How does the SEC’s climate disclosure rule impact early-stage investors? Project Frame April Community Meeting
The Securities and Exchange Commission (SEC)’s long-awaited new climate disclosure rule is here. While it faced pushback from all sides, the new rule provides much-needed standardization for climate risk disclosure, important for fending off potential greenwashing.
But what should early-stage investors be on the lookout for and how can they help get their portfolio companies ready?
Jake Rascoff, Director of Climate Financial Regulation, Ceres Accelerator for Sustainable Capital Markets at Ceres, joined the Frame community on April 11 to provide background on the new rule and share what investors should keep in mind.
At Ceres, Rascoff works to ensure the SEC and other regulatory agencies account for climate risks in their investor protection work and regulation of U.S. capital markets. Ceres is a member of Project Frame’s content working group, which works to build consensus around the terminology, methodologies, and best practices for investors dedicated to assessing and reporting forward-looking emissions impact.
The background: A long call for disclosure on climate risks
“This rule was proposed two years ago, almost to the day, in March 2022,” explained Rascoff, “but the history goes back a long way.”
He explained that Ceres and their investors have long been advocating for improved climate risk disclosure, including better data, having first approached the SEC with related concerns 20 years prior.
Fast-forward to 2010, when the SEC published their interpretive Commission Guidance Regarding Disclosure Related to Climate Change, which Rascoff says has “basically governed this disclosure landscape ever since.”
However, due to its nature as an interpretation as opposed to a rule or law, Rascoff said the 2010 guidance fell short. “It didn't lead to the sort of consistent and comparable and investor-grade disclosures that the market needs to assess these risks.”
In their analysis of 10,000 annual reports from 2016 to 2022, the SEC found that only 35 percent disclosed matters related to climate change, and “then within that, there was absolutely no guarantee of consistency or comparability or using the same metrics,” said Rascoff.
“When this stuff is in a voluntary corporate social responsibility report, for instance, it's not subject to the same level or sort of rigor and scrutiny that information in an SEC filing is, and so that leads to unreliable disclosures and the risk of greenwashing.”
Climate disclosure, not climate policy
Given that the SEC’s mission is to promote transparency to investors, Rascoff explained, “the SEC is well within its authority to mandate the disclosure of financially relevant information that's in the public interest.”
“The SEC does not actually care if or how a company is managing their climate risk. They do not care if a company sets a transition plan or wants to mitigate their emissions,” said Rascoff. Instead, “all that they are saying is, ‘The company needs to tell their investors whether they're doing it, and if they are doing those steps, how they are doing it.’”
Because of that narrow focus on material climate-related risks to financial and operational well-being, the rule differs from similar European regulations which extend to broader sustainability concerns, including biodiversity and human rights.
“The SEC makes absolutely no value judgment about whether investors should be putting their money in any certain company or sector. It just gives the investors the transparency, the information to let them do what they will.”
That means that companies will also have to disclose how they manage these risks, said Rascoff.
“This includes the risks to which you're exposed, your plans to mitigate those risks, and any tools you use to mitigate those risks,” he said. “This is one of the stronger anti greenwashing measures in the rule.”
Emissions disclosures
Scope 1 and 2 emissions disclosures are also mandated by the rule, though they are subject to material qualifiers. This means that should a company choose to withhold this information, they will have to make a case for why that information is immaterial, Rascoff explained, while smaller reporting companies and emerging growth companies do not have to report for the time being.
“It certainly leaves more discretion to management than we would like on things like emissions disclosure, but that doesn't mean it's voluntary.”
This is one of the changes seen compared to what had initially been proposed, in which Scope 1 and 2 reporting would have been mandatory, alongside the exclusion of Scope 3 disclosures.
However, as Rascoff pointed out, “the SEC is the exception, not the rule, on Scope 3. Every other mandatory climate disclosure regulation around the world all require Scope 3 disclosures.”
Other considerations for investors
For early-stage investors who may consider an IPO as an exit strategy, Rascoff advised that investors should start conversations with their portfolio companies about climate reporting and whether they can consider the use of a voluntary standard for reporting, such as the ISSB or GHG Protocol.
“Just as you might consider setting up the controls and procedures necessary for a public company reporting on your audited financials, the intent of this rule is to elevate climate disclosures to the same level,” he said.
For example, he offered the ability to utilize third party verification or assurance on emissions disclosures. While the verification field may still be growing, he explained that there are two levels of assurance that will be accepted with the new rule, each requiring differing levels of information and with start dates years into the future to allow both companies and service providers to prepare.
“The SEC recognizes they're not going to require that it's only the big four accounting firms doing the assurance work,” Rascoff said. “They're also going to permit smaller greenhouse gas emissions-focused service providers to give that third party verification provided that they meet certain independent standards that are consistent with other SEC obligations”
“We think that the landscape of assurance providers is going to evolve by 2030 or whenever it is that these are actually required in SEC filings in a manner that makes this less costly.”
Additional resources
Private Markets Decarbonisation Roadmap (PMDR): The PMDR is an alignment scale for general partners to classify where portfolio companies are on their decarbonization journey and track their progress over time. It's voluntary and flexible, no commitment required.
NZIF Private Equity Component (PE Component): The PE Component identifies four types of targets that private market participants can choose to set to further their net zero ambition. It's voluntary, no commitment required.
