True to its word, the SEC released its proposed rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors, last week. The rule would require companies to disclose a wide variety of climate-related information, including information about climate-related risks that are reasonably likely to have material impacts on its business and/or its consolidated financial statements, and greenhouse gas (GHG) emissions metrics that could help investors assess those risks.

Much has been made of the proposed requirements for GHG emissions reporting—not just for Scope 1 and 2 emissions (emissions from company operations and from the generation of electricity purchased and consumed by the company)—but also for Scope 3 emissions, or emissions from upstream and downstream activities in a company’s value chain. In this post, we will focus on the Scope 3 emissions requirements in the proposed rule.

First, not all companies would be required to report Scope 3 emissions. The proposed rules would require disclosure of Scope 3 emissions only if:

• The emissions are material, or if there is a substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision; or

• The company has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.

In limiting the reporting requirement, the SEC sought “[t]o balance the importance of Scope 3 emissions with the potential relative difficulty in data collection and measurement . . . .”

The SEC declined to propose a quantitative metric for the determination of materiality of Scope 3 emissions (although the proposed rule notes that some companies rely on such a metric, and it also seeks additional comment on whether such a metric should be included). Instead, it proposed to use its commonly known materiality standard, explaining that a “one-size-fits-all” approach would not capture the variability of regulatory, policy, and market conditions across companies, nor would it adequately capture the transition risk that is tied to GHG emissions and the choices that a company can make about its value chain because of them.

For companies that have set a GHG emissions reduction target or goal, the proposed rule states that disclosure is needed to help investors understand the potential costs associated with meeting such a goal and track the company’s progress along the way.

So what are Scope 3 emissions? As explained above, Scope 3 emissions are those from upstream and downstream activities in a company’s value chain. Some examples of these upstream and downstream activities include:

• Purchased goods and services;

• Transportation and distribution of purchased goods, raw materials, and other inputs;

• Waste generated in operations;

• Business travel and commuting by employees;

• Transportation and distribution of sold products, goods, or other outputs; and

• End-of-life treatment of a company’s sold products.

Scope 3 emissions data is difficult to gather and quantify, but the SEC is hoping that companies required to report will be able to influence the activities in their value chain and gather emissions data in the process:

“Although a registrant may not own or control the operational activities in its value chain that produce Scope 3 emissions, it nevertheless may influence those activities, for example, by working with its suppliers and downstream distributors to take steps to reduce those entities’ Scopes 1 and 2 emissions (and thus help reduce the registrant’s Scope 3 emissions) and any attendant risks. As such, a registrant may be able to mitigate the challenges of collecting the data required for Scope 3 disclosure.”

The proposed rule suggests that Scope 3 emissions data can be found in the following sources:

• Emissions reported by parties in the registrant’s value chain, and whether such reports were verified by the registrant or a third party, or unverified;

• Data concerning specific activities, as reported by parties in the registrant’s value chain; and

• Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a registrant’s value chain, including industry averages of emissions, activities, or economic data.

Companies required to report Scope 3 emissions must do so individually (i.e., listing the emissions from each GHG), and also in the aggregate (carbon dioxide equivalent). They must also report GHG intensity, or the ratio of the impact of GHG emissions per unit of total revenue and per unit of production. The risks associated with climate change must also show up in a company’s financial statement metrics, with certain metrics (for Scope 3 emissions, think transition risk) required to be included in a note to a registrant’s audited financial statements. Lastly, if a company is required to report historic data on its income statement and cash flow statement, it should be prepared to do the same for emissions data (to the extent such emissions data is reasonably available).

The proposed rule would phase in the reporting of Scope 3 emissions, with the first reporting required for large accelerated filers in fiscal year 2024 (filed in 2025). Smaller reporting companies would be exempt from the Scope 3 emissions reporting requirements.

The SEC is seeking comment on the proposed rule. The comment period will remain open until at least May 20, 2022.