Preparing for the SEC’s Upcoming ESG Climate Disclosure Requirements
The Environmental, Social, and Governance (ESG) landscape is entering a new era of climate compliance as the anticipated U.S. Securities and Exchange Commission (SEC) climate disclosure regulation takes shape. As the commission works through an unprecedentedly large number of comments – most around the topic of including or not including Scope 3 greenhouse gas emissions – the final ruling nears for reporting on climate-related data, targets, and risks for publicly traded companies required to file with the SEC.
While some companies are taking ‘a wait and see approach’ as to the exact details of the final ruling on mandatory SEC climate reporting, early action promises to help companies size up and mitigate climate risks, improve their competitive advantage, and demonstrate their commitment to sustainability. In this article, we share best practices and the benefits of clear and consistent climate disclosure for companies.
Climate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy.
As the effects of climate change become more evident, investors are increasingly interested in ESG factors when making investment decisions. Investor concerns, lack of transparency comparability, and varying reporting practices and framework have spurred the SEC to act and companies are similarly wise to enhance management of their climate assessment practices.
The expected amendments to SEC guidance originally released in 2010 will be the first major set of rules from the SEC that fall under the ESG umbrella. These regulations will be an important step in the preservation of economies and financial systems worldwide.
Benefits of SEC Oversight on Climate Disclosure
An impressive number of companies have voluntarily taken the initiative to track climate markers like their carbon footprint and set targets to reduce their emissions while also addressing the social and governance pillars of ESG. It’s a good start, however, without guidance, ESG reporting, and its data metrics have taken on a chaotic life of their own, with each company measuring and reporting on different aspects of ESG in different ways and to different stakeholders.
Without comparability and an accepted reporting framework, the data is next to useless for not only investors but for business partners, shareholders, employees, and consumers trying to assess a company’s true ESG performance and risks.
Consistency, clarity, and comparability are key.
It’s all about good, reliable data. The SEC disclosure requirements will focus on creating a unified reporting and disclosure standard for U.S. entities. The goal is complete transparency with reports that are easy to understand, interpret, and compare. If it’s not easy, then it won’t be effective. The varied information that companies are releasing about their activities in ESG reports does not currently meet investor needs for assessing risk.
Along with inconsistent reporting from companies, there are inconsistent ways of measuring performance. Since demand has been high for ESG funds that seemingly have higher than average returns, investors have developed proprietary algorithms to rate ESG performance.
What we know about the scope of SEC Climate Disclosure
We expect rules will be finalized in 2023 and the implementation process to begin shortly after. As both the SEC and businesses navigate through this process, we expect generous phase-in periods and possible exemptions based on company size and the impact of climate risk.
Expected SEC Rules For Domestic or Foreign Registrants
The SEC has been forthcoming on the projected regulations for disclosures on annual reports like Form 10-K and financial statements for those required to file with them. Most experts anticipate very few material changes to what’s already been released publicly, and many companies already measuring their activities hope they’ll easily adapt their data to fit within SEC guidelines.
Most Significant Disclosures Outlined by the SEC
The required disclosures for businesses registered with the SEC aim at illuminating climate-related risks to a company’s short, medium, and long-term health. The SEC is acting on behalf of investors who want to see meaningful climate data presented in a standardized way to allow for efficient comparisons. To make this easier for both companies and investors, the SEC has modeled its rules on the work of the Taskforce for Climate-related Financial Disclosures (TCFD), whose guidelines ensure disclosures give potential investors a real understanding of the carbon and climate risks in each company.
As of this article’s publishing date, here are some key highlights to note.
Oversight and Governance: The SEC will require information on the board, management, and processes for risk management. Basically, they will want to know who oversees climate-related risks within your company and who is ultimately responsible.
Greenhouse Gas (GHG) Emissions: Companies will initially be asked to measure and report on Scope 1 (direct), Scope 2 (indirect) GHG emissions, and potentially Scope 3 (indirect upstream and downstream) emissions.
A note on Scope 3 GHG Emissions: While it is yet to be determined if the SEC will include Scope 3 GHG emissions disclosures in its final climate disclosure rules, Scope 3 is required under the EU Corporate Sustainability Reporting Directive (CSRD) and the ISSB’s two Climate Disclosure Standards (S1 and S2).
Publicly Set ESG or Climate Targets: Disclosures around project scope, data, and plans to meet goals for companies that have communicated their intentions of meeting specific climate-related targets. This will ensure that they are held accountable to the public for their claims and statements regarding ESG activities.
