Navigating the environmental legislation landscape and reflecting on the recent developments, particularly those on emissions reporting and sustainability standards that have emerged this year, it becomes increasingly apparent that the global community is at a critical point in addressing the pressing challenges of climate change.
After carefully scrutinizing these legislative measures and dissecting their definitions, scopes, and compliance requirements, we aim to shed light on their significance and decipher their implications for businesses, industries, and the broader ecosystem.
1. EU EMISSIONS TRADING SYSTEM (ETS)
Initially established in 2005, EU ETS acted as a market-based mechanism to tackle the growing climate issue of GHG emissions within the EU.
As of 2024, ETS makes it mandatory for ship operators with activities in the European Economic Area (EEA) to monitor and report their emissions and purchase allowances for every ton of CO2 they emit.
The EU Emissions Trading System (ETS) law has changed how carbon pricing is determined for shipping. Rather than charging based on the cargo that a ship is carrying, the law now charges based on the vessel itself. Furthermore, the law has extraterritorial application, which means that if a vessel sails between an EU port and a non-EU port, half of the emissions from the voyage will be subject to the EU ETS. This is a move to encourage shipping companies to reduce their emissions.
Shipping companies must purchase allowances for the following emission categories:
• 50% of emissions from voyages departing from an EU port to a non-EU port and vice versa.
• 100% of emissions from voyages between EU ports.
• 100% of emissions from ships docked at an EU port.
Scope of Legislation:
• Ocean Carriers
• Energy Intensive Industries
• Major industries, including power and heat generation
• Aviation
Compliance requirements:
As per environmental regulations and efforts to reduce carbon emissions, businesses are required to possess emission allowances. Each allowance signifies the permission to emit one metric ton of carbon dioxide or its equivalent in greenhouse gases. Through this structured system, companies engage in emissions trading, allowing them to buy or sell these allowances within specified markets. This framework is a significant motivator for companies to limit their emissions since those exceeding their allotted allowances may face financial penalties or need additional allowances from the market.
2. EU CARBON BORDER ADJUSTMENT MECHANISM (CBAM)
According to the European Commission, the EU's Carbon Border Adjustment Mechanism (CBAM) is a tool to put a fair price on carbon emitted during the production of carbon-intensive goods entering the EU and to encourage cleaner industrial production in non-EU countries.
The Carbon Border Adjustment Mechanism (CBAM) is a tool that confirms the price paid for the embedded carbon emissions generated during the production of specific imported goods into the EU. This mechanism will help ensure that the carbon price of imports is equivalent to the carbon price of domestic production without undermining the EU's climate objectives. The CBAM has been designed to be compatible with the World Trade Organization (WTO) rules.
CBAM will apply in its definitive regime from 2026, while the current transitional phase lasts between 2023 and 2026. This gradual introduction of the CBAM is aligned with the phase-out of the allocation of free allowances under the EU Emissions Trading System (ETS) to support the decarbonization of the EU industry.
Scope of Legislation:
• High risk of carbon leakage sectors:
1. Cement
2. Iron and steel
3. Electricity
4. Fertilizer
5. Aluminium
Compliance requirements:
Importers must purchase carbon certificates corresponding to the carbon price that would have been paid if the goods had been produced under the EU's carbon pricing rules.
3. SEC DISCLOSURE GUIDANCE
The US Securities and Exchange Commission (SEC) is an independent federal government regulatory agency responsible for protecting investors, maintaining the fair and orderly functioning of the securities markets, and facilitating capital formation.
Established by Congress in 1934 as the first federal regulator of the securities markets, the SEC promotes full public disclosure, protects investors against fraudulent and manipulative market practices, and monitors corporate takeover actions in the United States. It also approves registration statements for bookrunners among underwriting firms.
Notably, the SEC recently implemented a groundbreaking regulation concerning climate-related disclosures, marking a significant departure in how publicly traded American companies address environmental considerations.
Scope of Legislation:
• Publicly traded companies in the US.
Compliance requirements:
The Final Rule requires companies to disclose material climate-related risks on their business and consolidated financial statements in the short term (the next 12 months) and in the long term (beyond the next 12 months).
Large accelerated filers with at least $700 million in shares held by public investors must begin disclosing Scope 1 and Scope 2 emissions in fiscal year 2026. Accelerated filers, including companies with between $75 million and $700 million in publicly held shares, must begin disclosing in FY2028.
Companies must provide the information necessary to help investors understand the nature of risk and the extent of the company's exposure to it.
4. California Climate Corporate Accountability Act
In late 2023, California Governor Gavin Newsom made a pivotal move by signing two groundbreaking laws for both public and private companies operating within California. In the quest for transparency and standardized disclosures, the law mandates companies with significant revenue to make climate-related disclosures starting in 2026
California Law: SB 253, The Climate Corporate Data Accountability Act, applies to California businesses with revenues exceeding US$1 billion. Starting in 2027, it will mandate the annual reporting of Scope 3 emissions—indirect emissions not directly controlled by the entity. To ensure accuracy, independent third-party verification is required, emphasizing transparency. While penalties for non-compliance exist, exemptions apply for good faith misstatements.
California Law: SB 261, Greenhouse Gases: Climate-Related Financial Risk, applies to entities in California with annual revenues exceeding US$500 million. While primarily addressing financial risks, SB 261 aligns with the Task Force on Climate-related Financial Disclosures (TCFD) framework, indirectly encouraging Scope 3 emissions disclosure. Stressing the importance of accurate reporting, the legislation promotes third-party verification that is aligned with the TCFD framework. Penalties for non-compliance or misstatements in reporting Scope 3 emissions underscore the legislation's commitment to accurate and transparent disclosure.
Scope of Legislation:
• Entities operating in California with annual revenues exceeding $1 billion, calculated globally.
Compliance requirements:
Large companies subject to this scheme will be required to report their emissions in three distinct scopes defined by the GHG Protocol: Scope 1, Scope 2, and the often-elusive Scope 3 emissions.
With the surge of new regulations, the imperative for companies worldwide to disclose their emissions, particularly Scope 3 emissions, becomes increasingly apparent. Organizations, stakeholders, and consumers have acknowledged by now that transparency in environmental impact reporting is no longer a choice but an unavoidable obligation.
In light of this new legislative reality, companies that proactively embrace the principles of accurate and transparent emission reporting stand to gain immensely. By pivoting their orientation towards sustainability, these forward-thinking organizations not only position themselves as early adopters but also unlock unparalleled opportunities amidst a landscape of change that impacts all.
Embracing accurate, primary, and modeled emission data isn't merely a compliance exercise; it's a strategic imperative with potentially transformative outcomes. The benefits include enhancing brand reputation, fostering stakeholder trust, driving operational efficiencies, and securing competitive advantages. Finally, that way, companies not only future-proof their operations but also pave the way for a more resilient and responsible business ecosystem.
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