The U.S. Securities and Exchange Commission's (SEC) proposed amendments1 on climate-related disclosures would require public companies, or "registrants," to provide detailed climate-related information in their registration statements and annual reports. While registrants fall under the SEC's rulemaking authority, there is good reason for non-registrants to also take note. In particular, the SEC's proposal on "Scope 3 emissions" would require registrants—with certain exceptions—to disclose greenhouse gas (GHG) emissions from upstream and downstream activities in their value chains.2 This proposal is consistent with the rise in investor demand for such information,3 as well as the significant support among investors for mandatory disclosure of Scope 3 emissions.4
In order to accurately calculate emissions from upstream and downstream activities, registrants will rely on their partners, suppliers and customers to provide emissions data. This process may implicate private companies by requiring them, to the extent they are not already doing so, to track, evaluate and report emissions data in order to maintain business relationships with public companies. This could impose significant costs on private companies, particularly those that play a significant role in the supply chains of public companies. Accordingly, private companies should prepare to assess and report GHG emissions as U.S. public companies seek more accurate and direct data—whether directly from suppliers or customers, or from services that aggregate this data directly from suppliers and customers.
What are Scope 3 Emissions?
The SEC bases its proposed GHG disclosure requirements on the Greenhouse Gas Protocol's concept of emissions "scopes," which defines three categories of emissions directly attributable to the registrant or indirectly attributable to the registrant's activities:
- Direct "Scope 1" emissions from sources owned or controlled by the registrant.
- Indirect "Scope 2" emissions from the generation of purchased electricity and other forms of energy consumed by the registrant's operations.
- "Scope 3" emissions, which are all other indirect emissions not otherwise included in the registrant's Scope 2 emissions that occur in the upstream and downstream activities of the registrant's value chain.5
Because Scope 3 emissions "can make up the vast majority of total emissions for many registrants,"6 the SEC explains that these emissions "may reflect a more complete picture of companies' exposure to [climate-related] transition risks than Scopes 1 and 2 emissions alone."7
What are the Proposed Requirements?
The SEC's proposed amendments would require registrants to disclose their Scope 3 emissions only if those emissions are material—i.e., "if there is a substantial likelihood that a reasonable investor would consider them important when making an investment or voting decision"—or the registrant has set a GHG emissions reduction target or goal that includes Scope 3 emissions.8
In assessing materiality, the SEC explains that registrants "should consider whether Scope 3 emissions make up a relatively significant portion of their overall GHG emissions," but does not provide a quantitative threshold.9 Instead, the SEC notes that some companies rely on "a quantitative threshold such as 40 percent when assessing the materiality of Scope 3 emissions,"10 and cites the Scope 3 emissions of oil and gas product manufacturers as likely to be material.11 The SEC clarifies that a registrant's Scope 3 emissions may constitute a relatively small portion of its overall GHG emissions "but still be material where Scope 3 represents a significant risk, is subject to significant regulatory focus, or if there is a substantial likelihood that a reasonable [investor] would consider it important."12
Moreover, the SEC proposes that registrants describe the data sources used to determine their Scope 3 emissions. To that end, the proposed rule identifies the following as potential sources of data:
- Emissions reported by parties in the registrant's value chain and whether such reports were verified by the registrant or a third party, or unverified.
- Data on specific activities13 reported by parties in the registrant's value chain.
- Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a registrant's value chain.
Recognizing the challenges for measuring and disclosing emissions that occur from activities outside a registrant's direct ownership or control—which relies on third-party data that may be difficult to verify—the SEC proposes several "accommodations" for registrants. This includes phasing-in Scope 3 disclosures after Scopes 1 and 2, with the first reporting of Scope 3 required for large accelerated filers in fiscal year 2024 (filed in 2025); a new safe harbor for Scope 3 disclosures; and a full exemption from the Scope 3 disclosure requirements for smaller reporting companies.14
For a deeper dive into these proposed requirements related to Scope 3 disclosures, see our client alert.
Implications and Next Steps for Private Companies
The proposed Scope 3 emissions disclosure requirements would not regulate private companies directly. However, private companies serving as suppliers, customers or partners within a registrant's value chain—e.g., food and agriculture suppliers, component manufacturers, equipment suppliers, professional service companies—may face significant indirect impacts. In order to report its Scope 3 emissions, a registrant will need to obtain data on the Scope 1 and Scope 2 emissions of suppliers, distributors and other business counterparties in its value chain—regardless of whether such entities are themselves regulated under the proposed rule.