Climate Risk Disclosures: Information around how you identify and prioritize climate risks and a description of and the metrics you use to assess those climate risks, along with detailed mitigation plans, and an understanding of their impact on financials.
In light of the pending regulations, it is crucial for companies to prioritize climate-related impacts that could have a material impact. To get ahead of the final climate-related reporting standards, companies should ensure they are well-prepared to meet the regulatory requirements and provide stakeholders with the necessary information to assess their climate risks and opportunities. The SEC fact sheet Enhancement and Standardization of Climate-Related Disclosures gives more detailed and in-depth information about the Commission’s position.
Ramifications for Private Companies
Currently, reporting disclosures on climate-related risks are only aimed at publicly traded companies that are required to file with the SEC. This does not mean that privately held companies will always be exempt from future legislation, nor can they ignore the rules and conduct business as usual. In fact, the SEC rulings will significantly impact all companies, especially mid-market businesses in the U.S. and global economy.
At the bare minimum, a non-public business should expect to measure their greenhouse gas emissions given that if they are an upstream or downstream entity working with a public company they could be asked to disclose Scope 3 GHG emissions, or if doing business in Europe as the EU’s ESG reporting rules will also apply to many US entities. If it hasn’t happened already, it will likely happen soon.
Ideally, however, a forward-thinking and proactive organization will do more than the bare minimum and address climate-related risks and ESG practices for long-term health and a competitive advantage in the marketplace.
Risk Factors of Ignoring SEC Climate Disclosure
For all organizations, public and private, mid-market and Fortune 500, the stakes are high for not making ESG a priority. The reality is: ESG will soon become ubiquitous, and the risks are substantial. With the SEC officially involved in the reporting of climate-related risks, the situation has escalated quickly. Beyond the obvious risk of being out of compliance with the SEC, there are other real threats to businesses that ignore climate-related risks.
Public companies that fail to file proper disclosures on time will likely face fines and possible penalties once the ruling is final. Additionally, the majority of the areas earmarked for reporting by the SEC affect financials directly or indirectly.
Shareholders and investors carry tremendous weight when it comes to ESG. They have the power to direct money to or from a business and view ESG as a direct indication of a company’s future profitability and future performance and investors clearly see climate change as material to company performance
This is happening across industries. Consumers are increasingly making purchases based on a company’s ESG reputation, whether real or perceived. Loss of public support could be devastating to an organization that ignores climate risks.
Future Business Risk
In the coming years, organizations will be evaluated as a partner or vendor based on things like their overall ESG goals, ability to achieve those goals, and, more specifically, the amount of GHG emissions, especially with the increased transparency that comes from the SEC effort to make it easy to compare data from one business to another. A company that is not competitive or proactive in these areas will risk losing market share, contracts, and investors in the future.
There is increasing pressure that Boards may be held personally responsible for environmental damage caused by their company. There is court precedent that under certain circumstances, actions, and decisions made by the board and even corporate officers may be liable.
What It Takes to Become SEC Climate Disclosure and ESG Ready
Since this is new territory and due to the complete lack of standardization across all ESG lines, the SEC ruling will make allowances for organizations ramping up internal departments to be able to handle the data collection and subsequent reporting and data assurance. It will take an organization-wide commitment and prioritization of ESG-related plans, goals, and reporting to become ready. Now is the time to start.
Global Reporting Standards
Most of the proposed SEC rule will align with The Taskforce on Climate-related Financial Disclosures (TCFD) framework. Beyond governments, international standard setters like the International Financial Reporting Standards (IFRS) are incorporating TCFD recommendations in the much-awaited International Sustainability Standards Board (ISSB) framework. All this to say, the TCFD is the clear front-runner in climate-related disclosures and preparing accordingly for TCFD disclosures will position companies for eventual SEC and other future ESG reporting requirements.
Climate Risk Assessment
The new SEC ESG regulation will require companies to disclose their assessment of climate-related risks and the impact of climate change on their business operations and financial performance. Companies will need a solid plan of attack for assessing climate-related risk.
Steps to Assessing Climate Risk
There are three main steps when tackling climate risk in your organization.
Identify Climate Risks and Opportunities – Create a list of possible climate related risks and opportunities with likelihood of impact to your business across time horizons and scenarios.
Assess Climate Risks and Opportunities – Prioritize the items on your list. Identify hot spots and critical areas that will have maximum financial impact.
Plan and Report Climate Risks and Opportunities – Devise a mitigation and adoption plan to address the identified risks. Then, disclose in detail any identified climate-related risks, the scope of climate events and their likelihood of impacting business and especially financial statements.
