With the comment period closed, we’re expecting the Securities & Exchange Commission (SEC) to issue its ruling on its disclosure, The Enhancement and Standardization of Climate-Related Disclosures for Investors sometime in April 2023. This disclosure is one of a number globally put forward to formalize and harmonize climate disclosures for the business community.

The final set of SEC Climate Disclosure rules remains to be seen, but companies anxious to begin preparations can look to the draft proposal from last year for guidance as a starting point. And while there has been pushback, considering the overwhelming support from investors and recent comments from SEC chair Gary Gensler, it seems unlikely that we’ll see a significant pivot from the agency’s original proposal to the final ruling.  Here’s what we know today from the proposal.

Who Will Have to Disclose?

One of the complaints from some government representatives and trade organizations is that the new disclosure will put a new and undue burden on small business operators. The scope of the framework is only those organizations registered with the SEC. Most small and family-owned businesses aren’t included in the scope of the disclosure requirements.

Nonetheless, while smaller businesses and those not registered with the SEC will not be directly impacted by the proposed frameworks, they may still be required to start providing more detailed and quantifiable ESG data to support those who are reporting. 

Because the proposed disclosures include Scope 3 emissions in the value chain, both from suppliers and customers, non-SEC-registered companies may still find themselves having to pull operational and emissions data to satisfy other organizations they work with.

Why Is the SEC Mandating Climate Disclosures?

Sustainability reporting and ESG are not new for most publicly traded companies. The rising demand for this information from investors, stakeholders, and customers means that many companies already prepare some kind of annual sustainability report. In fact, 90% of S&P companies publish sustainability reports.

The aim of the SEC proposal on climate change is to standardize these reports into a format and using data that can easily be accessed and interpreted by the SEC and investors. With so many different ESG frameworks out there, it can be hard to consistently compare data across reports. 

Some of the feedback on the proposed climate disclosures is that the SEC does not have the authority to mandate this type of reporting. Yet SEC-registered organizations have been providing details on litigation and other business costs related to environmental compliance since the 1970s. Reporting on climate-related risks and opportunities can be seen as an extension of that 50-year-old mandate.

Why Is Consistency So Important?

The demand for climate disclosures is only growing. Financial managers responsible for trillions of dollars in investments have called for reporting consistent with the Task Force on Climate-Related Financial Disclosures (TCFD) and GHG Protocol so they can make responsible climate-informed decisions.

Including climate-related financial disclosures is becoming standardized globally. The TCFD is part of the expert panel currently developing standards for the International Sustainability Standards Board (ISSB). 

Businesses may be familiar with the ISSB’s parent organization, the International Financial Reporting Standards Foundation, which also administers the International Accounting Standards Board (IASB). IASB’s accounting standards are adopted around the globe and, with input from organizations like the TCFD, it is expected the ISSB standards will be too.

What Is Included in the SEC Climate Disclosure Rules?

The detailed climate reporting requirements proposed will be discussed more broadly below, but in general, the rules would require organizations to disclose:

• The role and responsibility of corporate governance in relation to identifying and managing climate-related risks
• Potential and actual impacts of climate-related risks on business operations or financial performance over the short-, medium- and long-term
• How climate-related risks have, will, or might impact business strategy and outlook
• Processes for identifying, assessing, and managing climate-related risk and a description of how these processes are integrated into wider risk management systems
• The impact of climate-related events, like severe weather, or transition activities, like changing business operations to mitigate climate-related risk, on financial statements
• Scopes 1 and 2 GHG emission metrics, with additional Scope 3 reporting where the organization has documented Scope 3 emissions reduction targets
• Any climate-related targets, goals, or transition plans

There has been some pushback on the optional nature of some of these disclosures. We have talked about the softness of these requirements before. Scope 3 emissions can account for 50% or more of total emissions, so making the reporting of these optional can dramatically impact the effectiveness of emissions reduction initiatives.

Similarly, disclosing climate-related risks without connecting them to targets can mean these disclosures will be viewed as more of an accounting initiative than one that will drive any meaningful change. 

However, since most of the impacted organizations are already completing some kind of ESG reporting under another framework, the hope is that they will already have targets and goals documented, which may make a Scope 3 reporting requirement an easier pill to swallow.

When Will the SEC Ruling and Disclosure Requirements Come Into Effect?

The dates aren’t clear, but with the 2030 Net Zero deadline looming, we’re expecting the first round of reports to be required soon. 

The SEC is expected to issue its ruling in April 2023, with reports for the largest filers due potentially as soon as 2024 for the 2023 fiscal year. Additional companies would be phased in for a 2025 deadline, and the smallest companies would file their first reports in 2026.

How Will SEC Climate-Related Disclosures Be Reported?

Similar to what has been proposed in other jurisdictions, climate-related disclosures to the SEC will be included in annual financial statements including Securities Act or Exchange Act registration statements and Exchange Act annual reports. Climate disclosures would go in a separate and clearly identified section of the report.

In addition to quantitative disclosures, reports will need to include a narrative assessment of climate-related risks and opportunities as part of management discussion and analysis (MD&A). 

What Climate Risks Will Be Reported to the SEC?

The SEC is currently defining two types of climate-related risks that should be considered and included in reporting. These are physical and transitional risks.

