The U.S. Securities and Exchange Commission’s recent climate-related proposal raises the ethical, reputational, and financial stakes for public companies of all sizes.

The proposal builds upon—but is not identical to—frameworks that have already been published by the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas (GHG) Protocol. For companies without a strong Environmental, Social, and Governance (ESG) strategy in place, these new rules will require some significant changes to reporting structures.

This is a time of change and there are challenges ahead. Looking forward, Bob Hirth of global consulting firm Protiviti says that “over time, companies will look to peer reporting, best practice studies created by accounting, consulting firms and industry groups.” Hirth notes that there are several things that must be addressed right away, and that companies “can start by evaluating if they are already making some or all of the disclosures ... and where they are lacking.” Getting these preparations underway now by working with experts in this space will be key to preventing your company from facing potential enforcement action, reputational risk, divestment, or fraud.

Among many other things, the SEC proposal would require disclosure and audit assurance of Scope 1 and Scope 2 GHG emissions, as well as Scope 3 upstream and downstream emissions along a company’s value chain, if material or if a company has already set a target in this area. (Scope 3 is often seen as the most challenging to calculate.) The proposal would also require disclosure of climate-related events or transition activities on financial statements. This could significantly broaden the definition of materiality—from shareholders alone, to stakeholders investing in companies for reasons beyond the standard concerns of profit, revenue, or cash flow.

 “If adopted,” says Steve Soter, senior director, accounting industry principal at Workiva, “these standards will dramatically change the way financial reporting and ESG teams work together and share data. Traditional spreadsheets and shared drives won’t work anymore. For example, the financial statement impact of direct expenditures to clean up after a climate event will be easy to identify, but less dramatic changes in supply chains due to climate will likely be difficult to notice. I need processes in place that would help identify and quantify this impact and can withstand external audit scrutiny. This is where established ESG frameworks and standards can be helpful in building the processes necessary to make these assessments, and where ESG teams can serve as indispensable partners to their financial reporting colleagues.”

Even prior to the SEC proposal, however, reporting based on TCFD and GHG Protocol frameworks had increased significantly. According to the GHG Protocol’s website, “In 2016, 92% of Fortune 500 companies responding to the CDP used GHG Protocol directly or indirectly through a program based on GHG Protocol.” And more than 9,600 companies disclosed through the CDP in 2020, which represents “a 70% increase since the Paris Agreement was signed in 2015 and 14% up” from the year before.

The pending climate proposal is also just one of many: 10 days after the SEC’s announcement, the International Sustainability Standards Board (ISSB) published two exposure drafts (EDs) proposing standards for sustainability and climate reporting, and in April, a host of draft European Sustainability Reporting Standards were released by the European Financial Reporting Advisory Group in line with the European Commission’s Corporate Sustainability Reporting Directive (CSRD). ESG has entered the mainstream, and governments, regulators, and businesses around the world are taking note.

What’s In Scope?
One of the more eye-catching requirements of the proposal was the inclusion of Scope 3 GHG emissions. This covers upstream and downstream emissions that occur in a company’s value chain, which can be challenging to account for as it focuses on the supply chain as well as vendor relationships—plus, it often represents the majority of an organization’s total GHG emissions. It encompasses, among other things, business travel and employee commutes, as well as emissions resulting from the use of a product after it has been sold. Companies with publicly committed Scope 3 emissions targets, and for which Scope 3 is material, would need to disclose this.

As for Scope 1 and Scope 2 emissions from accelerated and large accelerated filers, these would now be subject to assurance by an independent party under the same swift timing as the financial statement audit. This requirement would represent an opportunity for financial reporting teams to help ESG teams deploy the processes necessary to comply since 10-Ks are often filed in February or March, several months before ESG reporting teams would typically provide their data for audit. Collaboration and consistency will be critical.

Further adding to the depth of information that will be required: Various climate-related financial statement metrics and related disclosures will be expected to be added in a note to the registrant’s audited financial statements. This note will be subject to internal control over financial reporting (ICFR) and compliance with the provisions of the Sarbanes-Oxley Act, significantly raising the bar around reliability in reporting.

How to Prepare
If the rule is adopted as proposed, these requirements will be phased in gradually—starting with 10-Ks filed in 2024 for large accelerated filers. Even so, almost immediate action will be required for reporting, ESG, and legal teams, as well as internal and external auditors, to prepare for the coming reporting changes.

“Financial reporting and ESG reporting teams need to begin working together right away to understand each other’s processes, timelines, data sources, and technology,” Workiva’s Soter says. “A 10-K filed in 2024 will cover the period beginning in January 2023—a mere six months away.”

Given that timing, and the expectation that most public companies will be expected to quickly transition to investor-grade and audit-ready climate-related reporting, it’s appropriate to now ask: How can you prepare?

While analyzing the more than 500 pages of the proposed rule is important and undoubtedly daunting, there is a wealth of materials, analyses, and tools developed by legal, accounting and consulting firms that will help registrants understand which activities must be undertaken, when and what this entails.

The first bullet point in the SEC’s helpful Fact Sheet outlines the key components of this proposal, stating that registrants will be expected to provide information on “climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook.” Per Soter, the importance of materiality is a main focus: The materiality assessment for financial reporting is now going to intersect with the materiality assessments for ESG. This, he says, is “a really big deal for financial reporting teams as materiality is a bedrock principle in audited financial statements and disclosure.”

“Instead of reporting what’s important only to investors,” Soter says, “ESG materiality requires companies to think about a broader set of stakeholders such as employees, customers, and the communities where they operate.”

Many larger companies already report ESG metrics based on the TCFD framework and obtain limited assurance on their GHG emissions. Despite this, Protiviti’s Bob Hirth counsels that registrants must ensure that their current GHG assurance provider will be qualified under the proposed rule and whether that provider will be “able and willing to move from limited to reasonable assurance knowing that their report will be part of an SEC filing subject to the inherent third-party liability related thereto.”

Alongside compiling significant additional data and disclosing it in their financial filings, companies will also be expected to add XBRL tagging to these new disclosures and present them in iXBRL format. This will mean the data is structured in a machine-readable format, in line with the SEC’s goal of standardizing reporting. Investment-grade financial data is already presented in iXBRL format, so there is a model to be followed here.

The Way Forward
Hirth outlines the simplest way for registrants to move forward, regardless of their size or the state of preparedness of their reporting: “Combine forces, create a joint team, develop a rigorous and regular meeting schedule, assign specific responsibilities and understand the details of the proposed rule.”

As Soter notes, “Implementing these standards isn’t something that can happen in a quarter or two, and if the proposal gets adopted in its entirety, companies need to start collecting climate data and quantifying its impact now as well as developing GHG reporting processes that will be ready in 2023 to withstand increasingly demanding audit assurance.”

By drawing on the ESG expertise provided by well-established reporting and compliance advisers, as well as trusted SEC and ESG reporting tools in the marketplace like the Workiva platform, companies that start now should be set up for success when the changes come into effect.

Want to learn more about the proposed ESG mandates? Workiva’s Steve Soter, Protiviti’s Bob Hirth, Etsy’s Chelsea Mozen and American Century Investments’ Sarah Bratton Hughes joined Ceres’ Kirsten Snow Spalding for a webinar where they talked more in depth on the topic. Sign up and watch it on demand now.

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