The Securities and Exchange Commission (SEC) announced a proposal to standardize ESG disclosures by companies and other registrants. The SEC, in this vein, would serve as a regulator of ESG disclosures, which would be a lot different from, say, Congress being in charge of ESG reporting. But the SEC believes that some sort of order is needed in the metrics that companies report and the way in which they circulate those numbers.
Standardizing ESG Reporting
In a statement, the SEC said that is proposing “rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas (GHG) emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.”
In other words, the SEC wants investors to be able to better understand a company’s climate-related risks and how it manages those risks relative to its peers. Another major point from the proposal would require companies to quantify the financial impact of these risks on its short-, medium-, or long-term performance. To follow up on that point, the SEC wants companies to then release a strategy of how they expect to get past the financial hurdles of their climate-based impacts. It should be noted that the SEC isn’t just talking about GHG emissions, but also, severe weather problems, natural disasters, etc. These types of risks would relate more to, say, an insurance company or a data center in Texas that operates on wind power but is at risk to hurricanes.
“I am pleased to support today’s proposal because, if adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers,” said SEC Chair Gary Gensler. “Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures. Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions. Today’s proposal would help issuers more efficiently and effectively disclose these risks and meet investor demand, as many issuers already seek to do. Companies and investors alike would benefit from the clear rules of the road proposed in this release. I believe the SEC has a role to play when there’s this level of demand for consistent and comparable information that may affect financial performance. Today’s proposal thus is driven by the needs of investors and issuers.”
A Tall Order
Whether you believe that the SEC should regulate ESG reporting or not, chances are that if you’re a reader of ESG Review, you probably agree that ESG reporting is important and needs to be standardized. The existing framework for ESG reporting is challenging because two companies in the same industry can calculate figures in different ways or just be reporting different metrics entirely. Similar to accounting regulations that make it easy to better gauge industry standards and averages, regulating ESG reports would give them more credibility, allow for better ESG ratings, improve the ability for investors to accurately construct an ESG portfolio, and make it easier to track a company’s ESG journey over time in a similar way that investors track revenue and earnings growth.
According to the SEC, “the proposed rules also would require a registrant to disclose information about its direct GHG emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3) if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. These proposals for GHG emissions disclosures would provide investors with decision-useful information to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks. The proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies. The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.”
The SEC said that it would phase-in this process over time to make it easier on registrants and compliance departments. It would prioritize Scopes 1 and 2 emissions disclosures over Scope 3 emissions discloses.