Standardized rule-making on climate disclosures has lagged in the U.S. But no more. Observers like Karen Alonardo of NAVEX Global expect the SEC’s proposed rule to be adopted later this year. Alonardo shares insight into the proposal here, highlighting what companies must do to prepare for heightened disclosure requirements.
For years, investors have sought information related to environmental emissions and other ESG matters to make well-informed investment decisions. However, it is widely known that inconsistencies exist in reporting standards and adoption of greenhouse gas (GHG) emissions tracking and disclosure. The SEC proposed rules March 22 that would require all publicly traded companies to disclose specific climate-related information. These disclosure requirements would help to address some of the issues companies and investors are facing regarding what ESG disclosure really means. The proposal, which passed with a 3-1 majority and is now in a 60-day public comment period, will help solve this issue. For those embedded in ESG work, the proposal was widely anticipated, but for organizations early in their ESG journey, there are several key points to understand and prepare for action.
Understanding the Proposal Basics
The SEC offers a summary fact sheet, but in general, there are three key areas where organizations should focus their attention, understanding and action:
- Answering the need for greater standardization of reporting: Part of the issue with ESG disclosure is the “framework patchwork.” Currently, ESG disclosure is far from standardized, partially because of the lack of regulation. With multiple voluntary frameworks available to align to, companies have a choice for disclosure. This leads to inconsistency in reporting which results in difficulties for investors and the public in understanding the information. The SEC disclosure proposal will align to the widely accepted Task Force of Climate-Related Financial Disclosures (TCFD) and the GHG Protocol. This will simplify and standardize reporting metrics.
- Require greater disclosure of “severe” events: The proposal also focuses on climate-related risks, such as “severe weather events and other natural conditions.” Assuming the proposal passes, companies will need to report on the impacts of such events to their business.
- Require emphatic greenhouse gas reporting: Finally, greenhouse gas emissions will need to be accounted for, independently attested to for some and disclosed. Disclosure applies to direct emissions, from resources owned and controlled by the company, including those from the company-owned facilities and vehicles (Scope 1), and indirect emissions from purchased energy or utilities (Scope 2). Because of this complexity, the full details of the disclosure requirements should be reviewed by affected organizations to understand the industry-specific requirements and nuances. A third tier of emissions, Scope 3, applies to those created by an organization’s value chain, which, according to the proposal, includes “indirect emissions from upstream and downstream activities in a registrant’s value chain, if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.” The SEC’s proposed rule exempts smaller companies from Scope 3 emissions disclosures, and for all companies, the agency proposes a longer phase-in period, as well as a safe harbor from certain forms of liability in specific cases.
What Is the Counterargument?
While the proposal passed with a 3-1 majority, the single dissent came from Commissioner Hester M. Pierce, who was appointed in 2018 by then-President Donald Trump. Those who oppose the rule claim it does not actually address comparability and that firms already have principles-based disclosure from 2010 guidance issued by the SEC. In Pierce’s objection to the proposal, she suggested that it helps the “climate industrial complex,” a term coined by climate change skeptic Bjorn Lomborg in 2009.
What Actions Should My Company Take Now?
If adopted as expected, these disclosure requirements would be effective for the 2023 fiscal year, which begins in just under six months. This means organizations should start preparations now if they haven’t already. There are three main actions that affected corporations should take now to stay ahead of the curve.
- Start calculating Scope 1 and 2 emissions now. Because these are not necessarily simple to calculate, publicly traded companies affected by these disclosure requirements need to assign dedicated resources and funding.
- Become familiar with the TCFD framework. An ESG program must be composed of cross-functional stakeholders, and the leader of the program should be familiar with disclosure frameworks. Doing so before the requirements are in place demonstrates a commitment to progress. Not only are ESG progress and disclosures expected to be mandated, but they are also the right thing to do and have positive benefits for companies who do so in earnest.
- Plan for attestation requirements. Many companies fall under the “accelerated or large accelerated filer” category, which means these organizations will need an independently verified attestation report for Scope 1 and 2 emissions. Preparing a report on greenhouse gas emissions doesn’t happen overnight: The process to gather, measure, compile and disclose this information involves many stakeholders and should happen well in advance of the disclosure requirements. Publicly traded companies are well-advised to establish a leader of the ESG function to oversee the program before disclosures are mandated.
What’s Next?
We’re currently in the 60-day comment period which will end in a final vote by the agency’s four commissioners. Given the initial vote and general enthusiasm for the actionable change that will ensue, this is expected to pass.
Scope 3 disclosure will remain a challenge, and the longer phase-in period means the bulk of emissions will remain unaccounted for some time. However, there is no doubt that this is a step toward accountability and action, and formalizing ESG reporting is a long-awaited and positive outcome to address climate change.
