SEC Climate Rule: How Carbon Footprint Disclosure Might Impact The Market

June 16, 2022 Juliette Cooke, CFP®, CKA®

The Securities and Exchange Commission (SEC) recently issued a climate rule that would require companies to disclose climate-related risks to investors, including the impact of any policies aimed at reducing their carbon footprint.

This rule will affect all companies with operations in the United States, whether or not they are energy producers themselves. Companies that make or supply products that use coal, natural gas, or oil will be affected by this disclosure requirement as well.

What is the SEC Climate Rule?

On March 21, the SEC released proposed climate-risk disclosure rules that require publicly traded companies to assess and disclose how climate risks could impact their businesses. Companies would need to consider how climate change might affect their business in areas like supply chain, manufacturing, product development, and marketing.

The proposal is the result of the SEC's work to develop guidelines requiring publicly traded companies to disclose climate-related risks under Section 13(r) of the Securities Exchange Act of 1934.

Under the proposed rules, investors would have access to a company's climate risk assessment and its mitigation plans. The agency's proposal would also require companies to report both direct and indirect greenhouse emissions such as those created by energy the company purchased.

To comply with these new guidelines, companies will need to conduct an assessment of how changes in climate may impact their business over time. While there’s no set method for doing so, one way is by calculating a company’s carbon footprint using third-party software or an internal carbon calculator.

Why Does the SEC Climate Rule Matter?

Public companies of all shapes and sizes would be subject to the SEC climate rule. Which in turn would provide additional transparency to all investors.

In fact, there’s an argument to be made that non-executive employees may be at an advantage over executives due to their ability to purchase securities directly through a broker. In order for them to do so, however, they must understand the carbon footprint (and other environmental factors) of their investment options.

SEC reporting on carbon footprint may help with that understanding by creating additional transparency on how companies are using energy resources and their methods for reducing associated emissions. Investors who care about how companies are managing risks to human health and safety, as well as physical assets, can now pay attention to how companies manage those risks related to climate change.

As an investor, you may now be able to gain greater insight into questions such as: How is a company preparing for possible changes in its supply chain? How has a company responded to extreme weather events? Are they disclosing efforts toward sustainability or leadership on environmental issues? And what is their position on renewable energy development?

When Would the Rule Become Effective?

The timeline is not immediately clear.

On March 31, 2022, the SEC announced that it was considering a new climate rule that would require extensive climate-change-related reporting.

The agency opened up a comment period, scheduled to close on June 17, 2022. What will happen after the comment period concludes remains somewhat muddled, at least from an outside perspective.

Typically, the wheels of government agencies grind slow but sure. Nevertheless, the SEC will have to provide further information before companies will know when they should be prepared to act.

Who Might be Impacted?

A good way to start thinking about how climate risk disclosure might affect businesses and investors is by looking at who is most impacted by the SEC's rules.

There are three main groups—companies, institutional investors (e.g., investment managers), and retail investors (e.g., individuals)—that stand to benefit from or suffer from climate change-related risks or opportunities in their investments. Each group could be impacted differently. The new rules would require companies to divest information about both the climate related risks and opportunities of their activities - these could help, for instance, ethically-minded retail investors make informed decisions about the kind of companies they want to invest in. Climate-change related opportunities that are disclosed under the rules could also help institutional investors broaden portfolios with a focus on long-term benefits.

One of the most obvious ways that the SEC climate rule would impact businesses is by requiring companies to calculate their carbon footprint.

How to Calculate the Carbon Footprint of a Business

Your carbon footprint is a simple equation that calculates how much carbon dioxide (CO2) you’re releasing into the atmosphere through business-related activities.

To find out just how large or small an organization’s greenhouse gas emissions are, you would likely need to gather data about its operations and fuel consumption. You can determine a product’s carbon footprint by looking at its production process, from mining raw materials through processing, transporting, and packaging to marketing.

However, you should always remember that environmental sustainability cannot be accomplished in isolation from other business factors. Stakeholders must take into account other aspects such as economic value, social benefits and cultural impact.

When calculating a company’s carbon footprint, keep in mind that every step in its supply chain affects how much CO2 is emitted during each stage of production.

With those caveats in place, here's one way to calculate the carbon footprint of a business:

Multiply your greenhouse gas emissions by their global warming potential (GWP).

This number represents how much CO2 would be released into Earth’s atmosphere if those gasses were emitted directly from a smokestack. There are many different types of greenhouse gasses that contribute to a business' overall carbon footprint, including methane, nitrous oxide, and more. To calculate a company's carbon footprint, you would multiply all greenhouse gas emissions by their GWP.

The formula might look something like this: 1,562.4 lbs CO2/MWh × (4.536 × 10-4 metric tons/lb) × 0.001 MWh/kWh = 7.09 × 10-4 metric tons CO2/kWh

Calculating one's carbon footprint can help you understand your direct and indirect emissions. From there, it's easier to know how to reduce it..

The SEC rule would require companies to disclose how they calculate and manage their emissions for fossil fuels used in electricity generation or purchased for use in manufacturing or other operations.

Companies also report on any emission reduction goals they have set for themselves; whether they have purchased any offsets; what type of offsets they have purchased; and what percentage of their total energy consumption comes from renewable sources.

Does the SEC Have the Legal Authority to Require Companies to Adopt Climate Change Disclosure Rules?

It does. Under the legal policy known as the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress expressly authorized the SEC to adopt rules that require public companies to disclose any material information about climate change.

While much of the existing regulation, Proposed Item 1504 of Reg. S-K, is devoted to disclosing information about supply chain GHG emissions, it does also give the SEC authority to issue other rules relating to greenhouse gas emissions, including disclosure rules.

A key point here is that while Section 1504 authorizes the SEC to adopt a number of disclosure rules regarding climate change, it specifically says that those rules may only be related to disclosing whether or not a company uses certain practices or supports climate initiatives in its supply chain or products.

Does the SEC Require Any Sustainability Reporting?

No, the SEC does not require any sustainability reporting. At least, not yet.

The proposed climate rule, however, would change that.

Right now, though, the SEC does require all publicly traded companies to disclose some information about their sustainability risks and management of those risks. For example, companies must disclose any risk factors that could materially affect their business or financial position. This includes any unusual or major events that might impact a company's profitability or reputation.

But given the broad nature of these requirements, it's important for companies to review what they report in their official filings with the SEC and make sure it is accurate and complete.

Companies that fail to do so could face serious consequences if they get audited by the SEC or if law enforcement gets involved on behalf of investors who lost money due to misleading information disclosed by a company in its public filings.

Considerations for Investors

Be aware that the SEC recently issued a new rule requiring companies listed on US stock exchanges to disclose their greenhouse gas emissions and their efforts toward curbing them.
Some market watchers are skeptical about how much value will be generated from these disclosures.
Others say that as a result of increased awareness about carbon footprinting, investors may start considering investments in companies with lower emissions as a way to mitigate potential risks from possible climate regulations in future years.

If you have concerns about how the SEC's proposed climate rule could affect your investment portfolio, contact the team at Cooke Wealth Management. We would be happy to review your portfolio with you.