The SEC’s recently released (and long-awaited) proposed rule changes that will require disclosure of climate-related risks (“the Proposed Rule”) are likely to have significant supply chain implications. The Proposed Rule would require listed companies to disclose information on climate-related risks and Greenhouse gas (“GHG”) emissions; as explained below, both of these disclosure categories include data related to corporate supply chains, and thus the Proposed Rule would essentially require public companies to obtain and analyze climate risks and climate impact data related to its upstream and downstream suppliers.
Climate-Related Risks Disclosure – the Extended Enterprise (including supply chains)
The Proposed Rule broadly defines “climate-related risks” to encompass both actual and potential negative impacts of climate-related conditions and events on companies’ consolidated financial statements, business operations, and value chains, as a whole. In turn, “value chains” are defined as both upstream and downstream activities related to company operations. The Proposed Rule clarifies that under this definition, upstream activities include activities by a party other than the registrant that relate to the initial stages of a registrant’s production of a good or service (e.g., materials sourcing, materials processing, and supplier activities), and downstream activities include activities by a party other than the registrant that relate to processing materials into a finished product and delivering it or providing a service to the end user (e.g., transportation and distribution, processing of sold products, use of sold products, end of life treatment of sold products, and investments). The SEC explained that it deliberately included value chains within the definition of climate-related risks in order to capture the full extent of registrants’ potential exposure to climate-related risks, which can extend beyond their own operations to those of their suppliers, distributors, and others engaged in upstream or downstream activities. Therefore, in order to comply with the proposed disclosure requirements, public companies will have to analyze and disclose not only their own climate-related risks, but also the risks stemming from their upstream and downstream suppliers (including impact of so-called “Scope 3” emissions).
Moreover, in addition to disclosing relevant climate-related risks, registrants would be required to describe the actual and potential impacts of the identified risks on their strategy, business model, and outlook. The Proposed Rule specifically notes that this disclosure includes any actual and potential impacts of climate-related risks on “suppliers and other parties in the company’s value chain.” Finally, publicly listed companies would be required to disclose governance related information related to any oversight of climate-related risks by the board of directors. Specifically, companies would be required to disclose:
- any board members or board committees responsible for the oversight of climate-related risks;
- whether any member of the board of directors has expertise in climate-related risks, including sufficient detail to fully describe the nature of the expertise;
- a description of the processes and frequency by which the board or board committee discusses climate-related risks;
- whether and how the board or board committee considers climate-related risks as part of its business strategy, risk management, and financial oversight such as when reviewing and guiding business strategy and major plans of action, when setting and monitoring implementation of risk management policies and performance objectives, when reviewing and approving annual budgets, and when overseeing major expenditures, acquisitions, and divestitures; and
- whether and how the board sets climate-related targets or goals and how it oversees progress against those targets or goals.
Similarly, the Proposed Rule would require disclosures about management’s role in assessing and managing any climate-related risks.
GHG Emissions Disclosure – Scope 3 Emissions
The second category of disclosures required under the Proposed Rule are GHG emissions. The SEC noted that GHG emissions information is important to investment decisions, including because GHG emissions data is not only quantifiable and comparable across industries, but also capable of being used to evaluate the progress in meeting net-zero commitments and assessing any associated risks. The GHG emissions disclosures required under the Proposed Rule are based on the concept of scopes, which are themselves based on the concepts of direct and indirect emissions, developed by the GHG Protocol. The GHG Protocol has become the leading accounting and reporting standard for GHG emissions and thus the proposed definitions of Scope 1, Scope 2, and Scope 3 emissions are substantially similar to the corresponding definitions provided by the GHG Protocol.
Any supply chain related emissions disclosures are encompassed by the term “Scope 3 emissions,” which are defined as indirect emissions, not otherwise included in a registrant’s Scope 2 emissions (i.e., emissions generated from the electricity, steam, heating and cooling consumed by the company), which occur in the upstream and downstream activities of a registrant’s value chain. These emissions stem from the use of the registrant’s products, transportation of products (for example, to the registrant’s customers), end of life treatment of sold products, investments made by the registrant, as well as the transportation of goods in the registrant’s downstream supply chains and employee business travel and commute. Recognizing the potential difficulty of calculating Scope 3 emissions, under the Proposed Rule, disclosure of Scope 3 emissions would only be required if those emissions are “material,” i.e., if there is a substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision, or if the registrant has set a GHG emissions reduction target or goal that includes its Scope 3 emissions. The Proposed Rule also includes a safe harbor for Scope 3 emissions disclosure from certain forms of liability under the Federal securities laws, an exemption for smaller reporting companies from the Scope 3 emissions disclosure provision, and a delayed compliance date for Scope 3 emissions disclosure.
Key Takeaways on Supply Chain Implications
Although the Proposed Rule has not yet been adopted and is almost certain to be challenged in court, companies are well-advised to begin implementing processes and procedures that would allow them access to their climate-risk and impact related supply chain data. As recognized by the SEC, the investment community is interested in having more visibility into how companies are responding to climate risks, and thus a mandatory set of disclosures in this area appears to be on the horizon. At the same time, because they are indirect and often several layers removed from the company, assessing supply chain related risks and impacts can be more difficult and thus time-intensive. Even non-listed companies not directly subject to the Proposed Rule will likely be impacted as listed companies in their value chains require additional reporting and cooperation by their value chain partners to comply with SEC obligations. Therefore, to prepare for upcoming regulatory requirements (and demands by key value chain partners), companies should consider:
- mapping out their upstream and downstream supply chains to understand relevant tier 1, tier 2, and below suppliers and their role in the company’s value chain;
- developing a supply chain risk assessment process (in addition to climate risks, it may be useful and efficient to assess risks of social risks also subject to emerging regulation and litigation, including forced and underage labor, human trafficking, and workers’ rights violations);
- establishing a board of directors committee that would regularly review climate-related supply chain risks and impacts;
- reviewing the efficacy of current policies, procedures, and other program elements to cover the risk of climate and governance failures both in supply chains and in broader enterprise operations;
- reviewing their current emission and other climate-related targets to make sure they are achievable; and
- communicating to their suppliers any climate impact and GHG emission goals and/or expectations.