Following up on our previous alert that summarized the Securities and Exchange Commission’s (SEC) Proposed Rule for the “Enhancement and Standardization of Climate-Related Disclosures for Investors” (the “Proposed Rule”), we now take a deeper dive into the Proposed Rule’s greenhouse gas emissions reporting obligations.

Greenhouse gas emissions (GHG) disclosure obligations are chief among the new requirements that would be imposed if SEC adopts its Proposed Rule, which requires all publicly traded companies to include in their registration statements and annual reports information on the climate-related risks that are reasonably likely to have a material impact on the company’s business, operations or financial condition.

The Proposed Rule would establish requirements for the measurement and reporting of GHG emissions to promote comparability and improve consistency across companies’ climate risk reporting. GHG emissions are defined as either:

• Direct: Resulting from sources owned or controlled by the company (Scope 1)
• Indirect: Resulting from activities of the company that occur at sources the company does not own or control (Scope 2 and Scope 3)

While Scope 2 emissions occur at sources not owned or controlled by the company, they are consumed in operations owned or controlled by the company. Scope 3 emissions are all other indirect emissions (i.e. they are not consumed in operations owned or controlled by the company), and include those emissions occurring in the upstream and downstream activities of the company’s value chain. Examples of activities defined as Scope 1, 2, or 3 are provided in our previous alert.

The Proposed Rule would impose specific and complex reporting obligations on companies for the disclosure of GHG emissions data based upon the applicable scope classification.

GHG Emissions Reporting Requirements

In general, companies would be required to report separately the total emissions in each scope classification for which they are required to report. GHG emissions data would be reported in gross terms and exclude any purchased or generated offsets, such as carbon offsets and renewable energy credits.

Treatment of Scopes 1 and 2 Emissions Compared to Scope 3 Emissions

The Proposed Rule would require all companies, regardless of size, to report their Scope 1 and Scope 2 emissions. Larger companies would be required to disclose Scope 3 emissions only if they are material to the company, or if the company has set a reduced emissions target that includes Scope 3 emissions. Smaller reporting companies would be exempt from the requirement to report Scope 3 emissions.

Determining whether Scope 3 emissions are material is a fact-specific inquiry and will likely present challenges for some companies because it involves collecting information from one or more third parties. Scope 3 emissions include upstream emissions attributable to goods and services that the company acquires, such as purchased goods. Scope 3 emissions also include downstream emissions arising from the company’s products, including but not limited to transportation and distribution of sold products, goods and other emissions resulting from production (e.g. byproducts, waste, etc.). Scope 3 emissions can also include end-of-life treatment by a third party of a company’s sold products.

Several factors are used to assess the materiality of Scope 3 emissions, such as whether those emissions make up a significant percentage of the company’s overall GHG emissions (e.g., greater than 40%), the total mix of information available to investors, including qualitative factors, and the probability and magnitude of potential, unrealized transition risks.

For each of its Scope 1, 2, and 3 emissions, if disclosure of Scope 3 emissions is required, the Proposed Rule would require a company to disclose aggregate greenhouse gas emissions as well as its disaggregated emissions of each constituent greenhouse gas (e.g., by carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), nitrogen trifluoride (NF3), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6)). The Proposed Rule would also require companies to disclose the sum of their Scope 1 and 2 emissions in terms of intensity, expressed in terms of metric tons of carbon dioxide equivalent (CO2e) emissions per unit of economic value (e.g., metric tons of CO2e per unit of total revenues) or per unit of production (e.g., metric tons of CO2e per unit of product produced). The intensity of Scope 3 GHG emissions must also be reported if a company is required to disclose Scope 3 emissions. If the company has no revenue in a given fiscal year, that company would be required to calculate its GHG intensity utilizing a substitute financial measure (e.g., total assets), with an explanation as to why the particular measure was used. The selected unit of production should be relevant to the company’s industry in order to facilitate investor comparison of the GHG intensity of companies within an industry without regard to the company’s size. These requirements are intended to provide investors with useful information regarding the relative risks to the company posed by each constituent greenhouse gas in addition to the risks posed by the company’s total GHG emissions by scope.

If a company is required to disclose Scope 3 emissions, it must identify the categories of upstream and downstream activities that have been included in its calculation. Companies would also be required to provide additional details on the data sources used to calculate those emissions, such as whether data was reported by entities in the supply chain or obtained from published databases and government statistics and whether reports are verified or unverified, among other specific information.

Although companies do not own or control the operational activities that produce Scope 3 emissions within their value chain, the expectation is that companies can influence and work with their suppliers and downstream partners and users to take steps to reduce their respective emissions. The SEC suggests that a company could seek to reduce the potential impacts of its upstream emissions by choosing to purchase from more GHG emission-efficient suppliers or by working with existing suppliers to reduce emissions. The SEC also notes in its Proposed Rule that a company could seek to reduce the potential impacts of downstream emissions by producing products that are more energy efficient or involve less GHG emissions when consumers use and dispose of them, or by contracting with distributors that use shorter transportation routes.

