This is Part 2 of 3 of an IDFA series breaking down the SEC's new climate disclosure rules. Please stay tuned to the IDFA Blog for more on sustainability topics or visit the IDFA Sustainability Hub and check out the new SEC Disclosure resources from IDFA and partner PwC.

On March 21, 2022, the Securities and Exchange Commission (SEC) proposed a rule requiring domestic publicly traded corporations[1] to file specific climate-related[2] disclosures as part of the company’s annual report. The proposed rule would require detailed information about the company’s greenhouse gas (GHG) emissions footprint and the risks the emissions and associated climate change may have on the company’s financial statements and business. Many dairy processors are privately owned corporations that have no SEC filing obligations, but a majority sell to or co-pack dairy products/ingredients for publicly traded major brands and retailers that are registered with the SEC[3]. Moreover, most major financial institutions that service the dairy industry are publicly traded and would be required to comply with a final rule.

In this IDFA Blog series, we will highlight the major requirements in the SEC proposal that, if finalized, would likely have an impact on the dairy industry.

Registrant Reporting Compliance Timing

Assuming the SEC meets its goal of publishing a final rule by the end of 2022 and there is no court-imposed delay, the SEC proposes to phase in the requirements based on a corporation’s filing status. Here is the proposed registrant compliance timing:

Reporting

Emissions reporting: As noted , the SEC strongly encourages companies to utilize the GHG Protocol and TCFD frameworks. All emissions reporting must be in gross numbers that exclude any purchased offsets or renewable energy credits (RECs) as explained below. Companies must report total aggregated emissions, disaggregated emissions by constituent GHG emission, and a carbon intensity metric. The SEC is proposing to require companies to express GHG emissions in terms of carbon dioxide equivalent (CO₂e).

Reporting Scope 1 and 2 GHG emissions: All companies will be required to disclose the Scope 1 and 2 GHG emissions and auditing of these metrics will be phased-in based on company size.

Reporting Scope 3 GHG emissions: The SEC recognizes the challenges associated with reporting Scope 3 emissions and therefore seeks to insert flexibility. The proposal would only mandate Scope 3 reporting if: (a) the company has made public climate commitments/goals that include Scope 3, or (b) if the Scope 3 emissions would be material to the company. In addition to the safe harbor explained above, the SEC proposes to delay compliance deadlines and lower the auditing requirement otherwise required for Scope 1 and 2 reporting,

Scope 3 emissions will be of most importance for the larger dairy value chain as dairy products, ingredients and raw milk from the farm would qualify as “purchased goods and services” under a food brand or retailer’s Scope 3. All Scope 1 and 2 emissions from the dairy processing facility are Scope 3 for the SEC-registered customer, as are emissions from dairy farms. There are several issues for consideration:

• Materiality: The SEC does not offer a clear quantitative threshold for determining when Scope 3 emissions are material to the company. There is a legal standard as noted above, but there is also substantial judicial interpretation over the boundaries of materiality. The SEC strongly suggests that a quantitative measure - 40% - is used by many industries, but that even smaller measures could be material if the business risk associated with those emissions is significant or if there is a substantial likelihood that reasonable investors would deem it important. This is particularly true if the future impacts of climate change could include a high magnitude of loss or liability. Given the SEC’s interpretation and the reality that most GHG emissions in the dairy value chain are based on the farm, Scope 3 emissions will almost certainly be material to food manufacturers and retailers.
• Boundaries of Scope 3: The SEC’s proposal looks broadly at Scope 3 for both upstream and downstream suppliers and activities. For dairy, this arguably includes not just the processing plant, but all ingredients and incidental additives that go into producing dairy products (i.e., packaging, chocolate, corn oil, enzymes) to downstream activities. Similarly, emissions generated at the farm could extend to feed, fuels and crop protection.
• Customer collaboration and expectations: In proposing to provide flexibility, the SEC expects Scope 3 reporting to incentivize companies to increase collaboration with the value chain to improve GHG emission measuring, reporting and reduction. The SEC specifically cites work done by the food and beverage industry as an example of the type of collaboration the SEC hopes to promote. Dairy processors should expect a higher level of customer interest in climate risks facing the value chain, how the value chain manages those risks, and measuring/reporting.

Scope 3 emissions is arguably one of the most controversial sections of the proposal. The SEC’s proposal is a compromise, and it will likely elicit significant opposition from advocacy groups and investor communities that support mandatory Scope 3 emissions reporting from all companies. Advocates may seek to eliminate the safe harbor, which would greatly increase the third party audit assurance necessity for Scope 3 emissions, increasing the burdens on dairy companies and dairy farmers.

The Innovation Center GHG emissions reporting guidance and metrics: The processor handbook and GHG metrics developed by the Innovation Center in collaboration with IDFA and processors complies with the GHG Protocol and thus will be accepted for SEC metrics. IDFA recommends that members continue to utilize the materials available through the Innovation Center, which would be necessary for GHG emissions reporting under a final rule. With the increase in customer collaboration and unique reporting metrics, the dairy industry may need to coalesce around a common set of customer reporting metrics.

FARM ES GHG Measuring Tool: The FARM ES tool is also based on the GHG Protocol and thus aligns with the SEC proposal’s accepted methodology. Most farmers do not measure GHG emissions on the farm and co-ops generally use statistical sampling known as “pooling” to generate emissions factors needed for GHG reporting. If done in compliance with the GHG Protocol, the statistical sampling method and the associated emissions factor should be acceptable to the SEC. That said, retailers and processors may seek individual farm GHG emissions and conduct third party audits to ensure the reliability of measuring methodologies.

Carbon offsets: The SEC’s proposal does not prohibit the sale and use of offsets and renewable energy credits (RECs), but offsets or RECs do not count as a reduction to the company’s reported total or aggregated GHG emissions. In addition, companies purchasing offsets/RECs must disclose information regarding short- and long-term costs and risks associated with the offsets/RECs. These include the amount of carbon reduction represented by the offset or renewable energy represented, source of the offset/REC, description and location of the underlying projects and any registries or other authenticities of the offsets or RECs, and the costs. Many farmers have installed digesters on the farm to generate carbon offsets that can be sold for income in carbon markets or to generate renewable energy.

Environmental advocates and regulators will continue to scrutinize carbon markets and offsets for "double counting". Per carbon credit standard setting bodies, if a farmer generates an emission reduction and then sells that reduction to a third party outside the value chain, only the third party can claim the reduction. If the farmer claims the reduction, it is double counting, a practice not allowed under most trading regimes. Moreover, the Standards Based Target Initiative (SBTI) does not allow the use of offsets to reach science-based targets.

The GHG Protocol is in the final stages of developing guidance on how to treat offsets and key issues such as permanence. The new guidance is expected to be completed by Fall 2022. In its proposal, the SEC commits to the GHG Protocol, including future guidance, which can be incorporated into a final rule directly, or by reference.

Stay tuned for Blog 2 in this series where we offer key takeaways from the SEC proposed rule.

[1] Private foreign issuers are also included in this proposed rule.

[2] Although the “social” prong of Environmental, Social and Governance (ESG) is not within the scope of this proposal, the SEC is expected to require mandatory reporting of diversity, equity, and inclusion metrics in the near future.

[3] Many dairy processors also sell to brands traded on European stock exchanges with similar carbon reporting mandates.