The SEC Proposed Climate Rule

The rule affects all U.S. firms that provide a product or service to multinational organizations and other large U.S. firms. All U.S. firms will be required to report beginning in the 2023 fiscal year or 2024 fiscal year depending on the size of the firm, with larger firms facing the first requirement.

Before detailing a few of the specifics, it might be helpful to define physical and transition risk. Transition risk refers to the regulatory and market risk of a building’s greenhouse gas (GHG) output. As countries and economic regions increasingly require reduction in GHG, at what point does a building become physically obsolescent? Much as an industrial building from the 1960s with a low clear height fails to meet today’s logistics requirements, so too will a building with poor energy efficiency fail to meet the regulatory requirements for low GHG output. Many countries set carbon neutrality goals and the built environment is among the most critical areas to achieve those goals. Although the U.S. did not yet set a specific carbon neutrality, the SEC rule will require all firms to report their GHG output.

The SEC proposed rule will require all public firms to report their GHG output, transition risk, for Scope 1 and Scope 2, with larger firms, or those making claims, requiring Scope 3. All reporting will require external attestation. That means that every GHG report will require third-party auditing, similar to financial reports. Just like a Certified Public Accountant must audit financial statements, a GHG expert will be required to audit the GHG statement. Also, organizations using Renewable Energy Credits (RECs) or carbon offsets (defined below) must report those separately. All energy output without those potential reductions must be shown first; then shown with potential reductions included.

Organizations must understand the three scopes of the proposed rule.

• Scope 1 is GHG from sources owned or controlled by an organization. This could include vehicles, manufacturing output, landfills and related areas.

• Scope 2 generally consists of purchased electricity, heat or steam where not generated by the organization.

• Scope 3, the most difficult and poorly understood at this point, are emissions from the value chain of the organization. This could include transport of goods, component parts of manufactured products, business travel and a host of services. It could also include the GHG output of purchased services such as janitorial, carpet cleaning and related basic building functions.

One extremely important consideration is that although only public U.S. firms will be required to report, what happens to organizations in the value chain? Anecdotal information suggests that major U.S.-based retailers such as Target and Walmart will require their suppliers to identify their carbon footprints. The only way firms such as theirs can accurately report Scope 3 will be for their supply chain to also report accurately. Even though a firm may not be a U.S. publicly traded firm, if they provide a product or service to one, they likely will soon be asked for this kind of reporting.

Because of the difficulty in estimating Scope 3, especially as firms slowly ramp up their reporting, the SEC included a safe harbor provision in the proposed rule. For Scopes 1 and 2, firms will be required to disclose truthfully and honestly all material facts. Failure to do so could open them up to fines and lawsuits. However, what the safe harbor provision does is acknowledge that Scope 3 may involve some estimates and assumptions. Firms simply will not be able to accurately describe all their service providers in the short term. So long as firms disclose all material facts, state the assumptions and are truthful, they will not be liable for an inaccuracy. This means that if in two years a firm learns that the GHG footprint of a service provider was significantly higher and revises their report, no one can sue them. However, any fraudulent or intentionally misleading statements will still be subject to litigation.

Physical risk is primarily weather-related risk. It can be broken up into two components: acute and chronic risk. The Task Force on Climate-related Financial Disclosures (TCFD) definition for acute risks is, “Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as cyclones, hurricanes or floods.” In other words, acute risks are weather events that cause sudden, dangerous and unpredictable damage to the building. Borrowing again from the TCFD, “Chronic physical risks refer to longer-term shifts in climate patterns (e.g., sustained higher temperatures) that may cause sea level rise or chronic heat waves.” Chronic risks require more long-range planning. Considerations might include the effect of prolonged heat on the HVAC system or how landscaping requirements change with limited water.

Beginning with transition risk, as firms are required to measure their Scope 1 and Scope 2, much of the reporting and information gathering lies within the built environment. The SEC has not yet prescribed a specific system to measure GHG. The most commonly used systems are the International Organization of Standards (IS0) 14000 family of environmental management, specifically ISO 14064, the fully ISO-aligned PAS 2060 standard from the British Standards Institute and Corporate GHG Protocol by the World Resources Institute (WRI).

