Supremely (un)Important? SEC Rules, Market Forces Will Be a Bigger Deal Than EPA Decision for Manufacturers

The U.S. Supreme Court’s June ruling on West Virginia v. Environmental Protection Agency (EPA) significantly restricts the agency’s regulatory powers: The EPA cannot regulate emissions from existing power plants via generation-shifting requirements. 

This decision prompted three responses: hand-wringing over the EPA’s ability to regulate in the future, excitement over the perceived deregulation of the power supply and (though the case was related to energy production), for manufacturers, confusion about what this means for them. 

The concern about the EPA’s future regulatory abilities is legitimate, but the excitement over deregulation is misplaced. Here’s why: Market forces have shifted the dynamic. Companies now face pressure in the form of:

• Public demand for accountability and corporate responsibility.
• The investment community’s reliance on environmental, social and governance (ESG) data sources.
• Soon-to-be enacted climate disclosure rules from the U.S. Securities and Exchange Commission (SEC) mean manufacturers must meet a higher standard of measuring, disclosing and ultimately reducing their emissions.

For manufacturers, the compounding pressures of investors, consumers and the marketplace require deep knowledge of supply chains, and (spoiler alert) far too many companies lack this type of in-depth knowledge of tier two and three suppliers.

The proposed SEC climate disclosure rules

The SEC has proposed rule changes requiring certain climate-related disclosures in registration statements and periodic reports toward the end of March 2022. These disclosures include information about climate-related risks that are likely to have a material impact on businesses, results of operations or financial condition. 

Climate-related risk disclosures would include a declaration regarding GHG emissions. These proposed declarations are based on the Greenhouse Gas Protocol, which includes: 

• Scope 1 and Scope 2 emissions metrics, both constituent greenhouse gasses disaggregated and in the aggregate, reported terms of intensity.
• Scope 3 emissions and their intensity, if they’re material.
• Scope 3 emissions, if the company has set an emissions target including these emissions.

The interesting part about the Scope 3 details is that it’s up to individual companies to define the materiality of their Scope 3 emissions on their overall climate disclosure. Given the impacts of the supply chain and the general push to outsource manufacturing, supply chain impacts are very relevant to the overall disclosure factor of a company. Therefore, companies that don’t disclose on Scope 3 (supply chains) are leaving their fate in the court of public opinion and in the hands of the ESG data sources used by investors.

This proposed rule aims to provide “consistent, comparable and reliable — and therefore decision-useful — information to investors.” It standardizes climate-related information in statements and reports to the agency. 

Moreover, this rule is both well within and consistent with the SEC’s authority to require disclosures from companies that protect investors. The agency explained that it proposed this rule because it’s responding to the “investor need [for] information about climate-related risks” that “have present financial consequences.”

The proposed rule responds to investor demand for more transparent ESG data while giving companies flexibility. It doesn’t require a company to undertake climate-risk planning or to use any particular methodology. 

Market pressure for greater corporate accountability

The momentum for corporate accountability and disclosures is ever-increasing. Manufacturers can no longer sit back and view sustainability as a nice-to-have. Demands for transparency and action continue. So, while the Supreme Court ruling is two steps back in the evolution of climate action, it does not take away the pressures companies are experiencing in today’s market. Investors, customers, workers and the market itself are all driving this pressure.

BlackRock, Vanguard Group and State Street Global Advisors, some of the largest and most powerful money management companies in the world, have publicly stated they will vote against directors of companies who fail to act on ESG matters. At the same time, consumers and workers are putting their time and money where their values are, as large majorities of both say they would look more favorably on companies that stand up for ESG principles.

The result of this pressure is obvious, as the market now expects greater accountability on ESG issues. ESG was mentioned in only 5% of corporate earnings calls in May 2019; just two years later, that figure had nearly quadrupled. 

Supply chain transparency helps manufacturers meet market demands 

Reporting capabilities rely on a foundation of supply chain transparency. Manufacturers need to see deep into their supply chain to understand where their risks are hidden. 

Many manufacturers lack this visibility into their supply chain. A 2015 study of over 500 companies in 71 countries revealed that nearly three-quarters of businesses don’t know their tier two and tier three suppliers. 

Yet those suppliers are where the risks lie. They might not be aware of sustainability best practices — or the regulations in their country might be looser than in the U.S. These suppliers might be polluting the environment or engaging in other practices that reflect poorly on manufacturers. This is why it’s so critical to understand the measures and control functions your direct suppliers put on their suppliers. If you’re not measuring controls that assert pressure, set expectations and help drive education and change, you’re at risk.

Without supply chain transparency, manufacturers don’t know what risks they face, which leaves them vulnerable. A supplier’s actions, even if that supplier is far upstream, could destroy a manufacturer’s reputation with investors and customers.