The Emissions Rule Is No SarbOx

Days on from last Wednesday’s announcement and chatter over the SEC’s forthcoming climate disclosure rules—which seem to have satisfied precisely no one—abounds. Some say the rules go too far, others not far enough, and 10 states are already suing to block the rules, arguing the SEC overstepped its investor protection remit. But whatever your view of this, we suspect the rule isn’t a major market-mover. This is worth keeping in mind because this debate isn’t going away soon, in our view.

We don’t normally comment on things that fall in the realm of sociology—issues society cares about but that don’t ultimately sway corporate earnings much and, as a result, aren’t major stock market drivers. And we won’t stray into the sociological aspects of this debate now. Nor the partisan ones, as we are always politically agnostic. But now and then, sociological issues spill over into markets via legislation or rulemaking. The SEC’s climate rules may be such a case. So let us review.

The rules, which the SEC has been weighing for two years, would require large companies to report “climate-related risks” that have “a material impact on company business strategy, operations or financial conditions.” They must also disclose so-called Scope 1 and Scope 2 greenhouse gas emissions starting in 2026, with smaller companies on the hook in 2028. That means disclosing emissions from their own operations as well as those generated by their energy purchases. It doesn’t mean capping them, reducing them or anything like that, and in this way, is in keeping with the SEC’s longstanding spirit of requiring companies to tell investors things it thinks are relevant to them. However, contrary to earlier proposals, it isn’t a blanket, permanent requirement—the disclosure rules apply only if climate-related risks have a “material” impact. “Material” is a fuzzy term, but regulators say it would apply to companies that would face business risks from changes to climate policies or climate-related market trends, which companies will also have to document and report.

One big difference between the final rule and prior proposals: Companies won’t have to disclose Scope 3 emissions, which would have required them to tally all their suppliers’ and customers’ emissions. This could have forced disclosure requirements on the legions of small and private businesses (as well as international suppliers) who wouldn’t be subject to the rule on their own, raising some thorny questions about regulatory reach. This has those who sought tougher disclosure rules rather incensed, arguing it guts the purpose and does little to actually highlight society’s emissions.

But it also has companies breathing a sigh of relief that the rules’ compliance costs, while potentially increased, won’t be as high as initially feared. In our view, this probably qualifies as positive surprise, as usually happens when rules get watered down over time. Again, we say this not because we have particular climate views, but simply because when companies expect regulatory costs to be one thing, and then they turn out to be something lower, then it is a positive development from a pure financial standpoint. And it relieves some uncertainty over how the rules would look. Companies have long argued estimating, measuring and reporting Scope 3 emissions would be hugely troublesome and unclear to investors. Now they don’t have to—likely a relief to stocks.

But it doesn’t remove all uncertainty. The rules could get further revised or watered down. Legal experts expect both sides of the ideological debate to mount more legal challenges, and the rules could get struck down before 2026 ever comes. This is a very realistic possibility worth considering, if you are weighing the rule’s future.

Furthermore, it is possible the election in November shifts things. While the SEC doesn’t turn over at an election (the five voting commissioners serve staggered five-year terms), two of these posts open before 2026, when the next president would nominate a new chair. Maybe that new chair has differing views about what is relevant to investors. And, considering this rule passed 3-2, further revision cannot be ruled out. The ink isn’t dry here yet.

So wait and see. And understand that markets are pre-pricing all of this. By the time the rules take effect, if they even do, they and their costs will be well-known. This isn’t a Sarbanes-Oxley situation, when Congress passed sweeping bipartisan legislation—at warp speed—upending corporate reporting rules and forcing stocks to price it in a hurry while a bear market was already underway. 2026 is two years out. Nor is the cost increase likely on a par with SarbOx, which carried criminal penalties for executives in the event of accounting errors. This is happening much more gradually, sapping its surprise power. Higher compliance costs could be a headwind, but a known one, fading into the structural backdrop as SarbOx’s have. Like SarbOx, it would probably add more incentives for companies not to go public, but this, too, is a structural issue rather than cyclical driver of corporate earnings. And, from an investors’ standpoint, relatively fewer IPOs means less equity supply—that isn’t bad for prices.

Still, we will keep an eye on things, both on the electoral and legal fronts, and watch where it goes from here. But we doubt it is make-or-break for stocks either way.