The SEC’s landmark climate regulations were quickly challenged in court and the agency voluntarily stayed enforcement while the judicial process goes on. The inclusion of a “materiality” qualifier in the agency’s rule may sound good on paper, but could be much more challenging to execute in reality, says Tim Siegenbeek van Heukelom of ESG and sustainability tech company Socialsuite.
When the SEC announced its proposed climate rules in 2022, corporations, sustainability practitioners, climate experts and all sides of the political spectrum expressed strong views. Some hoped the SEC would match the rigorous and prescriptive nature of the European European Sustainability Reporting Standards (ESRS) on climate, while others argued the SEC exceeded its remit.
The final SEC climate rule does not set a new bar like the EU’s Corporate Sustainability Reporting Directive (CSRD); rather it is raising the bottom but is still a significant step forward in U.S. climate-related regulation. At 886 pages, the SEC’s climate disclosure rules are looser and less prescriptive than either the International Financial Reporting Standards or ESRS.
In addition to being less prescriptive, the rules are also the subject of a court fight over whether they are even constitutional, an effort that may be bolstered by the U.S. Supreme Court’s July rulings striking back against federal agency authority.
If they do go into effect, materiality will be at the heart of the SEC’s rules.
Materiality
Perhaps the most dramatic change from the proposal: Most of the climate-related disclosures the rule covers are now mandatory only if they’re considered material. The SEC stayed consistent with its disclosure rules over the decades by requiring companies to only disclose climate issues that are “financially material.”
The implication is that many of the disclosures in the climate rule are expressly tied to materiality, including those relating to scenario analysis, targets, goals, transition plans, internal carbon price and some of the financial statement footnote disclosures. That’s great in concept, since it will enable companies in many cases to exclude disclosures they determine to be immaterial.
It does mean that companies will have to go through the exercise of assessing materiality, which is sometimes easy but can be much harder. There will be significant assumptions and potentially inconsistencies in how materiality is quantified and interpreted, potentially muddying the waters. Moreover, the definition of financial materiality has been debated for years, the latest definition to use comes from the Supreme Court ruling TSC Industries v. Northway: “a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote or make other investment decisions.”
There is also the risk that investors or the SEC will disagree with a company’s determination of materiality, or it could be out of sync with the market or investor views. Companies will clearly have to explain why they might not deem Scope 1 and Scope 2 emissions material. For many companies, it will be hard to argue that emissions are immaterial in a way that an auditor will approve. Therefore, in the end, most companies will likely still have to report their Scope 1 and Scope 2 emissions.
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Read moreDetailsGHG emissions
The reporting of material Scope 1 and Scope 2 emissions is required of large accelerated and accelerated filers. Reporting of Scope 3 (value chain) emissions is not required under the SEC climate rule.
In terms of disclosing Scope 1 and 2 emissions, the materiality principle comes into play here as well. Here is the slightly paraphrased explanation from the SEC climate rule:
Materiality of Scope 1 and/or Scope 2 emissions is not determined merely by the amount of emissions. The guiding principle is whether a reasonable investor would consider the disclosure of the company’s Scope 1 emissions and/or its Scope 2 emissions important when making an investment or voting decision or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.
A company’s emissions may be material because their calculation and disclosure are necessary to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations or financial condition in the short or long term.
Example: Performance on climate goals can make GHG emissions material
A company’s greenhouse gas emissions might be material if knowing about them helps investors see whether the company is making progress toward meeting certain climate goals or transition plans they have to disclose according to the climate rule.
However, the fact that a company is exposed to a material transition risk does not necessarily result in its Scope 1 and Scope 2 emissions being de facto material.
Example: A material transition risk does not necessitate material GHG emissions
A company could reasonably determine that it is exposed to a material transition risk for reasons other than its GHG emissions, such as a new law or regulation that restricts the sale of its products based on the technology it uses, not directly based on its emissions.
Whenever deemed material, disclosed emissions can be aggregated in terms of CO2 equivalent rather than disaggregated by gasses. However, if a particular gas is material, that gas will need to be disaggregated. All emissions must be disclosed in gross terms, not netted against offsets.
There is flexibility in determining the reporting boundaries used for GHG emissions as long as the method is disclosed. Similarly, no particular calculation methodology is prescribed, but disclosure of the used protocol or standard is required.
Climate-related risks
Companies need to report climate-related risks, including both physical risks and transition risks, that materially impact (or are reasonably likely to materially impact) the company. It is important to note that companies must disclose material climate risks across the entire value chain. While value chain GHG emissions are not required, you will need to assess your entire value chain for material climate-related risks.
The key exception to the materiality determination is for physical climate risks: Companies must disclose all financial impacts greater than 1% of profits before taxes.
Tim Siegenbeek van Heukelom is chief impact officer at Socialsuite, an ESG and social impact reporting provider. Tim has over 14 years of professional experience in the fields of ESG, corporate strategy, public relations, business intelligence, corporate governance and social impact. 
