The Supreme Court’s EPA Ruling Raises the Stakes for Stranded Assets

The US Supreme Court’s 6-3 decision restricting the Environmental Protection Agency’s (EPA) ability to set limits on power plants’ greenhouse gas (GHG) emissions, further hamstrings the current administration's plans to reduce US carbon emissions and meet international climate commitments. 

For banks and asset managers, the ruling preserves status quo uncertainty about the future of the US energy system that complicates both clean energy investment decisions and assessments about potentially stranded fossil assets. It also dramatically increases the likelihood of a disorderly transition to a low-carbon economy. 

The Intergovernmental Panel on Climate Change (IPCC), in its recent report outlining decarbonization pathways, warned about stranded assets, assets that lose value as a result of transition or physical climate risk. 

By significantly limiting the EPA’s ability to set CO2 emissions caps under the Clean Air Act, the ruling makes it harder to accelerate the decommissioning of fossil-fuel power generation, which currently provides about 60% of the nation’s electricity and is responsible for about 25% of the US’s GHG emissions. Long-term emissions regulations, like the one at issue in this case, give banks, asset managers, and other investors a predictable signal as to whether - and importantly when - a fossil-fuel power plant may or may not become a stranded asset. 

Without uniform federal regulation driving changes in fossil-fuel power plant use, stranded asset assessment is left to the markets, consumer preference, and an increasingly diverse patchwork of state climate regulations. For banks, the ruling may impact their ability to scale back or end their financing of fossil-fuel power generation. 

Because the underlying premise of the ruling was that Congress had not authorized the EPA to “transform the nation’s electrical power supply,” there are concerns that the ruling could call into question other US regulatory bodies’ ability to create climate-related regulations without explicit direction from Congress. This issue was raised by US Securities and Exchange Commission (SEC) Commission Hester Peirce this past March when she cast the lone vote against the SEC’s climate risk disclosure proposal currently under consideration following the close of public comment two weeks ago. 

When it comes to climate risk, US banking regulators have been clear that their focus is on mitigating systemic risk to the financial system, rather than policy decisions on climate/emissions reduction. The SEC has also actively tried to ensure that its proposed climate-risk reporting rule does not exceed its statutory mandate. 

For its proposal, the SEC leaned on its existing rules and guidance on climate-related disclosures as well as the Greenhouse Gas Protocol and the Task Force on Climate-Related Financial Disclosures, disclosure frameworks that many US companies are already familiar with.

As investors rely on public disclosures when making investment decisions, the overarching aim of the SEC’s climate reporting proposal has been to provide investors with consistent, comparable, and decision-useful risk assessment information that they can use when making investment decisions and to provide issuers with consistent and clear information about their reporting obligations. 

Under the SEC’s proposal, US public companies would have to report their climate change-related physical and transition risks and their GHG emissions when they file registration statements and in annual filings. They would also have to report the impact of climate-related events on a line item basis in their consolidated financial statements, as well as on the financial estimates and assumptions used in financial statements. 

In its proposal, which would put ESG disclosures on a similar footing to existing corporate disclosures, the SEC set a one percent threshold for materiality. 

For physical risk, this means that if a registrant has determined that a physical risk has had - or is likely to have - a material impact on its business or consolidated financial statements, that registrant would be required to disclose it. The proposal also says that a registrant’s disclosure should also include a description of the identified physical risk for the properties, processes, or operations subject to the physical risk on a ZIP code or a comparable geographical basis. 

On GHG emissions, the SEC’s proposal asks all US public companies to report information about their direct GHG emissions (Scope 1) and their indirect GHG emissions, which are emissions associated with the purchase of electricity, steam, heat, or cooling (Scope 2). It would also require companies to include these disclosures in their audited financial statements. For Scope 3 emissions, which include all other indirect emissions that occur within a company’s value chain, the proposal would require disclosure if a company has made a commitment that included a reference to Scope 3 emissions or if such emissions were material to investors.