TIme for SEC with your ESG
Calls for standard—and mandatory—climate-related disclosures have been growing from investors and other stakeholders for the last several years. Why? They recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions. Beyond that, stakeholders recognize that company activities can have a massive impact on climate change, even before these activities hit the income statement or balance sheet, so to speak.
In many regions and countries outside the United States, greater action, transparency, and regulatory attention are already the direction of travel. But not so much on this side of the Atlantic.
On Monday, March 21, the U.S. Securities and Exchange Commission proposed new rules that would for the first time require public companies to report greenhouse gas emissions, along with details of how climate change and related risks are affecting their businesses. The proposed provisions reflect elements of the Task Force on Financial-related Climate Disclosures.
Though some companies have voluntarily reported climate-related risk and financial information for years, until now there have not been any standardized requirements imposed by the SEC.
In short, this is a historic move, but one not without strong opinions on both sides.
What the rules would mean
Expanded action and transparency on climate change are very much top of mind for many companies, and we believe this will (and should) continue, because both are business critical to long-term value creation. So, why would the SEC wade into these waters? Chairman Gary Gensler in his own words: “Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. That principle applies equally to our environmental-related disclosures.”
The SEC has provided a handy factsheet, or if you are adventuresome, you can read the full 500+ page report.
We’ve captured a select summary of things we think companies should know below, and we are here for questions.
Emissions reporting: Scopes 1 and 2, and sometimes 3
The proposed rules mandate disclosures on Scope 1 and 2 emissions, both in absolute terms (excluding carbon offsets) and in terms of intensity (per unit of economic value or production, such as revenue or cars produced). GHG Scope 1 and Scope 2 emissions reporting would be required without regard to materiality.
Scope 3 emissions, or those arising from activities in the company’s broader value chain (either upstream with suppliers or downstream in the use of products of services, for example), are required if the emissions are “material” quantitatively or qualitatively, or if the company has set a GHG emission reduction target that includes Scope 3 emissions. Small reporting companies (SRCs) are exempted from this Scope 3 disclosure requirement under the proposed rules.
Trust but verify: Assurance
The rules require independent third-party attestation for Scope 1 and Scope 2 disclosures for larger filers beginning fiscal year 2024. The Scope 1 and Scope 2 GHG emission disclosures would be subject to limited assurance during a phase-in period, followed by reasonable assurance.
Reflections of TCFD: Governance, strategy, risks
Additionally, the proposed rules would implement a new climate-related risk disclosure framework modeled on guidance published by the TCFD as well as the GHG Protocol. The required disclosures would include:
- Oversight and governance of climate-related risks by the company’s board and management;
- How the company identifies climate-related risks, how those risks have materially impacted or are likely to materially impact its business and financial statements in the short-, medium-, and long-term;
- How those climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook;
- The company’s process for identifying, assessing, and managing the climate-related risks and whether (and how) those processes are integrated into overall risk management systems; and
- Climate-related targets, goals and transition plans
Going mainstream: Climate impacts in financial statements
Companies would need to disclose in financial statements how climate-related events such as severe weather and transition activities impact line items above a threshold amount, as well as how the company derived its metrics and made policy decisions. These requirements would be subject to existing auditing requirements and internal controls.
The proposed rules would be phased in based on the size of company, with the earliest implementation of certain provisions for the largest companies starting in fiscal year 2023 (reporting year 2024).
The comment period extends through May, but many experts surmise that SEC may not adopt final rules in 2022 given the magnitude of the proposal and different viewpoints, with inclusion of Scope 3 emissions likely to remain a sticking point. The SEC is apparently being quite careful with this rulemaking given the potential for lawsuits challenging its validity.
Interesting to remember is: The International Sustainability Standards Board is also working on climate disclosure recommendations, which by all accounts are likely to be even more stringent. The direction of travel, at least outside the US, is toward more transparency, not less.
What you can do (and how we can help)
We believe that climate action and transparency around those actions make business sense, and will be increasingly critical to attracting and retaining capital and talent, and to delivering on innovation. In other words, we don’t think companies should wait to get started.
Even for leaders on the fence about the urgency to move on climate, given investor focus, we’d recommend companies begin preparing, or accelerating their activities, by using the proposed rule as a guide and considering potential data, reporting, and resource implications, and to begin linking climate risk and opportunity with potential financial impacts.
We’ve supported clients on climate and environmental issues for nearly 20 years. A few things we would suggest:
- Elevate climate to the board (but don’t stop with climate). Board- and management oversight are critical elements of the proposed rules. But they are also critical to gaining buy-in and support. But don’t stop with climate—nature and biodiversity, along with water and other resources, are critical and should be on the radar.
- Continue working toward TCFD and CDP disclosures and best practices. These are built in large part around the frameworks for climate risk and disclosure that are reflected in the SEC’s proposed rules.
- Track and report emissions—all Scopes. Scope 3 can be notoriously difficult, but that is exactly where the greatest risk and opportunity often lies, and is of particular interest to investors.
- Integrate climate accounting with internal controls and processes, to ensure high-quality data. These disclosures are intended to be included in mainstream financial filings—and all that entails.
- Check out the competition. We see this as emerging table stakes. Your peers may already be way ahead on their climate commitments, so we don’t recommend waiting for the regulatory shoe to drop, so to speak.
- Use existing standards and frameworks to elevate credibility: Understand TCFD as mentioned, but also consider GRI and SASB, which help define how the company’s actions impact the environment and which specific climate issues may be most relevant to your industry.
For more information on how we can help, contact Victor Melendez, President & Chief Growth Officer.