A company could also choose to voluntarily disclose other measures of GHG intensity, including non-financial measures such as economic output (e.g. data processing capacity, volume of products sold or number of occupied rooms), provided the company includes an explanation as to why those particular measures were used and why the company believes such measures provide useful information to investors. In all cases, the company would be required to disclose the methodology and other information required pursuant to the proposed GHG emissions metrics instructions.

To balance concerns about reporting Scope 3 emissions with the need for emissions disclosures, the following accommodations are proposed for Scope 3 emissions disclosure:

• An exemption for smaller reporting companies (SRCs) from the Scope 3 emissions disclosure provision
• A delayed compliance date for Scope 3 emissions disclosure. All companies, regardless of their size, would have an additional year to comply initially with the Scope 3 disclosure requirement beyond the compliance date for the other proposed rules
• A safe harbor for Scope 3 emissions disclosure from certain forms of liability under the Federal securities laws

The safe harbor is a limitation on liability that would deem Scope 3 disclosures not fraudulent unless they are made or reaffirmed without a reasonable basis or disclosed other than in good faith. The safe harbor extends to any statement regarding Scope 3 emissions that is disclosed pursuant to the Proposed Rule or made in documents filed with the SEC. This provision is intended to address concerns of reliance on Scope 3 emissions data that would be derived largely from third parties in a company’s value chain.

It is important to note that companies in the financial sector would also be required to disclose their Scope 3 emissions if they are material and to describe the methodology used to calculate those emissions. A financial company’s Scope 3 emissions disclosures would likely include the emissions from companies to which the registrant provides debt or equity financing (financed emissions). While financial companies may use any appropriate methodology to calculate their Scope 3 emissions, the Partnership for Carbon Accounting Financials’ Global GHG Accounting & Reporting Standard (PCAF Standard) provides one methodology that complements existing protocols.

GHG Emissions Data for Historical Periods

The Proposed Rule would require the disclosure of GHG emissions data for the company’s most recently completed fiscal year and for the historical fiscal years included in the company’s consolidated financial statements set forth in the applicable filing, provided that such emissions data is reasonably available. According to the SEC, this information would enable investors to track emissions data over time and assess the company’s management of climate-related risks. For example, a company that is required to include income statements and cash flow statements at the end of its three most recent fiscal years would be required to disclose three years of its Scope 1, Scope 2 and, if material to the company or if it has set a GHG emissions target or goal that includes its Scope 3 emissions, its Scope 3 emissions, expressed both in absolute terms and in terms of intensity.

GHG Emissions Calculation Methodologies

Under the Proposed Rule, companies would be required to describe the methodology, significant inputs and assumptions used to calculate their GHG emissions metrics. As proposed, the description of the company’s methodology must include the company’s organizational boundaries, operational boundaries, calculation approach and any tools used to calculate the company’s GHG emissions.

Organizational and Operational Boundaries

Organizational boundaries determine the operations owned or controlled by the company. They are defined by the same scope of entities, operations, assets and other holdings that are included in the company’s consolidated financial statements and are set for the purpose of calculating the company’s Scope 1 and 2 emissions.

Companies would also be required to describe their operational boundaries in reporting their methodology, significant inputs and significant assumptions used to calculate their GHG emissions metrics. While organizational boundaries refer to the entities owned or controlled by the company, operational boundaries determine the direct and indirect emissions associated with the business operations owned or controlled by the company. This would involve identifying emissions sources within the company’s plants, offices and other operational facilities that fall within its organizational boundaries, and then categorizing the emissions as either direct or indirect emissions. The Proposed Rule would require companies to disclose their approach to categorizing emissions and emissions sources.

Companies may use any categories of emissions sources provided they describe how emissions are determined to be direct emissions, for the purpose of calculating the Scope 1 emissions, and indirect emissions, for the purpose of calculating the Scope 2 emissions. In addition, while companies may use reasonable estimates when disclosing their GHG emissions, they must describe the assumptions underlying the estimates and the reasons for using those estimates. Companies would also be required to disclose the use of any third-party data when calculating their GHG emissions, regardless of the particular scope, to the extent that those emissions are material. When disclosing the use of third-party data, companies would be required to identify the source of the data and the process undertaken to obtain and assess such data.

Selection and Disclosure of a GHG Emissions Calculation Approach

Companies would also need to select a GHG emissions calculation approach. The best option would be the direct measurement of GHG emissions from a given source by monitoring the concentration and flow rate for each constituent greenhouse gas. However, significant expense is likely to be involved in this type of monitoring. Therefore, the Proposed Rule permits companies to rely upon published emissions factors. The “emissions factor” is a ratio that typically relates to GHG emissions as a proxy measure of activity at an emissions source and allows actual GHG emissions to be calculated from available activity data. Examples of activity data reflected in emission factors include kilowatt-hours of electricity used, quantity of fuel used, hours of equipment in operation, distance travelled and floor area of a building. Whether a company uses emissions factors that have been published by EPA or another source, it must identify each emissions factor and its source.

Next Steps

If approved, the Proposed Rule would impose these and other onerous new reporting obligations on public companies. Its broad, sweeping nature will require companies to devote significant time and money to comply, particularly with respect to the reporting of GHG emissions. Companies are advised to take advantage of the opportunity to submit public comment on the Proposed Rule. The public comment process is open until May 20, 2022.

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