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Scope 3 emissions and the SEC’s proposed disclosure rules: Key take-aways from the public comment process

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02 August 2022

Companies face various challenges when they report on “Scope 3,” or indirect, greenhouse gas emissions.

Under the U.S. Securities and Exchange Commission (SEC)’s March 2022 climate-related rule proposal, many companies would be required to disclose their Scope 3 emissions on a mandatory basis for the first time, as early as for fiscal year 2024. The SEC has received a flood of public comments, both supporting and opposing various elements of the proposal. The chief criticisms of the Scope 3 requirements include difficulties with data collection and measurement, calculation methodologies, timing of compliance deadlines, liability concerns, and materiality standards. Companies are now preparing to deal with these challenges and are closely following the progress of the proposal.    

SEC proposal and Scope 3 emissions

In March 2022, the SEC proposed amendments to its rules under the Securities Act of 1933 and the Securities Exchange Act of 1934 that would require SEC registrants to provide certain climate-related information in their registration statements and annual reports. The proposal would require SEC registrants, including foreign private issuers, to include certain climate-related disclosures in their registration statements and periodic reports, including annual reports on Form 10-K and, in the case of foreign private issuers, Form 20-F.

Among other things, under the proposal registrants would be obligated to disclose their greenhouse gas emissions for their most recently completed fiscal year, including Scope 1 and Scope 2 emissions for all registrants. All filers except smaller reporting companies would also be required to disclose their Scope 3 emissions if the Scope 3 emissions are material, or if the registrant has a target or goal that includes Scope 3 emissions.

Scope 3 emissions are defined as indirect greenhouse gas emissions that occur in the upstream and downstream activities of a registrant’s value chain. A company may have to disclose, for example, upstream emissions attributable to purchased supplies and services, capital goods, fuel and energy related activities, waste generated in operations, transportation and distribution activities, as well as employee commuting and business travel. Downstream emissions could include those from processing, transportation and distribution of products sold, use and end-of-life treatment of products sold, leased assets and franchises, and investments.   

The proposal includes certain safe harbor provisions from liability with respect to Scope 3 emissions disclosures. The rule also proposes a longer phase-in period for Scope 3 emissions disclosures than for Scopes 1 and 2.

The SEC says it expects costs related to the proposal in the first year of compliance to be $490,000 on average for smaller reporting companies, and $640,000 on average for larger filers. Actual costs may be substantially higher, and will in any event pose a challenge for small and medium enterprises.  

Comments on the proposal

Due to intense interest from the public, the SEC extended its period for receiving comments on the proposal to June 17, 2022. Commenters have submitted over 3,400 individual letters, excluding over 10,000 standardized letters submitted by the general public. The commenters include corporations, private citizens, non-governmental organizations, trade and industry associations, law firms, investors and asset managers, and legal scholars.

Roughly 90% of the standardized letters support the proposal, while the individual letters both support and oppose various elements of the proposal. The SEC will consider this feedback in deciding whether to amend the proposal and vote on a final rule.

Criticisms of Scope 3 emissions disclosure requirements

Methodologies and materiality

The principal criticisms of the proposed Scope 3 requirements focus on ambiguities in data, methodologies and materiality standards. Many of the comment letters advocate rescinding or at least significantly scaling back the proposed Scope 3 disclosures.

The SEC, the commenters argue, should only require Scope 3 disclosures in the future once calculation methodologies are further developed. There are currently no widely accepted methodologies, which will diminish the ability of investors to compare registrants’ Scope 3 disclosures. In addition, significant challenges exist around data availability, data scope, the potential for double counting of emissions, and organizational barriers to information flow.

If the SEC retains the proposed Scope 3 requirements in its final rule, commenters encourage adding numerous limitations: the SEC should clarify that the “materiality” concept and disclosures should be based on existing materiality standards; disclosure of data sources should not be required; Scope 3 reporting should be limited to certain identified categories; and the SEC should allow Scope 3 disclosures to be “furnished” rather than “filed”.       

