Supreme Court Justice Louis Brandeis once called U.S. states laboratories of democracy. His point was that states can be a place where policy ideas are first tested. If those policies are successful and popular eventually, they may be taken on by other states or at the federal level.
Over the years California’s laboratory of democracy has produced environmental regulations and programs that have been modeled throughout the country. For example, the state was the first in the US to regulate tailpipe emissions, implement energy efficiency standards for buildings and appliances, and create a cap-and-trade program for carbon emissions.
The next step
This legislative session the state added another set of accomplishments to California’s list of policy innovations, this time in the field of emission disclosure requirements. In early September, the State Legislature passed bill CA SB253, which requires publicly all companies in the state that earn $1 billion or more annually to disclose their scopes 1, 2, and 3 emissions. The measure, which Governor Newsom said he would sign, covers all of the emissions a company creates in its own operations and with its suppliers and customers, and climate exposure.
The significance of this is that soon investors will be able to know who is actually following through on pledges to reduce emissions, and importantly whose bottom line is most likely to be hit by potential future climate regulations or the energy transition to a low carbon economy.
Discussing the legislation’s impact, State Sen. Scott Wiener (D-San Francisco), who authored the measure said, “These carbon disclosures are a simple but intensely powerful driver of decarbonization. When business leaders, investors, consumers, and analysts have full visibility into large corporations’ carbon emissions, they have the tools and incentives to turbocharge their decarbonization efforts.”
While some might dismiss this as only being action in one state, it is important to remember that California, on its own, is the world’s fourth-largest economy. As Politico reports, the measure applies to 5,400 companies including Fortune 500 companies like HP, Intel, Chevron, Cisco Systems, and Wells Fargo, which have operations around the US and globally.
When looking at the business community it should be noted that they were divided on the measure. Although some business lobby groups, like the California Chamber of Commerce, opposed it, several companies like Apple, Microsoft, and Ikea stated their public support for the bill.
Timing is Everything
The state’s actions come at a critical moment. Driven by the rise in extreme weather and the acceleration of the energy transition, climate-related disclosures should be a greater priority for investors.
While there could be great demand for this information, what pushed lawmakers to act is that currently, companies are not supplying this information. As the 2022 report, Still Flying Blind –The Absence of Climate Risk in Financial Reporting, which looks at the lack of accounting for climate impacts in company financial statements, shows 98% of the companies surveyed did not provide sufficient evidence that their financial statements include the impacts of climate-related matters.
In a sign of how widespread the problem is, the same report found that none of the auditors of the 46 U.S. companies provided evidence that they comprehensively considered the impacts of climate matters in such audits.
Acting Locally and Waiting Nationally
The importance of state action is magnified by the fact that even as this problem continues to plague investors, there has been little action at the federal level. For months, advocates have been waiting for the U.S. Securities and Exchange Commission (SEC) to issue similar regulations.
However, as the agency has delayed announcing the new rules, elected officials have become concerned. Some U.S. Senators and Representatives fear that the commission may buckle to pressure and water down its reporting requirements.
In contrast, the California law bill requires scope 3 emission disclosures and covers both public and private companies. How will this impact the SEC’s requirements? It could push them to issue stronger requirements since it resets the baseline of what is already required of public companies. Even if that does not happen, it only means that the federal government’s actions are a floor, not the ceiling, when it comes to climate disclosure requirements.
There are other key differences between California’s legislation and the SEC’s proposed rules. The SEC requirements will be much broader than what California has passed and as proposed, will include information on the forward-looking estimates and assumptions in the financial statements—those can be greatly impacted by a transforming energy system. The SEC’s rule also will require companies to disclose how sea-level rise, extreme weather events, or changes in government regulation will impact their business. Plus, the rule will mandate additional disclosures from companies that issued net-zero targets and emissions reductions as to how the company’s business plans will be impacted by them.
One reason California is seen as an innovator in policy is that many of the things that start in their laboratory of democracy soon become adopted by other states and even impact national policy. In addition to environmental policy, this has been seen on issues like taxes, smoking, and criminal justice reform policy. Will climate disclosures be another area where we see this happen?
To answer that question, it is important to remember the environment that these requirements are coming out in. We live in a time where the impacts of climate change are increasing, the energy transition is accelerating, and investor’s desire for information remains high. Added together, those factors create conditions that are only likely to push California’s climate disclosure requirements further.