By Greg Hotaling, Regulatory Compliance Manager, Confluence
In March, the U.N.’s IPCC produced its Sixth Assessment Report, highlighting the importance of addressing the climate crisis as soon as possible, including through the power of financial capital.i
Against this global backdrop, the SEC is finalizing its proposal that will require American public companies to disclose climate-related information and metrics in their annual reports and registration statements, and has targeted April 2023 for adoption of a Final Rule.
Whether that in fact comes to pass in May or later, investment firms need to be prepared. Some are still grappling with how to manage their climate-related data, as demand for more transparent ESG reporting continues to mount. Yet there’s still time for firms to improve their ESG strategy, to ensure they’re well-positioned with accurate sustainability information once the rules go into effect:
· Data: Prepare systems, whether in-house or outsourced, for ingestion of companies’ climate-related data. This effort would consider, for example, GHG emissions (Scopes 1, 2 and 3), TCFD recommendations (upon which many ESG frameworks are based), and ISSB reporting standards (which are being finalized and address ESG data). An important attribute for any such platform will be to handle large volumes of granular data efficiently.
· Automation / analytics: Enable systems to efficiently transform that data into actionable knowledge. Robust analytics, for ESG data coming from investee companies, can enhance an investment firm’s product offerings, facilitate its compliance obligations, and provide it with marketing advantages. The ideal solution would automate manual tasks, be scalable, and dynamically analyze data at fund and firm levels. Ultimately, such capabilities allow portfolio managers to spend more time on their core skills in fund construction and investment decision-making.
· Expertise: Tap dedicated ESG experts, from both a data and compliance perspective, including at management level. Transparency, disclosure, and audit trails become easier when companies have in-house experts who understand existing ESG regulation and how it will evolve.
· Budgeting: The above-described initiatives, of course, are possible only with an adequate budget in place. In the budgeting process, they should be seen as an investment in remaining competitive. ESG data, ESG compliance and ESG opportunities have arrived, and will not disappear regardless of political or investment climates.
Possible changes to the SEC proposal
Among the changes contemplated by the SEC, for its final version of the proposal, is a softening of Scope 3 GHG emissions disclosures.ii Representing a company’s indirect greenhouse gas emissions throughout its value chain, Scope 3 emissions are often far greater in volume than Scope 1 and 2 emissions, and yet frequently suffer from a lack of verifiable data. The SEC acknowledges this in its proposal, by mandating disclosure of Scope 3 emissions one year later than Scopes 1 and 2, and by providing some latitude for incorrect Scope 3 data.
Reports also suggested that the SEC could raise its threshold that would trigger a company’s disclosure of the financial impacts of its climate-related risks and transitional activities. Currently that threshold is set at 1%, as a proportion of a total financial line item for a relevant fiscal year.iii
The compliance dates could be modified as well. As currently written, the proposal requires the largest companies to begin making disclosures in 2024. Yet the SEC qualified that with the assumption that its rule would take effect in “December 2022”, a date which has now come and gone.
Opponents of the proposed rule have also questioned the SEC’s authority to promulgate it in the first place. Often cited is the U.S. Supreme Court’s ruling in West Virginia v. EPA, a 2022 decision in which the Court limited the authority of the EPA to require energy producers to shift much of their production to renewable sources. While that ruling may lack direct precedential value as it pertains to the SEC’s climate disclosure regime, it could more generally portend the Court’s willingness to scale back the powers of federal agencies such as the SEC.
Moreover, it remains to be seen whether the Biden Administration, or one with similar climate change goals, succeeds in the 2024 Presidential election. But even if the SEC’s proposal is upended by a new administration, or by courts, investment firms will enjoy competitive advantages in having ESG-ready capabilities. The demand for ESG data, and the capacity to analyze it, will only expand as global consensus settles on sustainability as the necessary path forward.
i See IPCC, “Headline Statements”, at https://www.ipcc.ch/report/ar6/syr/resources/spm-headline-statements/
ii Politico, “SEC’s Gensler weighs scaling back climate rule as lawsuits loom” (4 Feb 2023), at https://www.politico.com/news/2023/02/04/sec-climate-rule-scale-back-00081181#:~:text=Under%20the%20proposed%20rule%2C%20public,new%20updates%20on%20legal%20issues.
iii Wall Street Journal, “SEC Considers Easing Climate-Disclosure Rules After Investor Pushback” (3 Feb 2023), at https://www.wsj.com/articles/sec-considers-easing-climate-disclosure-rules-after-investor-pushback-11675416111; SEC, Proposed Rule, “The Enhancement and Standardization of Climate-Related Disclosures for Investors” (21 March 2022), II. DISCUSSION, F.2. (pp. 120-121), at https://www.sec.gov/rules/proposed/2022/33-11042.pdf.