Physical risks are those that pose an actual tangible risk to business operations. These might be issues like facilities located in areas prone to drought, wildfires, or hurricanes, which continue to grow in intensity every year. 

Along with documenting the nature of the physical risk, the report will also need to provide details of the location where the risk exists or could exist. These details include the physical address for a facility, along with the size and number of employees who work there. 

Transitional risks are those that may occur as a result of efforts to reduce climate impacts or market changes resulting from a more climate-conscious economy. These might include production downtime as a facility is retrofitted or operations are relocated. They might also include changes in consumer buying habits that leave a company vulnerable until they can adapt.

Regardless of whether a risk is identified as being physical or transitional, organizations should disclose not only actual risks, but potential ones as well. As we’ve learned through the COVID-19 pandemic, market and business conditions can change nearly overnight, and companies need to be prepared to address potential risks quickly.

Identifying Material Risks

A critical element of risk disclosure is a materiality assessment. The scope and scale of ESG reporting can quickly get out of hand if boundaries aren’t clearly defined up front, and the payback for risk management declines rapidly if time and energy is spent on risks that may seem manageable but have little material impact on an organization’s operations.

A climate risk materiality assessment takes into consideration two elements: the importance of the risk to business operations and to external stakeholders. These stakeholders could be investors or the community at large.

Priority should be given to risks that are material to both business and stakeholders. If there is additional bandwidth to address them available, additional risks can be added to the disclosure too. 

Materiality also takes into consideration issues like time horizons. One risk might be high priority to stakeholders, but is only likely to become an issue over the medium term, while another may be lower priority, but with impacts that will be felt in the near future. In this case, the second risk might be more material initially while the first would be addressed at a later date.

Ultimately, the SEC—following Supreme Court rulings—views materiality as the degree to which a risk would influence an investor’s decision to purchase or sell securities, or how they would vote as a shareholder. 

If you’re not sure how to go about identifying material climate-related risks for your organization, check out our Materiality Workbook for additional guidance.

What Climate Impacts Will Be Reported to the SEC?

One of the challenges in disclosing climate-related risks is that they are largely hypothetical. A hurricane may impact operations at a plant near the Gulf of Mexico. Market demand for low-carbon products may accelerate dramatically in the next 1-5 years. 

It can be easy for companies to reiterate boilerplate scenarios in each annual report, without providing any meaningful information.

This is where it is important to also document known and quantifiable climate-related impacts, particularly carbon dioxide and other GHG emissions. This could include impacts on:

• Business operations
• Products or services
• Suppliers or customers up and down the value chain
• An organization’s ability to mitigate climate-related risks or adopt new climate-friendly technologies
• Funding for research and development

By not only disclosing risks but also impacts, the reporting company will provide a narrative discussion of how these impacts have affected their financial statements, similar to what is already required for MD&A as described above.

What About Carbon Offsets or Renewable Energy Credits?

As part of disclosures on climate impacts, the report also needs to include details on carbon offsets or renewable energy credits (RECs) used, if any. This will not apply to organizations across all sectors, but is an important element to discuss because the use of these provides important context regarding how organizations are meeting their GHG reduction targets. 

While carbon offsets and RECs can be part of a broader approach to help balance climate-related expenditures in the short- or medium-terms, as carbon reduction targets become more and more stringent, they may not be an effective management strategy long term. These types of disclosures will help investors better understand future performance in a carbon-neutral economy.

What Isn’t Included in the SEC Climate Proposal?

Words like environmentally-friendly, sustainable, low-carbon and climate-conscious often get used interchangeably when they aren’t in fact the same thing in many contexts. In relation to the SEC proposal on climate change, it’s important to understand both which terms are used and which aren’t relevant.

As a disclosure proposal, the reporting requirements reference various ways to reduce carbon intensity and emissions through approaches like:

• Transitioning to lower carbon economies, both in terms of production and also using low emissions modes of transportation and supporting infrastructure
• Renewable power generation and use
• Producing and using low waste, recycled or other low-carbon-intensive consumer products and production methods
• Setting conservation goals and target to reduce GHG emission
• Providing goods and services to support other efforts in the transition to the low carbon economy

In addition to tactical steps and strategies to achieve goals and manage financial performance during transitional business activities, the proposal also required documented details of sustainability governance and a narrative review of how all of this integrates into large business operations and strategy, similar to the MD&A.

But what isn’t included in the proposal are other elements of environmental and sustainability reporting that you may be familiar with. For example, forestry stewardship may be top of mind for some companies based on where they are located or their industry sector but not explicitly called out in the SEC’s proposal. 

This may require some organizations to set new targets when they were previously focused on other elements of sustainability, while others will have to look more closely at how carbon reduction is tied to other sustainability efforts.

Ready to Start?

There is a lot of overlap between the carbon and climate reporting requirements in the SEC’s proposal and other ESG standards, but they will not be fully interchangeable. If you’re already reporting to other frameworks, it won’t simply be enough to attach a copy of that report to SEC filings. 

To avoid unnecessary duplication, you need to know exactly how the SEC’s final ruling and requirements are similar to other ESG programs and where it differs. A software tool like FigBytes can be a critical element of streamlining your reporting efforts and managing staff and resources effectively and efficiently.

If your organization is likely to be impacted by the SEC’s new climate disclosure requirements, the time to start compiling information is now. To begin on the right foot, speak with a FigBytes advisor today.