To prepare, private companies should start thinking about how to evaluate, measure and report their GHG emissions. Some initial actions to consider include the following:
- Review Your Business Counterparties: Evaluate the company's reliance on business relationships with registrants likely to be subject to the proposed Scope 3 reporting requirements. Because Scope 3 emissions are, by definition, indirect emissions, if you have business relationships with counterparties who are required to measure Scope 3 emissions, you can expect that such customers, suppliers or partners will seek emission information from your company and will be focused on both the content and quality of such information. Also consider that it may not matter if your counterparty is a U.S. public company. Ask yourself if you are part of the value chain directly/indirectly. If so, your company may get more pressure directly from intermediary larger suppliers/customers.
- Consider Your Investor Base: Investors are increasingly focused on transparency and disclosure around climate-related risks. Consider whether your investors also invest in entities that provide, or are likely in the future to provide, GHG emissions information. As such reporting becomes increasingly common it may become expected, even from private companies. Are your investors demanding this information irrespective of the proposed rule?
- Assess Internal Resources and Engage Experts: Evaluate whether your company has dedicated resources and management know-how to conduct a comprehensive assessment of your company's GHG emissions. At a minimum, such an assessment should provide an accurate accounting of your Scope 1 and Scope 2 emissions. Determine what additional resources must be allocated to properly track, calculate, interpret and report GHG emissions data. This might ultimately mean hiring a third-party consultant. Also consider engaging with trade associations to evaluate available resources in your company's industry.
Irrespective of potential requirements from business counterparties, private companies may face increased pressure to measure and report their Scope 1, 2 and 3 emissions from investors. This is part of a global megatrend regarding sustainability reporting and carbon accounting. In the United States, as investors become accustomed to receiving Scope 3 emissions data from public companies, the market may come to expect such reporting in connection with private securities offerings as well. The SEC observed as much in its proposed rule that "[t]he pressure on private companies to disclose information on climate-related risks is rapidly escalating within the private industry."15 This emphasis is not only on reporting in the first instance, but also on the quality of the disclosure provided.
Given these potential implications, private companies that have business relationships with registrants should consider submitting a comment letter on the SEC's proposed amendments ahead of the June 17 deadline. Comments may address any aspect of the proposed amendments, or respond directly to one or more of the 200+ specific topics the SEC lists for comment.
2 The SEC proposes to define "value chain" as the "upstream and downstream activities related to a registrant's operations. Upstream activities in connection with a value chain may include activities by a party other than the registrant that relate to the initial stages of a registrant's production of a good or service (e.g., materials sourcing, materials processing, and supplier activities). Downstream activities in connection with a value chain may include activities by a party other than the registrant that relate to processing materials into a finished product and delivering it or providing a service to the end user (e.g., transportation and distribution, processing of sold products, use of sold products, end of life treatment of sold products, and investments)." See SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors at 461-62 (2022), https://www.sec.gov/rules/proposed/2022/33-11042.pdf ("Proposed Rule").
3 See, e.g., Wellington Management, Global Proxy Voting Guidelines 9 (2022), https://www.wellington.com/uploads/2022/02/e1f38ecb3c5459eb94d0b0271136f144/wellington-global-proxy-voting-guidelines-2022.pdf ("We encourage all companies to disclose Scope 1, 2, and 3 emissions . . . Disclosure of both overall categories of Scope 3 emissions – upstream and downstream – with context and granularity from companies about the most significant Scope 3 sources, enhances our ability to evaluate investment risks and opportunities.").
4 Proposed Rule at 153, n. 412.
5 Example upstream emissions includes those associated with the production and transportation of goods a registrant purchases from its third-party suppliers and employee business travel/commuting, while example downstream emissions include those attributable to the distribution, use and end-of-life treatment of the registrant's products or the registrant's investments. Proposed Rule at 39-40, 150.
6 Proposed Rule at 424.
7 Proposed Rule at 165.
8 Proposed Rule at 151, 162.
9 Proposed Rule at 165 (emphasis added).
10 Proposed Rule at 165.
11 Proposed Rule at 165.
12 Proposed Rule at 166.
13 Proposed Rule at 172, n.466. Such data refers to a quantitative measure of a level of activity that results in GHG emissions (e.g., liters of fuel consumed, kilowatt-hours of electricity consumed or kilograms of material consumed).
14 The Commission's rules define a smaller reporting company to mean an issuer that is not an investment company, an asset-backed issuer or a majority-owned subsidiary of a parent that is not a smaller reporting company and that (1) had a public float of less than $250 million or (2) had annual revenues of less than $100 million and either (i) no public float or (ii) a public float of less than $700 million. See 17 CFR 229.10(f)(1), 230.405 and 17 CFR 240.12b-2.
15 Proposed Rule at 405.
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