Notably, when the SEC unveiled its climate disclosure proposal, Commissioner Peirce released a dissenting statement entitled, “We are Not the Securities and Environment Commission—At Least Not Yet”. In it, she argues that the SEC should not issue such an extensive and prescriptive disclosure framework because existing rules already capture material risks to climate change. With respect to Scope 3 disclosures, her statement highlights the potential confusion created by the proposal’s metrics for materiality, which she says depart significantly from existing legal standards. 

Timing

Many of the commenters argue that the timeline for registrants’ disclosure for Scope 3 emissions should extend well beyond the deadline for their annual reports. Companies often receive emissions information from their suppliers many months or even a year after their fiscal year ends. Furthermore, third parties whose data are being included in an SEC filing may insist upon the opportunity to review any disclosures prior to filing, which could cause additional delays. Commenters also recommend that the initial compliance deadline and phase-in period for Scope 3 emissions disclosures should be extended overall.

Safe harbor

The SEC should also broaden the safe harbor proposed for Scope 3 disclosures, some of the comments say. The proposal provides that statements regarding Scope 3 emissions would be deemed not to be fraudulent unless such statements were made or reaffirmed without a reasonable basis or were disclosed other than in good faith. Some commenters urge that, rather than requiring registrants to have a “reasonable basis” to believe their Scope 3 disclosures are accurate, the safe harbor should apply unless the registrant has actual knowledge that the third-party information it is using is erroneous. Many commenters have also asked the SEC to clarify that the safe harbor applies to registrants’ determinations of whether Scope 3 information is material.

Aggregation

If the SEC’s rule is adopted as initially proposed, registrants will have to disclose Scope 1, 2 and 3 emissions (as applicable) both on an aggregate basis and broken down by constituent gas. This requirement, commenters point out, goes further than the recommendations by the Task Force on Climate-Related Financial Disclosures (TCFD). They urge the SEC to require disclosure of a specific constituent gas only if that gas is material to the registrant’s operations. Many comments also raise questions about the aggregation of Scope 3 emissions data for multiple corporate entities. They ask that the SEC provide clarity on, for example, situations where Scope 3 targets and goals are set at the parent corporation level but not at the subsidiary level; if the subsidiary is otherwise subject to separate disclosure requirements under the proposal, how should Scope 3 emissions be allocated? What if Scope 3 data are only available at the consolidated entity level? 

What’s next

Companies have concerns about tackling Scope 3 emissions because they don’t have a clear roadmap on how to collect, analyze, reconcile and report complex data from a range of third parties when making public disclosures. Although many market participants already provide this information on a voluntary basis, they may not be ready to make the leap to the level of scrutiny that mandatory disclosures involve. These requirements may also discourage companies from setting voluntary Scope 3 targets or goals, if they wish to avoid being subject to the SEC’s proposed Scope 3 rules. 

To address these challenges, companies are devoting substantial resources to increasing internal staffing, assessing their own positions, evaluating their supply chains, and seeking external assistance from consultants and technical experts. While understanding the full extent of a company’s carbon impacts requires Scope 3 data, it is an open question whether and how this data can be obtained reliably, consistently, and in a reasonably cost-effective manner.

The SEC is likely carefully considering its proposal for another reason, however. On June 30, the US Supreme Court issued a key ruling in West Virginia v. EPA that limits the powers of the Environmental Protection Agency to regulate greenhouse gas emissions without explicit congressional authority. Some advocates fear that the same analysis may be applied to actions of other administrative agencies, including the SEC. This approach could present serious legal challenges for the SEC’s final rule, as litigants will likely use the Supreme Court’s recent decision to claim the agency is acting outside the scope of its expertise and past activities. On the other hand, many observers believe the proposal is well within the SEC’s historical mandate to provide investors with decision-relevant information.

Our team continues to track this issue closely. Watch this space for our updated assessments of the SEC’s proposed rule.

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