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What investors need to know about the SEC’s landmark climate proposal

07 April 2022

In Q1 2022, the Securities and Exchange Commission (SEC) released a set of rules mandating climate-related risk disclosure for public companies.

The proposed rules could play a pivotal role in helping investors to make more informed decisions and mitigate climate-related risks posed to the financial system. Even though the proposal directly targets public companies, it should also impact private market investors and global capital markets more broadly. As such, there are pressing implications of these rules for any private companies looking to exit via IPO.

We, as Apex Group, welcome and fully support the proposed regulation. It is a major stepping stone towards the standardisation of greenhouse gas (GHG) emissions reporting, aiming to ensure consistency, reliability, and comparability among different reporting companies. The new disclosure regime is being introduced by the SEC at a critical moment and responds to increased investor demand for enhanced transparency around climate-related disclosures. At the same time, in a world where human-induced climate change is increasing the frequency of disastrous wildfires, huge storms and floods, the disclosure of physical climate risks is more important than ever.

What are the new SEC rules?

Simply put, the SEC bases its rules on best-in-class climate disclosure frameworks and standards, such as the Task Force for Climate-related Financial Disclosures (TCFD) and the Greenhouse Gas (GHG) Protocol. Hence, the major requirement under the climate proposal will be for all US listed companies to report their Scope 1 (direct GHG emissions) and Scope 2 (indirect emissions from purchased energy) gradually over the next three fiscal years. Large companies, with a market value above $250 million, will also need to report their much more complex Scope 3 emissions (upstream and downstream emissions across their value chain).

Additionally, by 2026, companies will be required to provide “reasonable assurance” of their Scope 1 and 2 emissions undertaken by an “independent GHG emissions attestation provider”. This requirement will also be rolled out in distinct phases, with larger companies leading the charge and smaller ones following.

At the same time, the SEC requires companies to assess and disclose their exposure to climate-related risks, as well as their plans for managing them. The inclusion of scenario analysis, transition plans, publicly announced targets and the use of internal carbon prices is also among the proposed disclosure requirements. The new rules even cover the use of carbon offsets in order to enable investors to fully understand how companies are intending to address their GHG emissions responsibly and move towards their carbon neutrality goals.

What does this mean for companies and investors?

After the proposal has gone through the public comment period, gets finalised, and implemented, it will immediately start affecting listed US companies of all sizes. If they haven’t done so already, they will need to introduce the ‘climate’ parameter to the way they evaluate and manage their operational, supply-chain, and reputational risks. They will need to prove their resilience to climate risks and showcase their potential to adapt and thrive in a low-carbon economy.

Private companies cannot bury their heads in the sand and assume that this has no bearing on them. Private companies and their investors need to stay ahead of regulation, ensuring climate-related disclosure processes are in place before mandatory climate reporting rules are imposed. This will improve the company’s reputation, build trust among stakeholders, and offer them a competitive advantage. It is also worth pointing out that for any investor that wishes to exit via IPO, they will have to put in place processes so that it can fulfil these climate-related reporting requirements.

Why is third-party validation needed?

A key component of the proposal that needs to be underlined is the requirement for third-party verification for emissions reporting. As more and more companies are looking to disclose their GHG emissions, and ‘greenwashing’ concerns grow, the demand for independent validation is surging. Increasingly, firms are experiencing tricky questions when they appear to have “marked their own homework” when it comes to climate reporting.

An external - and independent - validator will ensure that data is as reliable, accurate and collected with a robust methodology, while identifying any weak points and areas for improvement in internal processes. Companies undergoing this process will build a stronger reputation amongst the stakeholders that matter - from customers to regulators, employees to shareholders, by demonstrating healthy ambition and the ability to communicate their carbon reduction strategies clearly and confidently and any progress made on implementing them.

Some companies may struggle with the reporting, particularly when trying to quantify non-carbon emissions such as methane or nitrous oxides. Risks from climate change can materialise in financial markets in the form of credit risk, market risk, insurance or hedging risk, operational risk, supply chain risk, reputational risk, and liquidity risk. GHGSat, a company that operates high-resolution satellites designed to detect and measure facility-level emissions worldwide, commented that “the challenge is that any such reporting relies solely on limited field measurements, estimates, and self-reporting, which are likely to underestimate emissions, particularly with companies that have intense industrial activity”.

They went on to say that “companies will need to consider new methods of quantifying and validating emissions, including satellite technology”. This summer, GHGSat’s constellation is set to double with the launch of three new satellites. Clearly, there a need for technical solutions from independent firms in order to try and capture as many sources as possible.

What next?

The SEC’s proposal is only the beginning. We are still expecting further regulatory pressure on companies for climate disclosure across all global jurisdictions. Our recently commissioned, independent research highlights that the vast majority of private equity market investors acknowledge that climate change is an urgent issue and want to play a leading role in the low-carbon transition. Some of them, the more forward-thinking ones, are already taking action by measuring the carbon footprint of their portfolios, planning their improvement pathways, and driving positive change.

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