In keeping with the growing trend of ESG and sustainability measures within the US and Europe, the Securities & Exchange Commission (SEC) released a climate disclosure proposal on March 21 that, if implemented, would require publicly traded companies to report on key areas of climate risk, as well as its impact, oversight, tracking and more. While the measure is designed to help investors evaluate risk, it’s also a step towards better standardization in how ESG and sustainable supply chains are measured and tracked. And while many industry experts have not been particularly surprised by the announcement – as momentum for climate risk accountability and transparency has only heightened over the past several years – it’s certainly garnered attention from large firms and sustainability teams on what steps to take to be in compliance with the potential ruling.
The SEC initially heard concerns from the public and investors around environmental risk disclosure as early as the 1970s, and even provided guidance on climate risk reporting in 2010. But even though the phase-in period wouldn’t begin until somewhere between 2024 and 2026 (depending on the company), the SEC’s latest ruling signals a more serious commitment to keeping public firms accountable to their initiatives.
In an effort to standardize reporting structures and centralize ESG data, the SEC has utilized the frameworks developed by the Task Force on Climate-related Financial Disclosures (TCFD) and Greenhouse Gas Protocol (GHG Protocol).
However, it’s also important to know that these proposed disclosures would only apply to public firms that already have these initiatives underway, and companies that do not have these commitments in place are not required to create them. While the latter has drawn criticism from sustainability leaders for being too lenient on companies without any ESG targets, there is also reason to remain optimistic (depending on how you perceive it) that tighter regulations for all firms is simply a matter of time, given heightened legislation in Europe and state bills throughout the country.
Key Components of Required Disclosures
The entire proposal can be found here, and it contains all of the requirements that must be included in the 10-k filing. But here is an overview of some of the foundational elements laid out in the document:
Companies must detail the climate related risks that could have a material impact on the firm over the short, medium and long term, and they should be bucketed into either physical or transition risk:
Physical Risk: Physical risk refers to the physical impacts that are the result of climate change, such as natural disasters, such as hurricanes and wildfires. Companies must disclose what these risks entail, including locations, functions and departments, as well as the frequency and time period they are likely to occur, and what assets are at risk.
Transition Risks: The risks associated with the move towards a lower carbon footprint are considered transition risks, and they also must be laid out in the 10-k as well. This includes impacts to regulatory, financial, and market impacts on the organization, as well as any technological or operational risks at play as well. For example, upcoming legislation related to water conservation in a particular state may impact a plant or supplier’s operations and thus the firm.
It’s important to note that the company’s entire value chain must be factored in as well – meaning that without a robust supplier intelligence platform with n-tier mapping capabilities, an accurate supply chain risk analysis is nearly impossible.
Impacts of risk on the company
Beyond identification, companies must also detail the risks’ potential impacts on the firm and how they are integrated into the company’s business model. While this encompasses numerous domains, financial impact and potential effects on overall business strategy must be included. If organizations use scenario analysis, they must also disclose all of the specific scenarios and projected financial impacts under each.
For companies that track carbon emissions, they must also disclose estimated costs of carbon emissions, how the price per unit and total price was calculated, along with methodology used and the ways the firm manages those related impacts.
The proposal’s section on greenhouse gas reporting has drawn praise from sustainability experts for requiring not just the calculation of total emissions, but explicit breakdown of emissions by gasses. It would also require companies to disclose Scope 1, 2 and 3 emissions in certain cases. And while there are exemptions and varying start dates for Scope 3 reporting, companies with value chain goals currently in place must generally report on the specifics of the GHG emissions, methodology and relevant time period.
The inclusion of Scope 3 when applicable has also been regarded as an important step towards achieving sustainable supply chains, as companies’ value chains make up the largest portion of their total emissions.
Target, Goals & Transition Plans
All climate and emission-related goals must be explicitly detailed in the filing, such as how the scope and calculation of targets are defined, units of measurement and benchmarks against which progress can be measured. If carbon offsets are used, the amount of carbon reduction should also be disclosed. In most cases, annual updates would also be mandatory and must include quantitative data to document progress.
Each section discussed contains many more details that must be reviewed by each company. However, it’s important to remember that while this is still a proposal, and public comments are open until June 17, the announcement comes on the heels of many legislative trends within both Europe and the US that aim to standardize and mandate climate disclosures and tracking. In short, stricter ESG compliance within the United States is only a matter of time, and leaning on reliable supplier intelligence platforms is of the utmost importance to procurement and supply chain professionals.