The Securities and Exchange Commission has proposed a set of rules that would standardize climate reporting by publicly traded companies in accordance with ESG investing precepts. If approved, the SEC estimates requirements could cost the average company more than a half-million dollars to set up proper reporting procedures. But the proposal would also make it easier for ESG investors to make apple-to-apple comparisons between companies.
ESG investing involves the environmental, social and governance guidelines companies are increasingly using to move toward more sustainable, ethical management practices and operations.
The SEC voted 3-to-1 on March 21 to draw up a proposal that would require companies to disclose their greenhouse emission and their financial exposure to climate-change risks. The lone no vote came from GOP member Hester Peirce. She says the proposal "steps outside our statutory limits."
The 60-day public comment period is underway. The SEC may adjust the rules based on input from interested stakeholders. Moreover, any regulation issued by the SEC will likely face legal challenges. It's also unclear at this point how the rule would be enforced.
What Are The Main Elements?
The proposed rules would require disclosures on Form 10-K filings about a company's governance, risk management and strategy with respect to climate-related risks, SEC Chairman Gary Gensler said in a March 21 statement. Moreover, the proposal would require disclosure of any company targets or commitments.
The proposal focuses on greenhouse gas emissions. Gensler wrote, "Those risks could include regulatory, technological, and market risks driven by a transition to a lower greenhouse gas emissions economy, with potential financial impacts on revenues, expenditures, and capital outlays."
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All filers would disclose their Scope 1 and Scope 2 greenhouse gas emissions. Those are emissions that result directly or indirectly from facilities owned or activities controlled by a company.
For example, PepsiCo has already opted to report greenhouse gas emissions related to its manufacturing operations as well as its trucking fleet. The new rules would mandate compliance in a consistent way for all filers.
Some businesses also would be required to disclose Scope 3 emissions from upstream and downstream activities in a company's value chain.
For instance, Coca-Cola would not only be required to report Scope 1 and Scope 2 emissions, but also Scope 3 emission such as emissions associated with the packaging of its products. To be sure, Coca-Cola already reports extensively on its climate footprint and goals for reducing emissions. The mandate would standardize that reporting.
Creating An ESG Investing Framework
The proposal would phase in Scope 3 disclosures after Scopes 1 and 2. However, smaller reporting companies (SRCs) would be exempt from Scope 3 disclosures. SRCs are defined as companies with less than $250 million of public float.
SRCs also have until fiscal 2025 to collect data and report it in 2026. Meanwhile, larger companies have until fiscal 2023 to collect information to report in 2024. Large firms have an extra year to report Scope 3 data.
"This is a proposal from the SEC, not a final rule," said Wes Bricker, former SEC accountant and current vice chair and trust solutions leader at PwC. "That's an important distinction because companies will be able to provide input before we have a final rule."
Nevertheless, Bricker says the SEC move to establish a baseline in climate reporting "raises the bar for all companies."
"Many companies made net-zero commitments, but what does that mean?" Bricker told IBD. "Is it for a segment of the business or for the entire business? You can't compare without consistency."
Climate Reporting: Assessing The Cost
About a third of companies already report some form of climate-risk assessment to investors. That means that for most companies, the cost of starting from scratch will be substantial. The SEC estimates that for non-SRCs, the cost in the first year of compliance would be $640,000.
To ensure compliance, companies should consult experts to understand their reporting obligations and avoid potentially costly omissions and mistakes.
Companies would also have to staff internal teams to maintain records, which eventually would be audited by a third party, as required by the proposal for greenhouse gas emissions reporting.
Businesses that already report would have to review their current practices to fill in any gaps or make adjustments.
Higher up the ladder, companies will have to consider the composition of their board, whose members need to understand and evaluate the disclosures.
Key Hire: ESG Comptroller
Bricker says companies will need to hire an environmental social and governance (ESG) team that addresses every facet of the reporting process. The key is to hire what he calls an ESG comptroller, similar to a firm's corporate comptroller or tax comptroller.
"Someone who has an understanding of the reporting required in the U.S. or U.K. or any country," he said.
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It's also important to hire an independent auditor to certify the report to avoid the risk or appearance of "greenwashing," Bricker said. The term greenwashing means providing false information in order to convey the appearance of being environmentally sound.
Bricker says overall the SEC proposal is a significant step forward, even if people disagree with some of the details.
"There is a really good point some have made that it's really Congress' job to make policy," he said. "This is about disclosure, and the SEC's job is about producing the right disclosure."
ESG Investors Clamor For Clarity
One thing is certain: ESG investors are keen to uncover every aspect of a company's impact on climate. For example, on April 11 the SEC ruled to compel Amazon to bring to a vote a shareholder advocacy group's climate-related request.
"The SEC has determined that shareholders asking Amazon why its retirement plan directs employee savings into big oil and companies burning down the Amazon is a valid question," said As You Sow CEO Andrew Behar in a statement.
"The brand damage of having the company say one thing and do another is important to measure and understand," Behar added.
Behar said the group applauds Amazon's "fleet of 100,000 electric delivery vehicles." At the same time, he pointed out Amazon also "has $621 million in oil, coal, and fossil-fired utilities and $48 million invested in deforestation-risk agribusiness."
Amazon uses Vanguard Target Date funds as its default retirement options. As a result, most plan investments flow into funds holding companies flagged as major greenhouse gas emitters, the group said. While Amazon offers one sustainable, ESG investing option for its employees, less than 2% of the plan's assets are invested in it.
As for the SEC's climate-reporting proposal, As You Grow President and Chief Counsel Danielle Fugere says the SEC has a "critical role to play" in providing investors with robust, complete and comparable data.
"Reporting of greenhouse gas emissions is the bedrock of sound investor decision-making on climate and transition risk," she said in a recent statement.
Follow Adelia Cellini Linecker on Twitter @IBD_Adelia.
