Small and medium-sized enterprise are likely not going to have in-house capabilities to perform such assessments, so an increased potential for out-sourcing this would be necessary if vendors want to remain on their customers’ “preferred provider” lists.

On March 21, 2022, the U.S. Securities Exchange Commission (“SEC”) approved and released a proposed rulemaking package (the “Proposed Rule”) that would enact sweeping changes to climate-related disclosures.  One key component of the Proposed Rule is a reporting requirement for certain Scope 3 emissions.

What are Scope 3 Emissions

Scope 3 emissions are “all other indirect emissions not accounted for in Scope 2 emissions.”  These emissions relate to emissions from sources outside a company’s control – for example, Scope 1 emissions are direct emissions from sources owned or controlled by a company, and Scope 2 emissions are emissions primarily resulting from the generation of electricity consumed by the company.  While companies generally can calculate Scope 1 and 2 emissions without significant difficulty, estimating Scope 3 emissions presents additional challenges, as Scope 3 emissions occur from other entities not owned or controlled by the company that serve the company’s value chain.

Who Must Report

The Proposed Rule requires non-smaller-reporting-company (“SRC”) registrants to disclose Scope 3 emissions and intensity: (i) if material or (ii) if the registrant set a GHG emissions reduction target or goal that includes Scope 3 emissions.  Thus, the Proposed Rule does not require reporting of all Scope 3 emissions, and a company’s obligation to report would depend on company-specific factors, discussed below.

First, the Proposed Rule exempts SRCs from disclosing Scope 3 emissions.  The SEC defines SRCs as an issuer that is not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent that is not a smaller reporting company and that: (1) had a public float of less than $250 million; or (2) had annual revenues of less than $100 million and either: (i) no public float; or (ii) a public float of less than $700 million.[1]

Second, the Proposed Rule applies a materiality qualifier to Scope 3 emissions that companies must report.  SEC regulations and Supreme Court precedent define “material” emission as emissions with a “substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision.”[2]  The SEC provides several examples of material Scope 3 emissions.  Generally, the SEC advises that Scope 3 emissions may be material where they assist investors to understand transaction risks.  Companies with significant Scope 3 emissions could face disruptions in cash flow and business models to the extent new laws or policies encourage changes to products, suppliers, distributors, or other commercial providers in a company’s value chain.  Moreover, consumer demand could influence a shift to less carbon-intensive products and services.  Conversely, companies sourcing materials and products with lower emissions compared to competitors may see cost savings and higher demand from consumers.  Thus, the SEC’s materiality approach is quite broad and requires companies to understand their company’s value, risks, and opportunities in deciding whether to  report Scope 3 emissions.

Third, even if Scope 3 emissions do not represent material emissions, a company must report Scope 3 emissions if it adopted emissions targets.  The Proposed Rule requires a company to disclose whether its emissions targets include Scope 3 emissions, and if they do, report such emissions.  This requirement allows investors to track a company’s compliance with its emissions targets and gauge what potential additional investments a company might need to implement to meet its targets.