Dissonance in Climate Disclosure: the SEC, EU, California, and ISSB Regimes

The global push for corporate climate disclosure has gained significant momentum in recent years, with major financial centers and regulatory bodies introducing new rules and frameworks. However, this increased activity has led to a puzzling divergence in approaches, particularly regarding the disclosure of greenhouse gas (GHG) emissions. While there is broad agreement on the importance of climate-related financial disclosures, regulators and standard-setters have taken notably different paths in implementing these requirements, especially concerning Scope 3 emissions. This divergence is particularly striking given the shared goals of enhancing transparency, combating greenwashing, and accelerating the transition to a low-carbon economy. The puzzle lies in understanding why, despite these common objectives, major jurisdictions have arrived at such different regulatory solutions. This situation raises important questions about the feasibility, effectiveness, and potential impacts of various disclosure regimes.

At the heart of this regulatory puzzle lies the challenge of Scope 3 emissions disclosure. Scope 3 emissions, which encompass all indirect emissions occurring in a company’s value chain, often represent the largest portion of a company’s carbon footprint. For many industries, particularly in the financial and technology sectors, Scope 3 emissions can account for over 90% of their total emissions. This makes Scope 3 data crucial for understanding a company’s true climate impact and assessing its exposure to transition risks.

However, measuring and reporting Scope 3 emissions presents significant challenges:

1. Data availability and quality: Companies often lack direct access to emissions data from their suppliers and customers, making it difficult to gather accurate information. Due to data scarcity, companies often report estimates based on aggregate industry information.
2. Methodological inconsistencies: There is no universally accepted methodology for calculating Scope 3 emissions or for estimating them absent underlying data, leading to potential inconsistencies and hampering comparability across companies and industries.
3. Double counting: The same emissions may be counted multiple times across different companies’ value chains, potentially distorting the overall picture of emissions within an industry or economy.
4. Resource intensity: Gathering and verifying Scope 3 data can be extremely time-consuming and costly, particularly for companies with complex global supply chains.
5. Liability concerns: The reliance on third-party data and estimations raises questions about the accuracy of reported figures and potential legal liability for misstatements.

These challenges have led to divergent approaches in different jurisdictions:

The European Union, through its Corporate Sustainability Reporting Directive (CSRD), has taken the most ambitious stance on climate disclosure, including mandatory Scope 3 reporting. The CSRD applies to a broad range of companies, including many private firms, and adopts a “double materiality” concept. This approach requires companies to report not only on how climate risks affect their business but also on their impact on the environment and society. The EU has also established a comprehensive institutional infrastructure to support companies in implementing these disclosures, including the development of detailed European Sustainability Reporting Standards (ESRS) by the European Financial Reporting Advisory Group (EFRAG).

In contrast, the U.S. Securities and Exchange Commission (SEC) initially proposed requiring Scope 3 emissions disclosure if deemed material or if the company had set related targets. However, in its final rule adopted in March 2024, the SEC removed the Scope 3 requirement entirely. This decision came after extensive public feedback highlighting concerns about data reliability, compliance burdens, and potential litigation risks. The SEC’s final approach focuses on requiring material Scope 1 and 2 emissions disclosures for larger companies, along with disclosures about climate-related risks that could materially impact a company’s strategy, profits, or financial condition.

California has charted a middle course with its climate disclosure laws enacted in October 2023. These laws require Scope 3 emissions reporting for both public and private companies doing business in California above certain revenue thresholds, regardless of materiality. However, recognizing the challenges associated with Scope 3 reporting, the laws include safe harbor provisions to protect companies from penalties related to Scope 3 misstatements made with a reasonable basis and in good faith. However, important questions have emerged as to California’s capacity to enforce these laws, particularly after the SEC has taken a different path.

The International Sustainability Standards Board (ISSB), while requiring consideration of Scope 3 emissions, has adopted a more flexible approach. The ISSB framework focuses on financial materiality and allows for jurisdictional adaptation, potentially enabling a more gradual and tailored implementation of Scope 3 reporting requirements across different markets.

In conclusion, the analysis of divergent approaches to climate disclosure, particularly regarding Scope 3 emissions, reveals a complex regulatory landscape shaped by competing priorities and practical challenges. Asked to strike a delicate balance between pushing for greater corporate accountability and recognizing the practical constraints faced by companies, policymakers opted for different approaches, objectives, and regulatory philosophies. The EU’s ambitious stance, with its comprehensive Scope 3 requirements and double materiality concept, aims to drive transformative change and combat greenwashing. The EU’s approach is bolstered by a more robust institutional infrastructure designed to guide companies through the reporting process which, by all accounts, it is expected to be burdensome. In contrast, the SEC’s decision to retreat from Scope 3 requirements acknowledges the current limitations in data quality, methodological standardization, and the heightened litigation risks in the U.S. market. All these risks and uncertainties are heightened by the lack of comprehensive institutional support for climate disclosure in the U.S. Moving forward, the central challenge for policymakers and regulators will be to design disclosure regimes that enhance supply chain visibility and incentivize decarbonization without imposing excessive costs or bureaucratic burdens that could hinder sustainability transitions. The effectiveness of these various approaches in driving actual emissions reductions and supporting the transition to a low-carbon economy remains uncertain and will likely be a subject of ongoing study and debate.