Bruce Dahlgren is CEO of MetricStreama leader in Governance, Risk Management and Compliance that enables organizations to thrive on risk.
The recent proposal from the Security and Exchange Commission (SEC) regarding stricter environmental, social and government (ESG) disclosure rules is the most exciting change in this regulatory space in years. This one proposal would “require” [SEC] registrants to provide certain climate-related information in their registration statements and annual reports.”
Unsurprisingly, the SEC’s proposal aims to bring the United States’ greenhouse gas (GHG) emissions regulations closer to global and EU standards. Ultimately, disclosure requirements are one of the best ways that governing bodies can expect ESG development to continue and ensure that companies improve their ESG performance in a transparent manner. We expect these new standards to drive change in several important ways.
How SEC Regulations Will Affect More Than Just Public Companies
Broadly speaking, the new rules proposed by the SEC will require public companies to disclose the climate-related risks affecting their businesses, as well as their greenhouse gas emissions. The SECs own data reports that about a third of public companies have already published climate-related disclosures in their financial statements since 2019 and 2020. But a deeper dive into the SEC’s proposal indicates that these stricter disclosure rules, if implemented, will have material implications for private companies of all sizes, too.
The rule to disclose GHG emissions from upstream and downstream activities in a publicly traded company’s value chain (called scope 3 emissions) creates challenges because it introduces the need to monitor the risk activities of third-party ecosystems. Under these regulations, medium-sized and private companies — many of whom have so far not measured climate-related risks or tracked emissions — would now have to comply. This means that these companies either have to start measuring and reduce their emissions or risk losing business as a non-compliant third-party supplier to a publicly traded company.
Another challenge with the scope 3 GHG disclosures, I think, is that the system does not have a good method to collect data and calculate the scope 3 emissions directly. Government-owned companies are concerned about how they will accurately measure and track their supply chain and customer base. As a result, these companies are now vulnerable to a different kind of risk exposure: the risk of inaccurate data and threats to brand integrity.
Preparation will help businesses thrive as regulations change
The purpose behind the SEC’s proposed mandatory climate disclosure rules is simple: It aims to standardize climate-related disclosures while ensuring consistency and greater transparency in reporting. This allows investors to make informed investment decisions.
Companies should always assess and update their risk appetite, but new disclosure measures would trigger a much greater shift in priorities. Any major change on this scale will require companies to reassess their risk, calculate the costs associated with compliance (or non-compliance), and evaluate any legal or regulatory risks. Many companies would not be prepared for this change if it happened tomorrow – and it is likely that when the proposed new rules are finally finalized and codified, some organizations will still be unprepared.
How do organizations move forward and stay abreast of the ever-changing regulatory environment? Coordinated preparation and a solid understanding that change will happen can help organizations get through this time. There are four key steps to achieving this.
Assess what emissions data is present in your system. Small, medium or private companies working with public companies should now start taking inventory of emissions and climate-related data, while larger companies may need to take stock, reassess and see if new data points need to be measured under the new regulations . For all organizations, remember to identify and disclose the potential physical climate-related risks, such as wildfires or hurricanes, that could have a financial impact on the entire business.
Define how each GHG emission class, according to range 1, 2 and 3, would be evaluated and determined. For example, are the scope 1 emissions calculated directly or are they analyzed based on fuel input? How does your organization ensure that business partners and suppliers comply with the provision of GHG emissions figures? These requirements are constantly changing, so organizations need to stay up to date as the methodology for calculating each emission class shifts.
Collect all climate-related data in a central repository supported by internationally recognized disclosure frameworks. As the US aligns its standards with the global yardstick, various ESG frameworks will provide accepted structures for measuring and reporting ESG risks, including greenhouse gas emissions. Examples of these frameworks include the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), and the Task Force on Climate-Related Financial Disclosure (TCFD).
quantify the cost of potential legal and regulatory risks associated with following this new disclosure. To stay fully ahead, organizations must forecast and budget for potential risks. Measuring the cost of potential capital, human or technological resources required to manage these risks can align leaders, board members and stakeholders with a clearly defined assessment of the organization’s risk attitude.
This trend of more globally aligned standards is likely to continue, especially as the SEC enacts and implements these new proposed disclosure rules. While these may seem like drastic changes in the US, in the long run more transparency will benefit the entire ecosystem – businesses and investors alike.