On March 6, 2024, the SEC released its final rules for climate-risk disclosures. Long awaited and hotly debated at every step along the way, these rules -- at last -- give public companies a clearer idea of what a regulated ESG reporting regime might resemble.
The intention behind the SEC’s final rule, titled “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” was always known, and indeed, the rule did not disappoint. It provides a standardization of climate-related disclosures in response to shareholder demands for more consistent, reliable, and comparable information about both the effects of climate-related risks and how public companies are managing these risks.
The rule asks companies to provide financial information about climate-related risks in such a way that issues, such as the costs and losses that may arise from adverse weather events, can be identified and quantified. What’s more, under the SEC’s final rules, it seems likely that some large companies will soon be required to disclose both Scope 1 and 2 greenhouse gas (GHG) emissions, if these GHG emissions are deemed material.
The SEC’s climate-disclosure rules represent a major change for public companies in the US, and yet they’re not the only upheaval on the horizon. In addition to these disclosures, US companies are also likely to be required to report on their governance of climate-related risks, including everything from risk management to climate targets and goals.
Challenges Abound
Although in March it seemed like there was finally some clarity for US public companies when it came to climate-disclosure requirements, this clarity was short-lived. Arguments have dogged the SEC’s climate-disclosure rule since the very beginning. Even adoption of the rule was far from unanimous with passage arriving via a three-to-two vote.
Conflict and controversy have continued -- and perhaps even intensified -- after the rules were released. According to an August 13, 2024, blog post from law experts at Cooley, there’s been “a deluge of litigation – even though, in the final rules, the SEC scaled back significantly on the proposal, putting the kibosh on the controversial mandate for Scope 3 GHG emissions reporting and requiring disclosure of Scope 1 and/or Scope 2 GHG emissions on a phased-in basis only by accelerated and large accelerated filers and only when those emissions are material.”
After facing multiple lawsuits, the SEC issued a stay on its final disclosure rules on April 4th, less than a month after the landmark rules were adopted. These rules are now pending as petitions to the Eighth Circuit are reviewed. The SEC has vigorously defended its rules, but as of this writing, it remains unclear whether or not these rules will be put into action.
Companies that consider the legal wrangling over climate-disclosure rules to be a reprieve are almost certainly deceiving themselves. Even without the SEC’s climate disclosure rules, there are growing pressures on US companies to provide far more by way of ESG disclosures and the pressures are coming from many fronts at once.
Getting Ready
Because it seems inevitable that far greater climate disclosures will soon be required, here are three recommendations for how public companies can prepare themselves for a new and more rigorous reporting regime.
Recommendation #1: Reuse whenever possible.
The disclosure rules proposed worldwide are neither novel nor new, and so companies have a terrific opportunity to reuse past preparations to meet future disclosure requirements. In other words, savvy companies should not try to reinvent the wheel, but should instead look to what’s useful from voluntary disclosure frameworks to help them move forward.
The SEC’s final rule is modeled in part upon the Task Force on Climate-Related Financial Disclosures (TCFD) framework, and so companies already relying upon that framework have an enormous leg up in meeting the regulatory requirements ahead.
One critical set of requirements that may or may not apply to your own company but is helpful nevertheless is the European Union’s (EU’s) Corporate Sustainability Reporting Directive, or CSRD. Not only will an estimated 50,000 organizations worldwide need to comply with CSRD, but the standards are considered to be among the most onerous out there. If you prepare for the CSRD’s requirements, which are well established in the ecosystem of governance today, then you’re well positioned to benefit from the interoperability that exists between CSRD and other sustainability regulations.
Another important touchpoint is two California Senate bills that have been rolled into a single bill, or SB 219. SB 219 has passed the California legislature and is waiting to be signed into law by Governor Gavin Newsom. If signed into law without changes, SB 219 would have an impact on both public and private companies doing significant business with California. The new California law is also likely to go into effect before other climate-disclosure rules in the US, making it extremely important to stay on top of developments occurring in California.
In addition, there are a wealth of other data management best practices that can augment and strengthen your ESG disclosures. Companies should, for instance, familiarize themselves with EDM Council’s Data Management Capability Assessment Model, or DCAM. By performing a DCAM assessment, which is based on well-established data management best practices, a company can evaluate its own internal data management and analytics capabilities. This type of gap analysis helps companies gauge strengths and shore up weaknesses.
The good news is that when taken in aggregate, the various frameworks and rules offer a complementary approach to preparing for the move from voluntary to mandatory ESG reporting.
Recommendation #2: Prepare to “assure” your results.
Much as financial information provided to shareholders is audited by an accounting firm, ESG disclosures will soon be subject to more rigorous review by qualified third parties.
Making results ready for assurances and auditing is one way to dispel charges of greenwashing, or making false or misleading claims about environmental benefits of a product or practice. Anti-greenwashing rules are on the rise. On June 20, for instance, Canada amended its Competition Act via Bill C-59 to explicitly prohibit companies under its purview from making deceptive environmental claims.
Companies keeping a close eye on CSRD and on SB 219 know that third-party assurance is mandated in the very first year of reporting. Applying principles from DCAM can help a company ready itself for the type of audit reviews that almost certainly lie ahead.
Key to preparation is making sure that your review of all ESG disclosures is data-centric. As you assemble data -- making it consistent with existing frameworks and standards -- you’ll be well positioned to get the assurances that will eventually be required.
Now is also an excellent time to begin differentiating between what assurances and audits entail. Broadly speaking, a “review” engagement will offer limited assurance, while an “audit” engagement, which costs more, offers greater scrutiny and a higher level of assurance. Deciding what’s right for your company will hinge on what’s ultimately required from a regulatory standpoint.
Recommendation #3: Think of Digitization Earlier, Not Later.
Turning your ESG disclosures into a machine-readable format may seem like the last step in a lengthy process of making your company’s actions disclosure ready. In reality, though, thinking about digitization from the very beginning can save a company enormous time and effort.
In both CSRD and the SEC’s climate-disclosure rules, required environmental disclosure data will need to be presented in a machine-readable format, in both cases, XBRL.
It’s wise to look at the digitization of data less as yet another requirement, and more as a checklist to make sure nothing is falling through the cracks. And in fact, the XBRL taxonomy could be viewed as an outline of key issues that will need to be resolved in a more stringent climate-disclosure reporting regime. In other words, the XBRL taxonomy itself can reinforce the gap analysis that companies are performing as they move from a voluntary climate-disclosure world to one in which environmental disclosures are mandatory. If you understand how data will be consumed by looking at the digital version of the taxonomy you will be reporting into, you will get a clearer picture of the expectations you need to meet.
The benefits of machine-readable, complete and consistent data also mean the production of comparable, transparent, and accountable information for all users in the market. Many investors appreciate digitization because it allows them to efficiently search, extract, and compare both accounting and sustainability-related financial disclosures.
As the pieces of the mandatory climate-disclosure requirements continue to fall into place, it’s clear that no company should wait until the last minute to give serious thought to the digital piece of new disclosure requirements. It’s far better to view the digital piece as an assessment tool for assisting your company as it moves through the various data-gathering stages to meet new requirements as they arise.
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