Climate policy is facing a global backlash: farmers’ protests in many European countries, opposition to the siting of renewable energy projects in the U.S., Canada, Denmark, Germany, Greece, India, South Africa, South Korea, and the United Kingdom, businesses withdrawing from climate alliances, and the emerging “greenhushing” reflected in the reluctance to use the Environmental-Social-Governance (ESG) concept in corporate communication.
U.S. climate policy remains embroiled in partisan divide. The 2024 Pew State of the Union poll reports that 59% of Democrats but only 12% of Republicans believe that climate change should be a “top priority” for the President and the Congress.
The partisan divide is accentuated when parties in power adopt a winner-take-all approach. This divide could be lessened if there is an attempt to compromise by conceding on some points to build a winning coalition. This is how the Inflation Reduction Act was enacted. How might then the Securities and Exchange Commission’s (SEC) recent climate disclosure rule fare on the compromise dimension?
The Logic of Information Disclosures
Justice Brandeis had famously noted that sunlight is the best disinfectant. This logic has spawned a new regulatory approach: information-based regulation. The argument is that incomplete and inaccurate information leads actors (in their roles as consumers, voters, or investors) to make poor choices. With better information, these actors can sharpen their assessment and, anticipating this scrutiny, companies, governments, and leaders start behaving in ways that cohere with societal expectations.
The downside is that this sunlight is not free: that is, collecting and reporting information is often costly. Organizations have to invest resources which could be used elsewhere. Moreover, what if the new expectations arising from information disclosures clash with other organizational or societal objectives? Thus, the debate boils down to what types and levels of information disclosures would best serve (multiple) policy objectives. In part, this is a political choice because groups tend to assess benefits and costs of information disclosures differently.
SEC Climate Disclosure Rule
The SEC recently announced a rule requiring publicly traded firms to disclose the impact of climate change events (droughts, floods, hurricanes, etc.) and policy and legal issues (such as litigation) on their finances. We term this as the vulnerability dimension.
The SEC rule also requires firms to partially disclose their contribution to climate change. We term this as the culpability dimension. Firms need to disclose their Scope 1 emissions generated within their facilities and Scope 2 emissions generated by utilities that supply them with electricity and heat.
However, the SEC rule does not require firms to disclose Scope 3 emissions that are generated by their supply chains and consumers who use their products.
Why so? Because it is polarizing. Last year, in the process of finalizing the above rule, the SEC invited public comments and received over 24,000 comments, including 4,500 unique letters! The key debate pertained to Scope 3 emissions in disclosure requirements.
For the climate movement, including Scope 3 emissions is essential because they constitute about 75% of corporate emissions. But firms complain that this information is difficult to collect because their supply chains span multiple countries. Should firms be obliged to track the emissions of their direct (tier 1) suppliers only, or the suppliers of their suppliers as well (tier 2), and so on? Think of an automobile firm. For reporting Scope 3 emissions, would a firm need to report the emissions of its tier 1 suppliers such as steel firms, or also of firms that supply coal/electricity to steel factories, and firms that supply machinery to coal firms for mining?
Climate groups are disappointed that the SEC excluded Scope 3 emissions from the disclosure rules and believe that the SEC gave in to business pressure.
But conservatives, echoing the major question doctrine, see the SEC as having overstepped its mandate by behaving as a climate regulator, especially regarding the culpability issue. Moreover, the culpability disclosures are less directly related to firms’ operations or financial health – unless one includes legal and policy risks. This is because emissions affect climate change at the global level and firms cannot do much individually to influence it. Not surprisingly, the SEC rule is already facing a legal challenge.
Investors are better off with some level of climate disclosures, especially, the vulnerability of firms’ operations and investments to climate change. But the culpability issue is more complex, especially when it comes to Scope 3 emissions that firms cannot directly control. Thus, SEC’s approach to exempt Scope 3 emissions seems like a reasonable compromise.
Most contentious policy changes are incremental. The SEC climate disclosure rule has sought a middle path to climate disclosures. Hopefully, most firms will endorse this approach (especially because California and the European Union have enacted stringent disclosure laws requiring Scope 3 disclosures). It would be excellent if they could mobilize to ensure that this rule survives legal and political challenges.
As firms internalize standardized disclosures of Scope 1 and Scope 2 emissions, and investors begin to factor in this information in their decision-making process, it might become less contentious to include Scope 3 disclosures later. This is the theory of change of policy incrementalism that those seeking climate progress should probably embrace.
