SEC’s new climate disclosure rules may have limited impact on emissions reduction

The Securities and Exchange Commission (SEC) recently approved rules requiring large publicly-traded companies to disclose certain climate-related information. These new rules aim to leverage investors to encourage public companies to address climate risks and reduce  emissions.

SEC’s rules require companies to disclose two broad categories of information:

• Any material climate risks a company is subject to and its plans and actions to address them.
• Scope 1 and scope 2 emissions of the businesses.
  • Scope 1 emissions are those generated by a company’s own economic activities.
  • Scope 2 are those associated with the electricity a company purchases.

Although well-intentioned, these rules are unlikely to make a meaningful long-term impact on emissions reduction.

The fundamental issue is that the SEC’s new climate disclosure rules do not have teeth. While some investors may value this additional information, the rules do not provide direct incentives to reallocate their portfolios because the rules do not change the relative return on various projects. Contrast this with policies such as emissions regulations, tax credits, or a carbon tax, which would all change the economics of certain projects.

Unlike legislation, these rules are not durable. Federal regulations are vulnerable to litigation and might be rolled back by a new administration. Investors make decisions by assessing future risks and returns. If they are unsure that a rule will still be in place in the long run, they may take a wait-and-see approach rather than taking meaningful actions today to respond to a new rule. Indeed, several entities, including the U.S. Chamber of Commerce, have already filed legal challenges against the rules–as have ten states, which questioned SEC’s statutory authority to make the rules. The Fifth U.S. Circuit Court of Appeals temporarily stayed the rules after two companies filed a lawsuit.

Despite the shortcomings, these rules are an improvement over their first iteration. When first proposed in 2022, the rules would have mandated large public companies to disclose “scope 3” emissions. These are the emissions generated by a company’s suppliers and customers. Requiring companies to disclose emissions information across their supply chains would create an onerous compliance burden for companies, especially those with complex global supply chains. Such a mandate is costly but provides little direct incentives for a reporting company’s upstream and downstream organizations to reduce emissions. 

Some research suggests that information disclosure rules may have some impact on companies’ behaviors depending on the design of the rules. A study finds that the Environmental Protection Agency’s voluntary emissions disclosure regulation led to some emissions reductions at targeted power plants. However, the same research suggests that some of the emissions reduction was due to companies’ gaming of the reporting requirements by reallocating emissions to other facilities not covered by the disclosure program. 

SEC’s new climate disclosure rules indicate that the U.S. federal government recognizes the importance of having the financial market incorporate climate risks and emissions information in investment decisions. However, U.S. lawmakers should recognize the limitations of the SEC climate disclosure rules as a means of permanently and meaningfully reducing emissions and look to leverage legislative action to address climate change when there is political feasibility.