Understanding Greenhouse Gas Emissions Reporting for the SEC
At this time, the SEC is not seeking to regulate or set forth parameters for the reduction of GHG emissions, but it is a major component of the disclosures and will be required to be submitted on annual reports. Since company comparisons will be made more data-driven, the leaders on GHG performance will be more easily identified – and the laggards as well.
Getting a handle on emissions and understanding how business operations affect this number is vital and a good starting point. The phase in period for reporting will likely only require Scope 1 and Scope 2 emissions at first, but the sooner Scope 3 is addressed, the better.
There are three distinct areas of emissions that have been defined as Scope 1, Scope 2, and Scope 3. Each scope refers to greenhouse gas emissions that either a company emits or results from purchasing goods and services from other companies.
Scope 1 – Direct emissions in Scope 1 refer to anything an organization directly owns that emits greenhouse gases into the environment.
Scope 2 – Indirect emissions defined for Scope 2 are those associated with an organization’s purchase of energy for electricity, heating, or cooling.
Scope 3 – Indirect Upstream and Downstream Activities is the largest bucket of GHG emissions for any organization. It is the aggregate of the emissions caused by other companies the organization does business with, as well as corporate business travel and employee commutes.
How to Measure and Report GHG Emissions
The most efficient way to get a handle on GHG emissions for all scopes is to enlist the help of software designed to measure all aspects of greenhouse gas emissions. There are simple calculators available that will aggregate data and give an output, but for mid-market sized companies, these calculators are not comprehensive enough to handle the complexity of most businesses.
Find a greenhouse gas emissions calculator that will not only compile and track data but will quickly give an emissions baseline and help identify areas of concern. It’s much easier to make goals for emissions reduction when there is a comprehensive, global view of operations. Whether public or private, anticipate the need for assurance-ready reporting. A good GHG emissions solution provides data reporting that can be used to inform investors, supply chain, and regulators. Armed with more data, companies are better positioned to set science-based targets and explore paths to reduce emissions.
Understand Climate-Related Risks to Your Organization
Central to the SEC requirement will be disclosure of information regarding climate-related risks to the organization. The Commission will want to understand how risks are identified, the level of risk they pose to the business, what strategies are in place to handle the climate-related risks, and overall risk management processes.
An internal ESG team should be responsible for the oversight and governance of all of the climate-related risks and their disclosures, but it’s a daunting task. Detailed processes for identifying, assessing, and managing are needed. A knowledgeable ESG consultant can help companies exponentially improve the effectiveness of your team to drive outstanding outcomes before the mandate even takes place.
Publicly Stated Climate-Related Targets
Organizations that have gone public with climate-related goals have set a positive precedent and are accountable to the SEC. Required disclosures will include the scope of activities and emissions, the timeline for achieving goals, and relevant data related to the progress of meeting targets. If a company has set overly ambitious goals with no practical way to execute and meet the goals, it will be an issue.
That’s why proper advance planning and a way to track progress are paramount in setting climate-related targets. Don’t let this be a deterrent. Instead, now is the time to lean on available resources and tools to help streamline the process and accelerate your ESG targets and performance.
Don’t Wait and See. Tackle ESG Right Now.
Standardization of reporting on climate-related risks is right around the corner. Public and private businesses that have not either implemented an ESG strategy or have a plan in place are already behind. Consider that not only is it now a best business practice across all industries, but it is also the cost of doing business and will need to be worked into budgets and corporate structure from here on out.
At this point, collecting the data is the biggest challenge and needs to be a top priority, but ESG as a whole needs to be managed carefully. Navigate the landscape early with a partner who can prepare you for this new era. An expert in the field will keep you appraised of changes, keep you up to date on requirements, and ensure you understand your legal responsibilities. If you are just starting your journey with ESG or further down the path than most, the right partner will walk with you to achieve your next goal.
Give Your ESG Team the Resources They Need to Succeed
Having the right tools is the key to success in any situation. It is possible to go from zero to sixty in ESG with the right tools and partner. Good.Lab has developed the technology and processes to get your company compliant and on track with ESG. With our GHG calculators and climate risk assessment services, your ESG team will have the resources they need to build a solid foundation for your future and relieve some of their burdens. Today is the day to start a conversation with Good.Lab about your ESG needs.
Disclaimer: Good.Lab does not provide tax, legal, or accounting advice through this website. Our goal is to provide timely, research-informed material prepared by subject-matter experts and is for informational purposes only. All external references are linked directly in the text to trusted third-party sources.
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