SEC adopts new climate disclosure rules
In March 2024, the Securities and Exchange Commission (SEC) unveiled its new climate disclosure rule, marking a pivotal moment in the integration of environmental considerations into corporate governance and financial reporting. This development, aimed at enhancing transparency and informing investor decisions, has sparked a robust debate on its implications, particularly against the backdrop of divergent views on how the extent of climate change reporting.
The push for mandatory climate reporting has gained momentum in recent years, driven by growing investor demand for companies to disclose their environmental impact. Investors increasingly seek detailed disclosures on how climate risks—both physical and transitional—affect companies. These insights are crucial for assessing the long-term sustainability and profitability of their investments.
SEC Climate Disclosure Rules
The SEC's final climate-related disclosure rules mandate companies to provide comprehensive information about the impact of climate-related risks on their business operations and strategies. Key requirements include:
Climate Risk Impact: Companies must detail how climate change could affect their operations, financial conditions, and market demand for their products or services.
Mitigation and Adaptation Strategies: Firms are required to disclose their strategies for addressing identified climate risks, including any efforts to mitigate these risks or adapt their business models.
Board Oversight and Risk Management: The rule mandates disclosure of how a company's board oversees climate-related risks and the management's role in assessing and managing those risks.
Climate Goals: Companies need to disclose their climate-related goals, including any targets for reducing greenhouse gas emissions and the steps they are taking to achieve these targets.
Scope 1 and 2 Disclosures: Firms must report their direct emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). Scope 3 is not included in the rules list (indirect, value chain emissions).
Severe Weather Events: The rule requires disclosure of the financial impact of severe weather events and other natural conditions related to climate change.
Carbon Offsets and Renewable Energy Certificates (RECs): Companies that utilize carbon offsets or RECs as part of their climate strategy must disclose their use and how it affects their emissions targets.
The SEC's rule is a significant step toward standardized climate reporting, offering a more structured and comprehensive framework for disclosing climate-related risks and efforts. This move is particularly timely, given that the European Commission has announced the European Sustainability Reporting Standards (ESRS), set to take effect in 2024. This initiative marks a significant step towards standardized sustainability reporting across the EU. In alignment with this, discussions on interoperability between the ESRS and the International Sustainability Standards Board (ISSB) Standards have been ongoing, involving the European Commission, the European Financial Reporting Advisory Group (EFRAG), and the ISSB.
Challenges and criticism
However, the rule is not without its challenges and criticisms. One concern is the potential for reporting inconsistencies, as the rule allows companies considerable leeway in how they assess and report risks, as highlighted by Professor Shivaram Rajgopal. This may lead to varied interpretations and applications. It could be argued that this flexibility is necessary to accommodate the vast differences across industries and companies, but it may also hinder comparability among firms.
Impact on SMEs
Moreover, the rule places a significant emphasis on Scope 1 and 2 emissions, which, while important, may overshadow the more complex and arguably more impactful Scope 3 emissions. Scope 3 emissions account for the majority of a company's carbon footprint for many firms, encompassing all other indirect emissions that occur in a company's value chain. The rule's less prescriptive approach to Scope 3 emissions could slow progress in addressing the full spectrum of a company's climate impact. However, it's important to weigh the benefits against the costs of requiring SMEs to monitor and report their emissions. A careful consideration should be given to the potential impact on these businesses as large firms could transfer there reporting cost to them.
For Small and Medium Enterprises (SMEs), the SEC's mandate on Scope 3 emissions reporting presents a uniquely daunting challenge. Scope 3 emissions, which encompass indirect emissions from a company's value chain, including both upstream and downstream activities, require a level of data collection, analysis, and transparency that many SMEs find overwhelming. The costs associated with this aspect of the rule could be disproportionately high for smaller companies, which typically lack the resources and infrastructure of their larger counterparts to systematically track and manage emissions across their value chains.
The Republican Pushback: ESG Investment Bans
In an unfolding political counter-movement, several Republican-led states have mounted significant opposition against the integration of Environmental, Social, and Governance (ESG) criteria in investment decisions, particularly targeting pension funds and public investment vehicles. These states argue that ESG considerations, especially those pertaining to climate change, may compromise the financial returns of public investments by prioritizing political ideologies over economic performance. This stance has led to legislative efforts to ban or severely restrict the use of ESG principles in managing state pension funds and public investments, framing such strategies as misaligned with the fiduciary duties owed to retirees and taxpayers.
This section of the political landscape adds a layer of complexity for companies attempting to navigate the SEC's new climate disclosure rule. The diverging viewpoints on the importance of climate risks in financial decision-making underscore the broader national debate on the role of corporations in addressing environmental challenges.
Impact on Africa
Climate reporting standards and rules aim to combat climate change by requiring businesses to report CO2 reduction efforts and environmental mitigation strategies. These standards encourage the adoption of green technologies, such as solar panels, promising favorable assessments for compliant companies.
However, recent research have highlighted a potential unintended consequence of the expansive deployment of solar farms as part of global efforts to transition to renewable energy. While these solar farms represent a significant step towards reducing reliance on fossil fuels, they might also influence solar power generation across the globe in unexpected ways.
Research suggests that the massive solar farms envisioned for the future could alter local and possibly global climate conditions. Such installations cover large areas and can modify the albedo of the Earth's surface, reflecting more sunlight back into space, which could impact atmospheric conditions. These changes, in turn, might affect the amount of solar energy that can be harvested not just locally but in distant parts of the world.
SEC rules should require companies to also consider this effect in their reporting mandates.
The CIBA Climate and Sustainability Reporting Course
Sustainability and climate change efforts are prominent compliance matters, and are currently viewed on corporate agendas as key for increasing efficiency and a source of competitive advantage. Leading finance executives understand that climate change efforts cannot be separated from business and there is an urgent need to involve key decision makers in reporting on progress as it relates to the climate change agenda.
Business accountants and finance executives are pressured to play a key role in preparing their companies for a new regime and reporting progress made in reducing emissions, whether directly or indirectly.
The Executive Education and License in Climate and Sustainability Reporting, developed by CIBA and Regenesys School of Accounting Science, will equip finance leaders to confidently fulfil this role and will serve as proof of your competency in this field.
The programme provides you with the knowledge, skills, professional direction and corporate strategy to assess changes in the environment, define a strategy to address them, identity opportunities of climate change and successfully report and disclose relevant climate matters.