2 Major Changes to the SEC Climate Rule, and What They Mean for Investors

“Don’t expect a single global standard anytime soon,” I wrote back in 2022. I was talking about the proposed global climate and sustainability reporting standards, including the SEC’s proposed Climate Rule.

Over a year and a half later, I have to wonder whether we can ever expect a globally consistent standard for climate-related reporting. The SEC finalized its Climate Rule in March 2024, after the European Union and the International Sustainability Standards Board completed their first sustainability standards in 2023.

However, implementation of the SEC’s rule is currently paused after being challenged in the courts both by those who think it goes too far and those who don’t think it goes far enough. And once that’s resolved, companies and investors will have to deal with major differences between the SEC’s rule and those applied internationally.

Still, a common understanding is crucial to helping investors understand the risks companies are exposed to as extreme climate effects become more frequent and more persistent.

Materiality: The Big If

In March, the SEC finalized its Climate Rule requiring US companies to disclose greenhouse gas emissions and climate-related financial impacts from 2025 onward. We previously highlighted key differences between the SEC’s proposals and those made internationally. But now, the finalized Climate Rule is also radically different from what was originally proposed two years ago.

The definition of “materiality” sits at the center of it all. For over 50 years, the SEC has relied on the Supreme Court’s definition of materiality, focusing on what information a “reasonable,” and purely financially motivated, shareholder would consider important to know.

Following criticism that the proposed rule ignored the existing materiality definition in places, the SEC made two important changes to the final Climate Rule:

• Disclosure of scope 1 and scope 2 GHG emissions (those attributable to a company’s direct operations and its energy use) will be required “if material.” In the proposed rule, scope 1 and 2 disclosures were mandatory for most companies irrespective of financial materiality.
• Disclosure of scope 3 GHG emissions (“value chain” emissions attributable to other products and services a company uses or produces) will not be required. In the proposed rule, scope 3 disclosures were required if material or if the company had set a target covering them.

What do these changes mean?

Scope 1 and 2: Still Table Stakes

Although scope 1 and scope 2 emissions disclosures are now only required if material, companies and investors continue to see these disclosures as table stakes.

By 2021, 71% of the large-cap companies in the S&P 500 already reported this information, according to a study by The Conference Board in 2022. And, according to the Investment Company Institute in its comment letter to the SEC, “How to measure and report scopes 1 and 2 emissions is now sufficiently developed to provide investors, including fund managers, with reliable, consistent and comparable information that can help them make investment decisions in a cost-efficient manner.”

Scope 1 and 2 emissions disclosures are also required by new reporting standards from the European Union, the International Sustainability Standards Board, and California’s Climate Accountability Package. (More on that in an article by Morningstar’s Jasmine Sethi.) So, companies are already likely to see such disclosures as a must.

However, there’s plenty to do and think about for smaller companies that want to provide similar information to investors. The Conference Board study noted that only 28% of mid-cap companies (S&P MidCap 400) reported their GHG emissions.

Scope 3: The Tricky Topic

Disclosures on scope 3 emissions are a different matter. They cover a wide range of upstream and downstream categories of emissions and are considered to be largely outside a company’s control in most cases.

As a result, opinions vary on how useful they are to investors and how easy they will be for companies to calculate. And existing disclosures on scope 3 are less common. According to The Conference Board’s study, only 43% of large-cap companies and 13% of mid-cap companies provided scope 3 disclosures of any kind.

The Investment Company Institute recommended that “the SEC not require companies to disclose scope 3 emissions at this time because of significant data gaps and the absence of agreed-upon measurement methodologies.” They got their wish from the SEC, but European and international standards, as well as the incoming California law, will all require scope 3 disclosures in the near future.

What Now for Investors?

It’s fair to say we don’t have the global alignment on climate reporting that was hoped for at the start of the decade. But what’s important is that we do have global agreement on much of what is now considered a basic requirement for investors seeking to evaluate sustainability risks and opportunities.

Gabriel Presler, global head of enterprise sustainability for Morningstar, says: “The value of articulating a management approach to governance, to risk, to strategy, and to basic metrics and targets around scope 1 and 2 emissions is now shared across the SEC proposal … and a range of other reporting frameworks.”

This core set of climate disclosures is required by regulators, and in many cases subject to third-party assurance. It means that investors will find new and inventive ways to sift through the data, uncover new sources of value, and manage risks.