Bruce Dahlgren is CEO of MetricStream, a leader in Governance, Risk Management and Compliance empowering organizations to thrive on risk.
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The recent proposal by the Security and Exchange Commission (SEC) regarding stricter environmental, social and government (ESG) disclosure rules is the most exciting change to this regulatory space in years. This proposal would “require [SEC] registrants to provide certain climate-related information in their registration statements and annual reports.”
It’s not surprising that the SEC proposal aims to align the United States’ greenhouse gas (GHG) emissions regulations closer to global and EU standards. Ultimately, disclosure requirements are one of the best ways governing bodies can expect ESG development to continue and ensure that businesses improve their ESG performance transparently. We expect these new standards will bring about change in several important ways.
How The SEC’s Regulations Will Affect More Than Just Public Companies
Broadly speaking, the SEC’s proposed new rules will require public companies to disclose the climate-related risks that impact their business, as well as their greenhouse gas emissions. The SEC’s own data reports that about one-third of public companies have already issued 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 nonpublic companies of all sizes, as well.
The rule to disclose GHG emissions from upstream and downstream activities in a public company’s value chain (termed scope 3 emissions) creates challenges because it introduces the need to track the risk activities of third-party ecosystems. Under these regulations, midsize and private companies—many of whom have not measured climate-related risks or tracked emissions up until this point—would now have to comply. This means these businesses will either need to start measuring and reducing their emissions or risk losing business as a noncompliant third-party supplier to a public company.
Another challenge with the scope 3 GHG disclosures, I believe, is that the system lacks a proper methodology to collect data and calculate scope 3 emissions directly. Public companies are concerned about how they’ll measure and track their supply chain and customer base accurately. As a result, these companies are now vulnerable to a different type of risk exposure—the risk of incorrect data and threats to brand integrity.
Preparation Will Help Businesses Thrive As Regulations Change
The goal behind the SEC’s proposed mandatory climate disclosure rules is simple: It seeks to ensure standardization of climate-related disclosures while providing consistency and greater transparency in reporting. This will allow investors to make informed investment decisions.
Companies should always be assessing and updating their risk posture, but new disclosure measures would initiate a much bigger shift in priorities. With any major change at this scale, companies will have to reassess their risk, calculate the costs involved with compliance (or failure to comply) and evaluate any potential legal or regulatory risks. Many companies wouldn’t be prepared for this change if it were to happen tomorrow—and it is likely that, when the proposed new rules are eventually finalized and codified, some organizations still won’t be prepared.
How do organizations get ahead and stay on top of the constantly changing regulatory climate? Coordinated preparation and a grounded understanding that change will happen can help organizations persevere through this time. There are four key steps to making this a reality.
1. Assess
Assess what emissions data exists in your system. Small, midsize or private businesses that work with public companies should start building an inventory of emissions and climate-related data now, whereas larger companies may have to take stock, reassess and see if any new data points will need to be measured under the new regulations. For all organizations, remember to track and disclose the potential physical climate-related risks—such as wildfires or hurricanes—that would financially impact the overall business.
2. Define
Define how each GHG emissions class, as per scope 1, 2 and 3, would be evaluated and determined. For example, are scope 1 emissions calculated directly, or are they analyzed based on fuel input? How will your organization ensure that business partners and suppliers comply with providing GHG emission figures? These requirements are constantly changing, so organizations must stay up to date in case methodology for calculating each emissions class shifts.
3. Collate
Collate all climate-related data in a central repository that is supported by internationally recognized disclosure frameworks. As the U.S. aligns its standards to the global measuring stick, various ESG frameworks will provide accepted structures for measuring and reporting on ESG risks, including GHG 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).
4. Quantify
Quantify the costs of potential legal and regulatory risks involved in following this new disclosure. To fully stay ahead, organizations must forecast and budget for potential risks. Measuring the cost of potential capital, human or technological resources needed to manage these risks can get leaders, board members and stakeholders in alignment with a clearly defined assessment of the organization’s risk posture.
This trend of more globally aligned standards is likely to continue, especially as the SEC sets and implements these new proposed disclosure rules. While these may seem like drastic changes in the U.S., greater transparency will benefit the entire ecosystem in the long term—both companies and investors.
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