The U.S. Securities and Exchange Commission’s (SEC) proposal for mandatory corporate climate risk disclosure rules, announced this week, should create a tectonic shift in the Environmental, Social and Governance (ESG) information ecosystem. For years, companies, investors, and policymakers have decried the lack of standards governing companies’ measurement of their ESG performance or mandates that companies report ESG data at all.
The lack of rules has been terrible for companies, for investors, and for the planet. If implemented well, however, the new SEC rules should be a major step in the right direction.
The damage wrought by the current patchwork system is not abstract. It has delivered discord, disarray, confusion and, ultimately, the misallocation of capital. Without standardized, mandatory ESG disclosure rules, the scope, depth, timeliness and format of companies’ self-reported ESG performance data are primarily left to the discretion of those companies’ managers. This variability, in turn, means that a company’s self-reported ESG data cannot accurately be compared with that of any other company, effectively compelling well-intentioned ESG investors to “fly blind” when committing their capital.
The SEC’s proposed corporate climate disclosure rules would not only increase the availability of companies’ self-reported ESG performance data, but bring transparency, credibility, and, importantly, comparability to their reports.
In effect, these rules would help to increase the supply of “investment grade” ESG performance data from companies; this is a commodity that 97% of investors say is important for companies to collect and use, and 85% of investors say is “more important” than companies’ other data when informing their investment decisions, especially data describing companies’ environmental risks and impacts, according to the 2021 Benchmark ESG Survey: Investor Attitudes on Company ESG Data. If adopted by the SEC, these rules would accomplish this by minimizing the level of discretion that managers of SEC-registered, publicly traded companies exercise when disclosing information describing their exposure to financially relevant sustainability risks, their plans to manage those risks and, finally, the outcomes of their subsequent risk management efforts.
As anticipated, the proposed rules primarily concern covered companies’ disclosure of their operational greenhouse gas (GHG) emissions and their management of them. And while the introduction of more robust governance of companies’ ESG disclosures is supported by investors and non-financial corporations, as well as the general public, the rules are not without controversy. Specifically, early opponents of the SEC’s proposed rulemaking lament the potential requirement for covered companies to disclose the GHG emissions produced across their full value chains, or the emissions they neither directly own nor control.
To be sure, these so-called Scope 3 emissions are arguably more important than companies’ Scope 1 or Scope 2 emissions, oftentimes comprising the greatest share of a companies’ aggregate enterprise emissions profile. The controversy, however, stems from the challenge of quantifying these upstream and downstream emissions, not to mention managing them and providing the assured, substantiating evidence thereof.
But it doesn’t have to be this way. Taking a closer look at the SEC’s proposed rules, it’s clear that fulfilling the potential compliance obligations will require business leaders to complete two fundamental ESG performance management processes—perform a robust materiality assessment and establish an appropriate system of record for climate-related and other ESG KPIs.
The Materiality Assessment
Charting a course of preemptive compliance with the Commission’s proposed rules will require business leaders to first perform a comprehensive materiality assessment focused, as the SEC has proposed, on their organizations’ outward climate-related impacts (i.e., GHG emissions) and inward financial impacts—both actual and potential.
The implications are that business leaders will no longer be afforded discretion in determining which climate-related issues would be considered “material” to current and prospective investors. To that end, business leaders will need to perform a full-fledged accounting of their enterprise- and asset-level operational emissions and climate risks. And they will need to be prepared to report both their plans to manage those impacts and risks, as well as the outcomes of those plans.
The System of Record
Clearly, generating, analyzing and reporting such granular data of this volume would be an all but impossible task without appropriately comprehensive, technologically-augmented accounting processes. This is where the advantage of today’s cloud-based ESG performance measurement, management, and reporting solutions is most apparent.
Once the materiality assessment is performed, these digital solutions enable enterprise end-users to automate their climate and ESG performance data collection and analysis. This, in turn, equips companies with the insights needed to evaluate the effectiveness of their emissions and climate risk mitigation efforts. Further, these cloud-based platforms help companies to integrate the bottom line outcomes of their ESG performance into their regular financial filings with minimal risk of human error or delay.
It’s unsurprising, then, that a plurality of respondents to the 2021 Benchmark ESG Survey: Investor Attitudes on Company ESG Data said the best driver of improvement for companies’ collection, usage and disclosure of investment-grade ESG performance data is to “provide digital technology and tools that help collect accurate and reliable data.”
Conclusions for Companies Affected by the SEC’s Proposed Rules
In the unlikely event that the SEC’s proposed rules are scuttled outright, it’s clear that policymakers are advancing efforts to hold companies accountable to their climate-related impacts and risks.
What business leaders must appreciate, though, is that establishing an effective ESG performance measurement, management and reporting system helps companies achieve far more than regulatory compliance. With a strong ESG program, driven by the right technological support, business leaders can tap untold business performance outcomes, from investor relations to talent retention and acquisition and beyond.
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