For the first time, US public companies will be required to tell investors about their exposure to climate risks and greenhouse gas emissions.

On Wednesday, the Securities and Exchange Commission approved requiring US-listed companies to communicate how they are managing material risks related to climate change and how those risks affect their bottom lines. Large companies will also be required to disclose their direct emissions from their operations and energy use, known as Scope 1 and Scope 2 emissions.

"I think it's important for the US to have its own standards based on US law, based on the economics of our markets, based upon what investors here are using to make investment decisions, and I think today's action is that important step for our US capital markets," SEC Chair Gary Gensler said during the meeting. "These roles will enhance the disclosures that investors have been relying on to make their investment decisions. Issuers and investors will benefit from the consistency, comparability, reliability of these disclosures."

The measure passed 3-2 along political lines following two years of review and over 24,000 comments on the proposal.

No Scope 3 standard

The SEC notably pared back the final ruling, trimming a provision that would have required companies to report their Scope 3 impact — that is, indirect emissions from suppliers and consumers.

The Scope 3 standard faced considerable resistance from conservatives and business groups who complained about high compliance costs and overreach, while climate-focused investors and lawmakers pushed for the SEC to include Scope 3 to help crack down on companies downplaying their full environmental impact.

SEC's exclusion of Scope 3 data is considered a win for many businesses given that indirect emissions make up the largest and fastest-growing category of emissions.

Scope 3 categories include emissions from purchased goods, employee commutes, projects financed, and the use of products sold, among others. In the oil and gas sector, Scope 3 emissions can account for up to 95% of emissions; in financial services companies, the figure is even higher at up to 99%.

Nevertheless, the landmark ruling by Wall Street's top regulator sets mandatory requirements — detailed in the SEC press release — that provide greater consistency, comparability, and reliability in climate data so that investors and consumers can make more informed decisions.

"I think what's kind of most important is that the information begins to flow," Bryan McGannon, managing director at US SIF (the Sustainable Investment Forum), told Yahoo Finance. "So even if it doesn't include Scope 3 information, investors are going to get, for the first time, companies reporting their climate risk."

Josh Griffin, co-founder and chief policy officer at NZero, a climate data platform, told Yahoo Finance that companies are "seeing that their customers want a better understanding, and it’s showing up in market choices. Companies that not only invest in technologies to reduce their emissions but [also] are transparent about their efforts are being rewarded by their customers. This is where these regulatory requirements from the SEC are so vital because they create consistency and shared expectations."

What the SEC climate rule means for companies

The landmark rule will affect thousands of companies, many of which already provide this information publicly on a voluntary basis or to comply with other regulations.

Companies will now face four main types of disclosure requirements when they register with the SEC and in their annual reports: what their climate risks are, how they are adapting to those risks, how the board of directors is overseeing climate strategy, and how climate targets will affect the business.

Large non-exempt companies will also have to list their Scope 1 and Scope 2 emissions. Many already track that information: As of 2022, nearly all S&P 500 companies and 90% of Russell 1000 companies published sustainability reports, according to the Governance & Accountability Institute.

"There are fairly well-established methods for being able to build out Scope 1 [data]," Rob Fisher, the US ESG Leader at KPMG, told Yahoo Finance. "Scope 2, frequently, it's not overly complicated. There are many aggregation services ... that are able to get your Scope 2 emissions."

The SEC expects large corporations such as Apple (AAPL), Tesla (TSLA), and Exxon (XOM) to begin reporting their climate risk-related information in their fiscal year 2025 and to report their greenhouse gas emissions by fiscal year 2026. They will also need to submit a limited third-party review of their emissions data by 2029 and a full audit by 2033.

Smaller companies and emerging growth companies will have an additional two years to disclose their climate risks and will not be required to report their emissions, which provides space for new technological developments to evolve.

"The climate rule [that] got issued in March 2022 was basically before the rise of generative AI," KPMG's Fisher noted. "And now, you know, things have kind of gone crazy. … So, I think the intersection of AI and this new reporting requirement is quite interesting because we can do some things very differently now in how we address the rule this time around than we could last time."

Fisher noted that for "most organizations, building out a Scope 1 and 2 greenhouse-gas inventory is certainly not trivial, depending on the scope and size of the operation. But certainly ... the big thing is that the data generally resides inside the virtual four walls of the organization."

How prepared they actually are to meet these requirements is not entirely clear. A KPMG survey found that 4 out of 5 companies say they are ahead of their peers when it comes to sustainability reporting, yet nearly half still lean on spreadsheets to manage data instead of advanced data systems.

"The tools are more readily available and more seamless for companies to gather their Scope 1 and 2 emissions," nZero's Griffin said. "Scope 3 still presents a lot of challenges because of jurisdictional issues, but the market for collecting such data has also grown quite a bit in the last two years."

SEC went to 'great lengths'

The SEC's rule marks a step up in climate disclosure requirements, and it's been a long time coming.

Since 1971, the SEC has recommended that companies communicate the cost of complying with environmental regulations. In 2010, the agency went further to suggest that companies should voluntarily provide details about their exposure to climate risks, if material.

Increasing extreme weather events, scrutiny around inflated sustainability claims, and pressure from activists, investors, and governments only heightened the pressure for mandatory disclosures.

By 2021, the SEC began seeking feedback on the shape of climate disclosure policy. When it released its draft proposal in March 2022, it drew polarized responses from groups on both sides of the aisle that only intensified as ESG investing became a political lightning rod.

And while the rule has been finalized, the issue is far from settled. Lawsuits against the SEC are virtually guaranteed, experts say, something Gensler has been preparing for.

Although the removal of the Scope 3 rule may lessen the risk of litigation from the US Chamber of Commerce, American Farm Bureau Federation, and National Association of Manufacturers, it could provoke the opposite reaction from green groups.

"I think what has taken them long to come to the final rule was to make sure that what was in the final rule is as durable as possible to withstand litigation challenge," US SIF's McGannon said. "I think they went to really great lengths to ensure that the rule would stand."

Climate regulations around the world

Companies have also been closely watching whether the SEC's rule would align with disclosure requirements that have gained traction around the world or else join what Fisher called a "patchwork quilt" of regulations that collectively raise compliance costs.

One benchmark is the European Union's Corporate Sustainability Reporting Directive, which took effect on Jan. 5, 2023. The EU law has a broader definition of materiality that includes human and environmental impacts as well as financial impacts. The EU also mandates reporting of Scope 3 emissions, which the SEC stopped short of.

The United Kingdom, Canada, Japan, and Hong Kong have also set climate reporting standards. And earlier this year, China hinted at joining them.

Then there's California's climate disclosure law, signed by Governor Gavin Newsom in October 2023, which made the state the first in the US to approve such a measure. It also set the stage for legislators in New York and Illinois to follow suit with their own climate disclosure bills.

California's two climate disclosure laws, SB 253 and SB 261, go much further by requiring disclosures from both private and public companies that do business in the state. Those with revenues over $500 million must publish their climate risk plans, and those with over $1 billion in revenue are required to disclose their greenhouse gas emissions.

The effect is that many large multinationals or companies with operations in California will be required to report Scope 3 emissions even if the SEC is not requiring them to do so.

"Scope 3 may be out of the SEC’s climate rule but it’s very much in scope for US multinationals and likely many private companies," Fisher wrote in an email following the decision. "The SEC’s rule followed actions of the EU, California, and the ISSB, all of which require Scope 3 reporting. Regulatory relief in one jurisdiction does not alter the burden imposed in others."

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