A New Business "Climate" Could Be Around The Corner
Here's What We Know
The SEC's proposed "Climate Rule" has the potential to significantly impact how businesses operate, requiring public companies to disclose climate-related information and financial metrics. However, the proposal has faced opposition from various industries. Will this rule change the game for the mortgage industry? And what do we know about the timeline?
A year ago, the SEC proposed a ruling that could have enormous impacts on publicly traded companies. The proposed ruling, entitled “Enhancement and Standardization of Climate-Related Disclosures”, has proven to be one of the most high-profile and debated rulings in SEC history, raking in more than 14,000 comments across industries spanning from manufacturing to academia.
This ruling, often referred to as the SEC’s “Climate Rule”, establishes new and far-reaching requirements for publicly traded companies to disclose climate-related information on registration statements and annual reports, such as the form 10-K. More specifically, the Climate Rule requires companies to disclose information regarding climate-related risks for investors, greenhouse gas emissions (GHG), and certain climate-related financial metrics in audited financial statements.
The number of comments made on the ESG Rule, 9,500 more than the landmark Dodd-Frank Rule
The ruling responds to increasing global demand for greater transparency around Environmental, Social, Governance (ESG) standards. These standards have continued to make their way to the forefront of investors’ minds in light of persistent natural disasters and increased risks related to climate change.
With this aim in mind, the proposed climate-related disclosures encompass many of the key concerns ESG aims to address and will demand fundamental changes to how businesses define and quantify their impact on the environment. For example, reporting on climate-related risks will require businesses to conduct assessments on existing assets to determine what, if any, climate-related risks there may be.
In tangible terms, owning property on the Florida coastline will present different risks than owning that same property in the center of Pennsylvania.
Furthermore, businesses would have to begin monitoring their environmental impact by recording all Direct (Scope 1) and Indirect (Scope 2) GHG emissions. This includes any emissions that the business either produces directly from their operations, or purchases from an energy supplier (including gas, water, and electric). These emissions are relatively straightforward to record, though the proposed ruling introduces a new wrinkle. The SEC is proposing certain stipulations for some businesses to report on additional emissions in Scope 3, which would require those businesses to document emissions up and down their entire value chain. This means that businesses would be accountable for climate impact from producers, suppliers, and any other party involved in business operations, over and above their own.
Reporting GHG emissions may require businesses to change operations to account for this new requirement, and in the case of Scope 3 emissions, require external audits or new processes entirely. In terms of the mortgage finance space, this includes Financed Emissions, which are GHG emissions banks and investors finance through their loans and investments, including mortgages; and Facilitated Emissions, which are emissions associated with "off balance-sheet activities performed by financial institutions" with capital markets transactions, including securitization.
Lastly, and perhaps the most demanding, is the new requirement for businesses to report climate-related financial metrics in their financial statements, most notably any climate cost that represents more than 1% of a total line item. This departure from the previous requirement to report only what is considered “material” for investors would force businesses to be much more granular when considering climate impact and would provide investors with more insight into how businesses are affected by the environment.
Though many applaud the new proposal for its focus on ESG and climate-conscious requirements, this proposal has been met with outspoken and nuanced opposition from organizations across several industries, including leaders across mortgage finance. According to research performed by Harvard Law School, 2/3 of those who critiqued the ruling cited wanting a disclosure threshold based on investor materiality, as opposed to the 1% threshold proposed. Within the mortgage finance space, organizations such as Mortgage Bankers Association (MBA) and Securities Industry and Financial Markets Association (SIFMA) stated the SEC’s proposed regulations are unnecessary to achieve their goals and called them “overly prescriptive.”
The percentage of critics that said the new disclosure requirements will present operational issues
Costs of compliance could force smaller organizations out of the market
Could have a negative impact on affordable/equitable housing goals
Potential Industry Downstream Impacts
Although the proposal has yet to be finalized, the SEC has proposed the following schedule to implement this ruling, which would hold large companies accountable for reporting on climate-related impacts as soon as next year (FY2023). With delays in finalizing the ruling, the likelihood of pushing back the proposed implementation will continue to rise. Even though the timeline will likely change, the order in which these changes would take place is likely to remain the same.
Rule proposed to become Law
Report all scopes every fiscal year going forward
Above Graphic: This timeline* highlights the schedule to implement climate-related disclosures for three types of companies. “Large” companies are considered any company with over $700M of public float and include companies such as Tesla, IBM, and Coca-Cola. Medium companies are a bit smaller, and have between $70M -$700M of public float; some examples of medium-sized companies include Spotify, Wendy’s, and Netflix. The final category are small companies, which includes any company with less than $70M of public float, some examples include Time Studios and Inogen.
* - this timeline is most likely going to bump out by at least a year
Though nothing is finalized, this ruling is sure to make waves for publicly traded companies and may even change how businesses operate, especially those companies that would be subject to the highly-debated Scope 3 emission reporting requirement. As the SEC works to address comments and finalize their proposal, we will regularly monitor changes to the Climate Rule and look for potential implications these changes will drive for ESG, investors, and the mortgage finance industry.