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Private firms may be asked to divulge GHG emissions under US ESG proposal

07 June 2022 Amena Saiyid

US private investors in funds with an environmental, social, and government (ESG) focus may be obliged to divulge their GHG emissions under a proposed rule.

The US Securities and Exchange Commission (SEC) proposed a rule 25 May that lays out a framework for greater investor clarity by requiring ESG-focused funds disclose the criteria they use to screen companies, the indices they follow in their annual reports, and how they cast proxy votes with companies on ESG issues.

The proposal, which is subject to public comment before it is finalized, does so by seeking to require ESG-focused funds—including impact funds that have identified GHG emissions reductions as a goal—reveal the carbon footprint and the weighted average carbon intensity of their portfolio.

The SEC, however, made it clear that ESG funds that do not consider the GHG emissions of their investments are not required to disclose those metrics.

"With access to GHG metrics, fund investors and market participants could review the relative carbon footprints and carbon intensity of ESG-focused funds against comparable funds and determine whether a fund's climate or sustainability disclosures align with its actual GHG metrics," the SEC wrote in its proposed rulemaking.

No regulations on ESG funds

Asset managers and issuers can basically say whatever they want with ESG reporting and they can choose their own methods for calculations or disclosure, according to Sotiria Anagnostou, sustainability director at STORE Capital, a net-lease real estate investment trust.

The "SEC guidance will hopefully establish a framework and we will see increased standardization in emissions reporting, making it easier to identify greenwashing," Anagnostou told Net-Zero Business Daily by S&P Global Commodity Insights.

The 25 May proposal follows the climate-related risk disclosure rule that the SEC proposed in March and is still receiving public comment on.

In that proposal, SEC required publicly traded companies to disclose Scope 1 emissions, or direct GHG releases from its operations, and Scope 2 emissions from purchasing power and heat from a third party. For Scope 3 GHGs, or emissions across the entire value chain of a product, the SEC said it would take a blended approach. It would require reporting from those companies for which these emissions were "material" or where they have declared a GHG reduction target in their own sustainability reports.

March's proposed rule, however, stopped short of seeking the same types of disclosures from private firms.

GHG data inform climate risk

In the 25 May proposal though, the SEC acknowledged that reports from private firms are not required, but made the case that they should provide rough estimates of GHG emissions to give investors the data they need to make decisions.

While the agency's ESG proposal is about preventing greenwashing claims and not about disclosing climate risk, the SEC said: "We believe the proposed information would provide quantitative metrics related to climate for investors focused on climate risk while also providing verifiable data from which to evaluate environmental claims."

The onus of ESG disclosures under this proposed rule would fall on the shoulders of those managing ESG-focused funds.

While the ESG proposal requiring greater disclosure may not have any direct implications for private firms, lawyers, and analysts interviewed by Net-Zero Business Daily said it may lead to greater transparency.

Cascading impacts

Sarah Fortt, an attorney with Latham & Watkins who also is global co-chair of the firm's ESG practice, does not see any direct impacts on private firms arising from the proposed rule. But the SEC has proposed a GHG data disclosure requirement for ESG-focused funds, which include impact funds, and it also has sought progress reports for impact funds that have identified GHG reduction among their goals.

These two potential requirements, if they make it into the final rule, may have "cascading effects on the practices of portfolio companies, both public and private, as investment companies and advisers seek to comply," Fortt said.

Investors want data to be able to make comparable, consistent, and reliable decisions on where to allocate their money, Conway Irwin, financial services research director for S&P Global Commodity Insights, told Net-Zero Business Daily. The SEC proposal seeking data from private firms would not provide perfect transparency, but would allow investors to have a more complete picture than they would have without this requirement, she added.

The SEC's request for disclosure of an ESG fund's carbon footprint and weighted average carbon intensity (WACI) is seen as overly ambitious and somewhat prescriptive, according to several lawyers who say the US is far behind its European counterparts.

As defined by SEC, the carbon footprint is a measure of the amount of absolute GHG emissions that a fund portfolio finances, through both equity ownership and debt investments, normalized by the size of the fund, or the net asset value of the fund. A fund's WACI measures a fund's exposure to carbon-intensive companies.

Comprehensive view of GHG emissions

At least one lawyer said this might be a way for SEC to obtain climate data from private companies that it couldn't otherwise.

However, the SEC said its proposed request would provide a comprehensive view of GHG emissions associated with the fund's investments.

Although the thrust of the SEC proposal is to prevent "greenwashing," Fortt said the SEC proposal may just be "kicking the can down the road" because greenwashing has evolved beyond mislabeling.

There are plenty of questions on the margin, particularly involving methodology, Fortt noted. These can range from determining whether an assumption used in a particular approach is acceptable to assessing whether the threshold for determining something is "green" is reasonable, she added.

"These types of nuanced considerations are likely to pose particular challenges moving forward as different jurisdictions potentially come to different conclusions on these questions," Fortt alluding to the EU's Sustainable Finance Disclosure Regulation, which she said applies to managers of public and private investment vehicles.

Questioning methodology

The SEC, however, has anticipated the questions about methodology in its proposed rulemaking. For instance, it is asking ESG-focused and impacts funds that include GHG reduction goals to disclose the screening methodology that is used to include or exclude companies in their portfolio holdings.

In addition, the proposal would require the fund to briefly explain the criteria the screening applies, such as particular industries or business activities it seeks to include or exclude, and if applicable, what exceptions apply. The fund under this proposal would be required to state the percentage of the portfolio to which the screening criteria apply, and to explain if the screening applies to less than 100% of net asset value.

To illustrate this point, the SEC said a fund's carbon footprint would help investors understand the extent to which a fund's investments contribute to emissions and how it changes over time. The carbon footprint of one fund would then be compared with those of other environmentally focused funds.

On the other hand, it added, a fund's WACI would allow investors to more effectively analyze the fund's exposure to climate risk and to compare the climate risk exposure of different funds.

ESG on a pedestal

Clark Hill environmental attorney Maram Salaheldin said it will be interesting to see how the final ESG and climate disclosure rules look in comparison to the proposals.

According to Salaheldin, one of the issues playing out in the public discourse is "whether ESG issues are being placed on a pedestal" ahead of other concerns, such as cryptocurrency. Another is related to the level of detail that the SEC is seeking in its proposed rule, and whether it traverses into the domain of non-public, proprietary information, such as strategies for proxy voting, trading, methodologies, and the like.

However, the "SEC has made it clear that they want the industry, investors and the public to really engage with these rulemakings and weigh in on the practical challenges, the unintended consequences, alternative metrics [to carbon footprint and WACI], and ways in which these rules can be made successful and effective in what the agency is trying to achieve," Salaheldin said.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.


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