As outlined in an Editorial for the Journal of Sustainable Real Estate, ISO standards are globally accepted for greenhouse gas (GHG) reporting across virtually every major economic region. The Climate Neutral Now initiative of the United Nations Framework Convention on Climate Change (UNFCCC) secretariat recognizes the use of ISO standards for reporting GHG inventories. That standard is accepted or cited by every major global environmental, social and governance (ESG) reporting platform. As a stated goal of the proposed SEC rule is to “limit the compliance burden associated with these disclosures (P. 36),” selecting an accepted global standard minimizes the reporting cost for multinational firms. ISO is already the most used standard for reporting by S&P 500 companies, with two thirds of reporting firms using the standard. For FMs looking to adopt a system that will work across regions and regulatory regimes, using ISO seems the clear path.

ISO requires reporting of energy, water and waste. Each of these measures is then converted to GHG output. As requirements to report these items become increasingly relevant to the firm, what systems are in place to measure? Organizations are already tracking energy in some manner; but are they tracking the whole building's energy? Are they currently tracking water or waste?

Each specific electric grid has a different GHG output. In the U.S., the Emissions & Generation Resource Integrated Database (eGRID) published by the EPA provides information on those grids. Organizations should have information on the GHG output of the energy grid they are using. Similarly, each water supply and trash management systems have unique GHG output factors.

Organizations in need of specific guidance through this process should contact an ISO professional.

The physical risk component of the law requires all firms to identify the potential material risk from hazards such as floods, hurricanes or wind. Typically, this data can be found from a physical risk assessment provider. Every major public rating agency now provides this service along with numerous independent firms. Unfortunately, while each of these firms use the same basic underlying data, many analyze them in different ways.

It will take time to understand the building data being presented, and it will take time and resources to implement procedures to act on the data. This could be anything from what resiliency measures need to be installed at a building level to new emergency health and safety procedures being implemented.

Firms will need to report on water usage if pulling significant water from a region. Consider how prolonged heat stress might impact on the building. Firms with property in a coastal region will need to address rising sea levels. As above, firms should seek outside expertise to help provide and understand this data.

Firms would also be required to report GHG footprints from energy both with and without the inclusion of RECs and carbon offsets. At a high level, RECs are a market instrument that represents 1 megawatt-hour (MWh) of electricity generated from a renewable source. They typically involve a contractual agreement to purchase that renewable energy and receive exclusive rights to retire it in a specific asset name. In other words, if a firm purchased an REC from a solar power farm, they would receive the right to claim the lower GHG footprint of the solar power instead of their specific grid power.

Recently, corporate GHG has treated the U.S. as one energy grid for REC purchases. However, many ISO auditors accurately state that the U.S. is not one grid and that for an REC to count as a Scope 2 reduction, it should at least have the possibility of consumption. Organizations considering a new REC purchase should consider whether they could potentially consume the energy or not.

Importantly, an REC is not a carbon offset, although in some cases the purchase of an REC could be used to create one. There are a few important points to understand about carbon offsets. First, they are financial securities, and although private placements have historically been treated as forward contracts, these may be subject to SEC scrutiny. Any firm attempting to sell a carbon offset should be able to support required disclosures through their SEC broker dealer registration, show detailed record keeping qualifying as an excluded forward or similar diligence. If they cannot, this is likely a firm to avoid. Second, every carbon offset should be registered on an internationally accepted platform such as the United Nations compliant Gold Standard and Verra, or on a government regulated platform such as the Western Climate Initiative or Regional Greenhouse Gas Initiative in the U.S., and comparable platforms internationally.

In summary, the U.S. SEC has proposed to require all firms to report their physical and transition risks, which directly impacts facilities as the majority of GHG output and all the physical risk stem from the built environment. The most globally accepted standard is the ISO 14000 family of environmental standards, and firms adopting measurement using ISO should be well positioned for compliance. Even if a firm is not a U.S. firm required to report, if they provide a service or product to one, this likely will affect them soon! Firms should start planning for these requirements now.