California legislators passed a bill Monday night that would force larger companies doing business in the state to disclose how much carbon dioxide pollution they, and their supply chains, generate. It will be the first mandate of its kind in the nation if it’s signed into law and comes ahead of the Securities and Exchange Commission’s (SEC) ESG rules, which are expected soon.
The bill, SB 253, requires the California Air Resources Board (CARB) to develop rules by 2025 for companies with annual revenues over $1 billion. By 2026, the companies would have to publicly report greenhouse gas emissions that come from their operations. They will also be required to disclose how much pollution is generated by their supply chains and customers by 2027.
The requirement that companies disclose emissions from their supply chains and consumer use of their products and services, or “Scope 3” emissions, has received the most pushback. The aim is to encourage companies to create products that pollute less and force suppliers to slash their own emissions. Scope 3 emissions typically make up the largest percentage of a company’s overall carbon footprint, which is why environmental advocates have fought to include them in new rules for some time.
The bill will now go to Governor Gavin Newsom’s desk to sign into law. How California might enforce this law is obviously still to be decided. Ultimately, the Air Resources Board will be tasked with crafting the appropriate regulations.
Proposed SEC Rules
The SEC proposed rules in 2022 that would mandate similar disclosures by publicly traded companies at the federal level. Those rules were expected to be finalized earlier this year but have faced delays with stiff opposition by companies that have been particularly reluctant to share their Scope 3 emissions. Disagreement about what should be included has fueled the holdup. Many companies, financial advisers, and asset managers are starting to prepare, however.
The proposal would make many public securities issuers disclose their carbon footprints, requiring Scope 1 and 2 emissions, or those that relate to their operations, to be verified by independent third parties. Wide-ranging Scope 3 emissions, which can pertain to everything a business sells, would also have to be reported by many large companies, as would their reliance on carbon offsets.
Since the proposed rules were outlined, there has been significant pushback, with a record-breaking 15,000 comments about Scope 3 reporting submitted to the regulator. When the rules do finally arrive many, including SEC chair Gary Gensler, expect there will be some changes.
The first big question is where emissions disclosures will be required to be provided. In the current proposal, some information is required in financial statements, while other information is required in the SEC filing but outside the financial statements. The information included in the financial statements is subject to a higher level of diligence by the external auditor. It may be that we could see information requirements being shifted from the financial statements to the rest of the filing.
Secondly, the proposed definition of materiality may be watered down. This is currently deemed to be a higher standard than the current definitions of materiality in the SEC financial disclosure area and inclusion of some information in the financial statements which would subject these disclosures to ICFR.
Finally, the timeline for reporting on Scope 3 emissions may be extended, as the timeline is currently perceived to be aggressive by many. The calculations for Scope 1 and 2 are widely perceived as fit for purpose now, and many businesses have been providing this data for a number of years. Scope 3 is a very different story and is likely to be challenging requiring massively enhanced protocols, processes and infrastructures.
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