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Climate Crisis Demands Market Transformation—But First, Standardization

June 3, 2022, 8:00 AM

As the U.N. Intergovernmental Panel on Climate Change (IPCC) prescribes in its latest report, rescuing ourselves from global climate catastrophe requires one bold remedy: urgent, public policy-driven market transformation.

Achieving the transformative climate change mitigation at the rate, size, scale, and depth urged by the IPCC, though, will be all but impossible without first establishing the standards by which companies’ progress toward that transformation are evaluated and disclosed.

Perhaps no public policy intervention has greater potential to drive this standardization than the Securities and Exchange Commission’s recent proposal to require that public companies make standardized climate-risk disclosures. Realizing that potential, though, is a challenge in and of itself.

Scope 3—Corporate Value Chain

Indeed, these rules are subject to change. While many companies are capable of measuring and disclosing both the emissions they own, such as those attributable to company-owned buildings and vehicles (i.e., Scope 1), and the emissions they control, such as those attributable to purchased electricity (i.e., Scope 2), firms’ upstream and downstream corporate value chain emissions (i.e., Scope 3) pose a different challenge.

And business leaders are making their objections to the SEC rules’ Scope 3 provisions known. Hanging in the balance is the SEC’s potential to deliver a complete market standardization and, in turn, the market transformation it promises to facilitate.

But this is an untenable outcome. While a pared-down version of the rules would nevertheless compel companies to elevate their goals and refine their strategies for Scopes 1 and 2 climate risk management, the IPCC’s report confirms that we need to abandon such incremental approaches to decarbonization.

To that end, the SEC should neither surrender its Scope 3 provisions, nor should it shy away from bringing greater transparency and credibility to companies’ use of carbon offsets and other intangible instruments that companies may use to reduce their emissions. Doing so would necessarily equip companies with a more complete understanding of their climate risks.

And it’s with this insight that companies will not only be able to build more operationally efficient and climate-resilient organizations but, together, enable them to build a decentralized incentive framework for advancing corporate sustainability.

What to Expect From Mandatory, Voluntary Disclosures

Should the SEC adopt a sufficiently comprehensive, compulsory climate risk disclosure regime, in the near term we will see companies embrace data management and reporting technologies to at least achieve compliance. In the long term, companies will eventually compete for fear of rejection in the capital markets.

Companies will adopt decarbonization solutions that help them exceed the SEC’s requirements, outperform their competitors on climate risk mitigation, and otherwise lay the groundwork for a more efficient, transformative decarbonization of the private sector. This much, at least, is what the global proliferation of mandatory and voluntary corporate sustainability, or environmental, social, and governance (ESG) disclosure frameworks suggests we can expect.

Regardless, from the outset, the SEC’s application of uniformity to companies’ compulsory measurement and disclosure of their value chain climate risks will give business leaders clear direction. Stakeholders need to know on which horizon to set their sights. And they need to know how to determine whether they’re making progress toward that horizon, how to adapt their efforts, and how to share the evidence of their progress.

Relatedly, with respect to market transformation, these rules will cause companies to adopt renewable power purchase agreements, building energy efficiency appliances, electric vehicles, and other conventional emissions reduction instruments. This demand, in turn, would drive innovation and scaling of these instruments, as well as a shift in the skillsets of the labor force.

Yet we could expect these outcomes even without ambitiously comprehensive disclosure rules. The differentiator, with respect to both market standardization and eventual transformation, is how a requirement to measure and manage Scope 3 climate risks would drive a more universal evolution of ESG performance data management and reporting software.

Today, these systems enable their users to measure and continuously monitor both the climate and bottom-line impacts of their decarbonization efforts—across their full value chains. Beyond compliance with the SEC’s rules, the insights made possible with these systems will bring efficiency and effectiveness to companies’ internal climate-alignment efforts which, in turn, burnishes their sustainability credentials with investors. And with the widespread adoption of these solutions, we will ultimately witness the operationalization of the SEC’s rules, whereby shaping business decisions around these climate criteria will become commonplace.

Incorporate Blockchain

With robust Scope 3 rules established and compliance solutions ubiquitous, companies will leverage emerging technologies to stand out. Specifically, a robust disclosure regime would likely drive businesses to incorporate blockchain technology applications into their operational procedures. This will bring the necessary transparency, traceability, and veracity—evidence—to the climate-related outcomes of their use of carbon offsets, sustainability-linked bonds, and other alternative instruments to fund their decarbonization goals.

Akin to the uptake of ESG software, companies’ usage of blockchain applications to improve their climate-risk measurement, management, and reporting will help them go beyond compliance. Blockchain will help them unlock still more value from their climate-related transactions.

For the market transformation the IPCC prescribes, though, the key outcome of a wider uptake of these blockchain applications will be how it helps to establish the market infrastructure needed to decentralize, or democratize sustainable finance. Sustainable finance is meaningless if it isn’t equitable. In short, companies will be able to commodify and tokenize their sustainability performance. And this means investors of all stripes will have access to those tokens, thereby formalizing a market-driven incentive framework for continuous climate-alignment.

Whatever path the SEC takes, the fact remains that incremental approaches to public policy-driven decarbonization are simply not good enough. That is not how we avert climate catastrophe.

Mobilizing the private sector, as President Biden’s administration has sought to do, means holding companies accountable for their climate credentials. And by bringing piercing transparency and rigorous standards to climate-risk measurement and disclosure, the SEC stands a chance of creating the information ecosystem needed to bring structure and efficiency to a market that rewards corporate sustainability.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Mahesh Ramanujam is the former president and CEO of the U.S. Green Building Council. He is a global leader and advocate for ESG, net-zero, and U.N. sustainable development goals.