Yesterday the Securities and Exchange Commission (SEC) released a new disclosure proposal, The Enhancement and Standardization of Climate-Related Disclosures for Investors, a much-anticipated rule that would require companies to report climate-related information in their SEC registration statements and annual reports. The disclosures would provide critical information, including ESG data, helping investors better evaluate risk and protecting public interest.
New but not unfamiliar
The proposal will require organizations to report data that many companies are already providing voluntarily to the Commission or in response to increasing investor demands. This includes information required by popular ESG reporting frameworks like the Task Force on Climate-related Financial Disclosures (TCFD) and Greenhouse Gas (GHG) Protocol.
If passed, it will standardize elements of ESG disclosure, and for many companies, provide clarity and simplicity to the reporting cycles they are already completing. Key proposed disclosure requirements include:
- Climate-related risks and their material impacts
- A company’s governance of climate-related risks and process for risk management
- Scopes 1, 2, and potentially 3 depending on materiality and company size, with increased reporting requirements over time
- Data verification from an independent service provider, depending on company size and with a phase-in over time, to promote the reliability of GHG emissions disclosures for investors.
Investors need data to drive decisions and reduce risk
Critics claim that addressing climate change is out of scope for the SEC, but ignoring the material risks associated with climate and ESG performance isn’t something that investors can afford. The SEC is not claiming to fix the climate crisis, but rather, mandating that companies disclose the associated financial risks to protect investors and the public, the literal mission of the Commission.
The proposed rule states, “Investors need information about climate-related risks—and it is squarely within the Commission’s authority to require such disclosure in the public interest and for the protection of investors—because climate-related risks have present financial consequences…. While climate-related risks implicate broader concerns—and are subject to various other regulatory schemes—our objective is to advance the Commission’s mission to protect investors, maintain fair, orderly and efficient markets, and promote capital formation, not to address climate-related issues more generally.”
Ted Dhillon, FigBytes CEO & Co-Founder, expressed cautious optimism on hearing the SEC news. “While this is a move in the right direction for the financial industry, there is still much work to be done, and regulation to be implemented, by governments and industry leaders to address the climate crisis and standardize ESG reporting. It’s exciting but we need more—ESG extends beyond the ‘E’ and climate risk,” Dhillon stated.
Concerns about data integrity are not unfounded, but they are solvable
Additional criticisms of the SEC proposal claim that mandating disclosures isn’t realistic or will promote greenwashing as ESG data is an elusive, slippery thing—impossible to capture and quantify. While admittedly challenging, it is very possible and necessary to capture operational data to accurately monitor ESG progress and organizational risk. Organizations may be tempted to solve reporting challenges with homegrown solutions, but the requirements for investor grade data support investment in climate accounting software solutions now to meet the future mandate, which would begin in fiscal year 2023 for many companies.
Some companies that have previously relied on GHG emission estimations using AI will have to adapt and move towards more accurate methods of reporting, using real, auditable data, under the proposed disclosure mandates.
“Operational data is gold. Machine learning-based approaches for impact estimations will continue to be scrutinized,” Dhillon stated. “While important, AI should be used for value-added functionality like scenario analysis and reduction strategies. Not for substituting real data just because it is difficult to get to. This market will need to evolve to comply or face penalties like those seen in other parts of the world.”
Still soft on Scope 3
The proposal includes features meant to lessen the reporting burden for companies, especially in the near-term with phase-in periods. If implemented, it makes practical sense that companies will need time to adapt to the new rule. Although increased regulation has been long discussed and anticipated, building an ESG data collection and management strategy takes time.
However, the rule seems too lax in certain areas, especially with regard to Scope 3, providing “a safe harbor” for inaccurate reporters and exemptions for many companies. Dhillon worries this gives companies too much discretion and will discourage accurate and comprehensive reporting overall.
“It’s a good start. This move aligns with the direction many future-focused organizations are already headed, while offering more clarity, rigor, and motivation to provide not only accurate data but also to drive down emissions according to commitments. I want to see this adopted but also look forward to agencies and industries taking more strides to standardize ESG Reporting across the board,” Dhillon stated.
