Climate-related disclosures that provide investors with consistent, comparable and decision-useful information are the goal of a Securities and Exchange Commission (SEC) regulation that is currently scheduled for publication in October 2023.
The regulation requires specific publicly traded companies to disclose information about:
- Governance of climate-related risks and relevant risk management processes.
- Material impact or likely impact of climate-related risks identified by the company on the business and consolidated financial statements in the short-, medium- or long-term.
- Effect or likely effect of climate-related risks on the company’s strategy, business model and outlook.
- Impact of climate-related events such as severe weather or other natural conditions and transition activities on line items of the consolidated financial statements as well as estimates and assumptions in financial statements.
The timeline for implementation is based on the publication of the final rule. “The SEC originally planned to issue the final regulation in December 2022, then the target slipped to May 2023, and in the most recent update, the SEC indicated the rule is likely in October 2023,” said Ted Kowalsky, director of commercial sustainability for Guidehouse. “Given that timeline, odds are strong that if the rule is published in October, it would likely go into effect for fiscal year 2024, with first reporting in 2025.”
The SEC rule will apply to publicly traded companies in the United States that fall under the definitions of large accelerated filers, accelerated filers, non-accelerated filers, and smaller reporting companies. “The draft rule had a three-year phase-in, with the first reporting being due from large accelerated filers,” said Kowalsky. “Unfortunately, the SEC has been mum on whether that reporting cycle may change and when it will begin to come into force. We will have to wait for the final rule announcement later this year for more clarity on timings.”
Even if publication of the final rule is delayed beyond October, the urgency for companies to begin preparing now is increasing. Only 30% of U.S. companies report Scope 1 and 2 emissions and only 21% report Scope 3 emissions, according to Reuters Insights Sustainability research. Results of surveys with companies also show that, overall, only 32% of U.S. organizations currently have no greenhouse gas emissions reporting at all, and another 16% don’t know if they report on GHG emissions.1
The ability to meet the reporting requirements of the SEC Sustainability Rule depends on the maturity of the company’s climate and sustainability efforts to date and the robustness of the existing processes in place for capturing and managing the necessary data, said Aliesa Adelman, associate director of innovation and sustainability for Guidehouse. “Many companies have made great strides in integrating climate and sustainability considerations into their operations, including reporting on environmental, social and corporate governance measures, calculating GHG emissions, engaging their supply chains and undertaking reporting aligned with sustainable frameworks such as the Task Force on Climate-related Financial Disclosures, Global Reporting Initiative or Sustainability Accounting Standards Board.” All these efforts can be leveraged for SEC reporting as a starting point, she said.
“Other companies are at a more nascent stage of their journey, with climate and sustainability managed as a separate or a standalone reporting effort and not yet fully integrated into all aspects of business, such as financial pro formas, enterprise risk management and procurement,” said Adelman. “Usually, we see companies at this earlier stage focus heavily on decarbonization measures and less on climate risk analysis for physical risks such as impacts from acute weather events and transitional risks.”
“On balance, many public companies have made tremendous progress building the foundation on which the SEC rule will be built,” said Kowalsky. “That’s because many companies are already undertaking their own sustainability journeys around reducing GHG emissions and setting trajectories and targets to reduce emissions and pursue decarbonization. For instance, most firms have a strong awareness and rich data around their own performance toward reducing electricity, moving toward renewables, and pursuing energy efficiency measures.”
Even if a company has an existing focus on sustainability, there will be challenges, said Kowalsky. “The challenge for many companies will be obtaining emissions and energy efficiency data from across the entire enterprise chain; tying the data into standard approaches for calculating GHG emissions; then translating, quantifying and threading that back into their corporate disclosure processes for the firm.”
“Preparing for these regulations will entail some level of change management and will augment the level of scrutiny, traceability and transparency of sustainability and climate risk management,” said Adelman. She suggested that questions companies will have to ask include:
- How audit-ready are the company’s carbon footprints?
- Have climate targets been set and risks quantified?
- Are reports publicly available?
- How have the company’s board and executive teams been engaged?
The draft rule prompted more than 14,000 comments, and those comments crystallized around some key areas. “Many firms and industry trade associations flagged the requirement for Scope 3 emissions—those generated upstream and downstream by a firm’s supply chain—as a big challenge owing to the depth of data quality needed,” said Kowalsky. “Other challenges identified include the idea of what constitutes a material climate-related risk to a firm, and what the thresholds are for reporting that risk in dollar terms.” The SEC rule phases in a requirement for registrants to secure either limited or reasonable assurance for the disclosure, he said. “In time, firms will need to consider how that will fit into their existing annual accounting and audit periods.