First Takes on the SEC Climate Disclosure Proposal
The blog originally appeared on Workiva.com. Written by Steve Soter, Senior Director, Accounting Industry Principal, Workiva.
The U.S. Securities and Exchange Commission has finally released its proposed climate disclosure rule with some long-awaited details and a few surprises too.
With the U.S. regulator finally issuing proposed requirements that would begin to align with its global counterparts, the proposed rule itself is 500+ pages long. Fortunately, the SEC published a fact sheet with a tidy summary. Jonathan Gregory of The Hershey Co. and I shared some of our early thoughts on the proposal in a LinkedIn Live event (watch the replay). One of my main takeaways is the conversations companies should be having now to comply with evolving global regulations, including the new SEC proposal.
True, the proposal is open for public comment for 60 days, and the details could change before the SEC adopts the final rule. Even then, the rule would be phased in starting with reports for fiscal 2023 for large accelerated filers. But Jonathan said Hershey’s SEC reporting team, legal team, internal and external auditors, and ESG (environmental, social, governance) team are already mapping out reporting and internal control processes to be ready for what’s next. You might consider doing the same thing.
“It's not done in a vacuum,” Jonathan said. It has to really be a cross-functional initiative across all the core functions.”
So let’s quickly recap highlights of the proposal before jumping into what I’d suggest companies can do to prepare for new ESG regulations.
A few surprises
The SEC wasn’t shy about proposing a few items that I thought they might wait on, from iXBRLTM requirements to climate metrics’ inclusion in audited financial statements, not just the MD&A (management discussion and analysis) part of a 10-K.
A few months ago, I wasn’t sure if the SEC would require disclosures on Scope 3 greenhouse gas emissions, which are upstream and downstream emissions along a company’s value chain, such as from employees’ commutes. But any public company with a Scope 3 emissions target, or for whom Scope 3 is material, will need to disclose it. There will be a safe harbor exemption, however.
Larger public companies will also have to find a qualified independent party for assurance to provide an attestation of Scope 1 and 2 emissions under the proposed rule.
As expected, the SEC modeled its disclosure framework partly on recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), supported by more than 2,600 organizations globally.
Key points of the proposed rule
If the SEC adopts the rule as proposed, a public company would need to disclose:
- How the board and management are governing climate-related risks
- Climate-related impacts, goals, targets, and transition plans
- Scope 1 and 2 greenhouse gas emissions, with audit assurance and attestation for accelerated and large accelerated filers (Scope 1 refers to a company’s direct emissions from operations, and Scope 2 refers to indirect emissions from energy purchases)
- Scope 3 emissions, if material or if a company has set a target for all other upstream and downstream supply chain emissions, with a safe harbor
- In a financial statement footnote, climate-related financial impacts, such as additional expenses due to a severe wildfire or flood, for example
Companies would need to add XBRL® tagging to these new disclosures and present them in iXBRL format, just as they do for investment-grade financial data, so they can be read by both machines and humans.
Consistency between ESG and SEC reporting is going to be absolutely paramount. ESG teams accustomed to publishing sustainability reports in the summer will likely have to significantly accelerate some internal deadlines for compiling ESG data now that the SEC is proposing climate disclosures in 10-Ks, often filed in February or March.
A note on what the SEC wants in disclosures
The SEC in September 2021 issued a sample comment letter regarding climate change disclosures and has since posted comment letters to a few companies asking for more information about their disclosures. These letters offer helpful hints of what the SEC is looking for under existing guidance.
In its proposal, the SEC asks for climate-related disclosures that are material. From the SEC’s perspective, materiality is determined by shareholders. By contrast, ESG materiality generally includes a much broader group of stakeholders, including customers, employees, and members of communities where a company operates. Navigating this nuance will likely become increasingly challenging, and public companies will need to be cautious in how they assess materiality from both an ESG and financial reporting perspective. Workiva has created a guide to ESG materiality assessment that you can use to help determine what is material to ESG stakeholders.
Truth and consequences
The proposed rule should shed more light on corporate impacts on the environment and potentially reward companies disclosing measurable ESG results and progress. Some of these forward-thinking companies have been voluntarily disclosing ESG performance for years.
While we wait for feedback from the public on the proposed rules, one can’t help but wonder how these rules might affect the converging financial and non-financial reporting landscape. Would these rules discourage public companies from setting a Scope 3 target so that they wouldn’t have to include it in their SEC filings—a possibility the SEC acknowledges it its proposal? Would SEC registrants be tempted to “bury” certain operating expenses by relating them to climate in order to make their operating results look better?
Although these questions are interesting to contemplate, the SEC has clearly signaled that companies who play fast and loose with their disclosures won’t find much patience from the commission. I expect that the SEC will enforce these proposed disclosures no differently.
What companies can do to prepare
For those of you who have been involved with SEC reporting for a while now, this proposed rule may bring back feelings of when Sarbanes-Oxley became a thing.
For ESG practitioners and SEC reporting teams, I think the proposed climate rule comes down to this:
- The addition of these new disclosures and audits into SEC filings will drastically accelerate deadlines for ESG reporting teams as 10-K due dates are non-negotiable and drastically raise the stakes for reporting reliability
- The addition of climate-related metrics to the financial statements are no joke and will be subject to internal controls over financial reporting (ICFR), which get audited by both management and external auditors
- As a result, companies will need to engage their internal audit teams to implement robust controls that govern data related to climate metrics, models, and assumptions that will affect financial statements and other disclosures to the SEC
- They’ll also need visibility into how these metrics get sourced, prepared, and reported to ensure consistency across the various places that climate metrics will now be disclosed, both for SEC reporting and to other ESG reporting stakeholders
- The SEC wants to know how management and the board are staying on top of ESG risks, so it makes all the sense in the world for financial and ESG teams as well as internal and external reporting teams to stay in sync
For CEOs and CFOs, especially of larger companies, I think a key question has to be: do I have the right technology and teams in place to be ready for a final SEC rule in the next 18 months or so?
At a minimum, teams would benefit from having a connected hub uniting financial and non-financial reporting where SEC, ESG, legal, board reporting, and audit teams can work together to keep executive ESG task force or board committee members informed. I’m talking about one place where they can all use the same source data, with complete visibility and control into the myriad of reporting processes, all with auditability and assurance. Call it a digital headquarters if you will.
Workiva could be a natural fit for your team, not only because Workiva is a leader in SEC reporting software, iXBRL support, and services but also because organizations have used our platform for investment-grade ESG reporting, board reporting, SOX compliance, and internal audit management for years.
With our world-class network, Workiva is happy to share resources and best practices that we’ve seen work for other companies. Organizations have a lot to do to get ready for compliance with a final SEC climate rule, so start now with making sure you have strong people, processes, and technology in place.
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