In March 2022, the Securities and Exchange Commission (SEC) issued a proposed rule on climate-related disclosures. Since then, organizations have evaluated how the proposed rule could impact them and how best to prepare. However, with over 15,000 comment letters from companies, investors and myriad other stakeholders, the requirements are expected to change when adopted by the SEC, which is currently expected to happen in the first half of 2023. With anticipation mounting, sustainability leaders are asking, “What can we do now while we wait?”
Although companies are being proactive, they struggle with dedicating resources to prepare for rules that will likely change. At the same time, there has been a rapid acceleration of environmental, social and governance (ESG) activity abroad — most notably the Corporate Sustainability Reporting Directive (CSRD) regulation in Europe and the International Sustainability Standards Board (ISSB) that seeks to influence regulation — leading to questions about how those developments may impact US-based companies’ reporting.1 Despite the current uncertainty around the content of the final rules, there are actions companies can take now.
1. SEC Climate Rule Preparation: Build or strengthen your GHG emissions inventory.
When surveying the broad landscape of existing voluntary ESG reporting and the emerging mandatory reporting regulations, there are several common themes. One of the most significant areas of commonality relates to greenhouse gas (GHG) emissions. The SEC and ISSB proposals, as well as the draft CSRD European Sustainability Reporting Standards (ESRS), would all require disclosure of Scope 1 and Scope 2 GHG emissions, and in many cases, Scope 3 emissions.2,3 All three initiatives have incorporated the GHG Protocol (the Protocol) in some form to date, as it is the most widely used framework for calculating and reporting GHG emissions.4,5 As a result, establishing a strong foundation for emissions accounting by leveraging the guidance and methodologies in the Protocol is an important step companies can take now. In doing so, companies may find areas of uncertainty or ambiguity in the Protocol guidance. We encourage companies to provide feedback to the Protocol authors to help drive rigor and clarity in these standards⁶ as well as engage with sustainability professionals familiar with the interpretation and application of the Protocol.
Compiling a GHG inventory is similar in some ways to preparing consolidated financial statements. You will need to build the inventory from disaggregated information at the emission-generating asset level, such as the amount of electricity used in a particular building or the amount of fuel used to power heavy machinery. Raw data is converted to GHG emissions using various factors and conversion rates. It is not uncommon to use estimation or extrapolation methodologies for areas where actual data is unavailable. These methodologies can be complex and are often subject to higher risk of human error in unautomated systems. As such, implementing strong internal controls, including appropriate reviews now, will be critical to ensure high-quality future mandatory reporting.
Now may also be a good time to begin exploring digital enablement for the GHG inventory. Inventories supported with automation are less exposed to the risk of human error and can facilitate faster reporting, which will likely be needed to meet the accelerated reporting timelines proposed by the expected regulations. For example, the SEC has proposed that emissions data be included in the annual report, which is due within 60 days of year-end for large companies. While it is possible that the SEC will relax this timeline in the final rules, it is likely that investors will continue to pressure companies to provide emissions data at the same time that financial information is released.
Regardless of whether a company employs digital enablement, companies should consider moving up their current ESG reporting deadlines, which are typically discretionary under today’s voluntary reporting scheme and often occur after financial reporting deadlines. This could include increasing the frequency of data collection efforts, internal review and analysis.
2. Engage with finance and internal audit teams at your organization.
Due to the similarities between reporting financial and nonfinancial information, we are seeing increasing collaboration between the finance and sustainability functions in the sustainability disclosure process, including emissions reporting. These groups possess the relevant skill sets for identifying areas of improvement in how ESG information is collected, aggregated, reviewed and reported. They also understand systems of internal control and the importance of maintaining proper documentation.
Engaging internal audit to review your most salient ESG metrics may be beneficial. Internal audit can apply financial auditing rigor to ESG data and identify gaps for improvement, particularly around the accuracy and completeness of relevant calculations. Further, the internal audit function interacts with many groups throughout an organization and can be helpful in integrating ESG into overall enterprise risk management.
3. SEC Climate Rule Preparation: Align with TCFD recommendations.
Many of the global regulatory standards are based, to varying extents, on the recommendations from the Task Force on Climate-related Financial Disclosures (TCFD). This publicly available framework provides guidance on disclosing climate-related risks and opportunities. Organizations may consider using this framework to strengthen their current voluntary sustainability reporting and, in preparation for the final SEC rule, understand where there may be gaps in their process.
With the caveat, again, that details of each reporting requirement are at varying levels of finality, and in most cases, are still subject to change, the SEC proposed climate rule, the CSRD ESRS, the ISSB requirements, and the CDP disclosure currently cover common themes that link back to the TCFD guidance:
- An organization’s climate targets and goals, including plans to achieve them
- An organization’s transition plan for moving toward a lower-carbon economy and how that will impact its business
- The resilience of an organization’s business model considering this transition and anticipated impacts of climate change
- The risks and opportunities that will directly affect a business because of climate change
While the specific requirements may vary among the proposed standards, the structure of the standards aligns with the TCFD’s four thematic areas of governance, strategy, risk management, and metrics or targets. As such, establishing a strong ESG strategy and risk management protocol can serve as the foundation for the various reporting requirements.
Lastly, each of these proposed regulations includes some reference to the use of scenario analysis to evaluate the possible future climate-related outcomes on your business. While it remains to be seen the degree to which this will be mandated, initiating a high-level scenario analysis will likely help inform your overall climate strategy and risk management process, and subsequently, your reporting. This analysis does not need to be a heavily quantitative exercise. Rather, it can begin as a qualitative assessment to understand the landscape of potential scenarios and their possible outcomes based on your organization’s distinct profile.
4. SEC Climate Rule Preparation: Establish governance.
As with any new regulatory development, it is important for management and boards to identify who will be involved in preparing and leading the company through the change. ESG governance will look different for every organization, but cross-functional groups from the organization can enable effective collaboration to identify and address next steps. We are seeing committees composed of representatives from legal, investor relations, finance, internal audit, procurement or supply chain, and HR, in addition to relevant subject-matter professionals and chief sustainability officers.
Many of the existing and pending regulations require disclosures about both the board’s and management’s roles in overseeing climate risk and strategy. Instituting this infrastructure now can enable more robust responses to these requirements.
Guest Author: Kristin Sterling Oliphant is partner, US-West ESG Reporting Leader, Climate Change and Sustainability Services, Ernst & Young LLP. Read more Ernst & Young blogs and reports here. More: Read all guest blogs here.