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There’s no doubt that the SEC’s historic climate disclosure proposal is a step in the right direction. The proposed regulation, which is currently in a public comment period after receiving initial approval in late March, would require public companies to report to their investors and the federal government their impact on the climate.
The proposal would, in theory, provide visibility of risks companies take on by contributing to climate change or by running afoul of government environmental regulation. Armed with this reporting, investors could make more informed decisions and obtain leverage for changing business practices that generate increased risk.
Unfortunately, fundamental flaws in the proposal’s regulation of greenhouse gas emissions reporting will cause it to fall short of those goals. By tightening up its requirements around key emissions, the SEC has an opportunity to expose the true environmental risks faced by companies.
The SEC’s proposal allows companies to self-police
The proposed rules require public companies to report on three categories of emissions as defined by the Greenhouse Gas Protocol. The first two categories cover the direct emissions from company activities and indirect emissions through the purchase of electricity, heat, and steam. The SEC’s proposal is clear here: all public companies must report Scope 1 and 2 emissions.
Scope 3 essentially covers the emissions of everyone the company does business with, including upstream suppliers and downstream consumers. Though it’s difficult to generalize, about 70 percent of a company’s emissions fall into this category.
It’s here that regulation becomes controversial… and the SEC’s proposal becomes ambiguous. For starters, the requirement to report Scope 3 emissions would only pertain to the largest companies and would not kick in for another two years in most cases.
But more problematic is the proposal’s materiality clause. It would be left up to the company itself to determine what Scope 3 emissions are “materially relevant” to its investors. The SEC defines materiality as anything a reasonable investor would deem relevant to their decisions about whether and how to invest.
A recent study from MSCI found that when left to self-policing, companies often report emissions in a way that does not line up with what outsiders consider to be material. Though that research was not conducted on reporting practices under SEC materiality legislation, it’s fair to question whether that would change under the new proposal.
So how can the SEC close the loophole? It could throw out the materiality standard entirely or, as it’s done in other instances, it could require all companies or a subset of companies to report on specific emissions regardless of whether or not the business deems them material.
For example, the SEC could decide to make Scope 3 mandatory for every company, though that would be burdensome. A more likely alternative would require Scope 3 reporting for companies above a certain size while keeping the materiality criteria for smaller companies. Or the SEC could require reporting on oil and gas emissions and have everything else in Scope 3 fall under the materiality criteria. There are a variety of options.
The point is that the SEC could make some reporting obligatory and leave firms to make their own decision about the materiality of the rest.
Transportation emissions should be mandated as materially significant
These transportation emissions are part and parcel of every company’s real estate decisions. While many companies report on some of these emissions—like employee commuting, business travel, and commercial vehicle trips—the vast majority are left out of the equation entirely.
Approximately three-quarters of all car travel is for non-work. Where residences are built and where offices and worksites are located determine how and how often these non-work trips take place. Use phase emissions are explicitly called out in GHG protocol, but most companies don’t pay attention to this category.
But imagine if tomorrow it was dictated that no vehicles were allowed to travel to a suburban shopping mall. Business activities would be crippled and the value of the asset would plummet. Baked into the model of the asset is the assumption that people need to use certain modes of transit to support the business.
Given the importance of transportation in contributing to emissions, the SEC should mandate Scope 3 transportation emissions beyond employee commuting. Not doing leaves a huge portion of overall emissions hidden.
New technology makes this reporting possible
Not long ago, measuring the emissions impact of consumer-related transit would have been burdensome and inaccurate. But thanks to cutting-edge location analysis software pioneered by Local Logic, that’s no longer the case.
Using AI to process massive data sets, we’re able to analyze the ways in which building location decisions influence how people move around. Population density, proximity to public transportation, walkability, and other factors can be examined to better understand mobility patterns and their impact on consumer travel.
Detailed emissions reporting is a first step toward a more sustainable future
To date, a significant percentage of climate and emissions risk information has been obfuscated from investors. It’s not so much that companies are hiding this data so much as it is a general lack of visibility and understanding of this information.
The SEC’s proposed regulation can change that. Requiring relevant and detailed Scope 3 emissions is critical to providing information to investors and empowering them to hold businesses accountable for climate risk.
And while the SEC’s proposed regulation focuses narrowly on the financial materiality of climate change, the reporting of this data will no doubt lead to broader change. Once this emissions information becomes publicly available, it can be used by governments to determine zoning laws, infrastructure projects, and private sector incentives for sustainable development.
Reporting this data is a first step toward bringing about optimal, large-scale social and environmental change.