Moving Forward with the SEC’s Proposed ESG Regulations
36 years have passed since the term greenwashing was coined by New York environmentalist Jay Westerveld in 1986. The term refers to companies' marketing and PR tactics that deceptively persuade the public to believe that their products, aims, and policies are environmentally friendly. Since then, we’ve seen massive growth in the ESG space. This has unsurprisingly led to an increase in greenwashing activity from corporate entities claiming to be mission and impact-driven. Experts in the space believe that the only way to end greenwashing is to create a reporting system built on transparency. The question everyone’s been asking is will the SEC's new regulations meet this need and officially put an end to greenwashing?
In March 2022, the SEC published its proposed climate-related disclosure rules. For the first time, U.S. companies will be obligated to provide information on the climate risks associated with their operations, and how they plan to mitigate those risks (see our post from June 03, 2022). These proposed regulations require public corporate entities to disclose vital information on their ESG activity, specifically as it relates to climate-related risks and emissions. This means that companies will need to identify and list what issues are material to their business, how these issues impact their business, and how they plan to mitigate that impact. Additionally, companies will be required to disclose their Scope 1 and 2 emissions, as well as Scope 3, if deemed material. The regulations also include a number of nuanced details regarding climate-related goals, transition plans, data inclusions, and in-line calculations of the financial impact of the identified material risks. The SEC has also released proposed regulations that elaborate on the specific standards that investors will be required to follow. These are designed to complement the reporting elements that are now required of corporate entities to ensure that ESG investments are following similar criteria for disclosure and transparency.
SEC’s Open Commentary Period for Proposed Regulations:
The SEC originally requested for public feedback to be submitted by May 10th. This deadline was extended to June 17th, as they recognized the attention this proposal has received. Given the public’s increased interest, the SEC made the smart decision to extend the commentary period, giving interested parties extra time to thoughtfully curate their submissions. Now that the commentary period has closed, the SEC will review each submission and determine if and how to integrate them. When finalized, these regulations will have a big impact on the ESG space, signifying a new era of climate-related reporting. These proposals will be one of the first U.S. regulations put in place to require public (and some private) corporate entities to disclose vital non-financial information. Given those implications, we at Rho Impact felt obligated to provide commentary and contribute to this important development. Using our technical knowledge and practical expertise, our commentary suggested a robust baseline for climate-related disclosures in the hopes of enabling systematic improvements over time.
What Did we Include in our Commentary to the SEC:
In our commentary, we suggest that the SEC’s regulations should encourage a higher level of disclosure. Such disclosure will allow for meaningful auditability, traceability, and ultimately transparency. To achieve those goals, we focused more on the process of generating the ESG metrics, rather than simply stating the output values. In doing so, the regulations should incentivise corporate entities to uncover and engage with all their material issues, not just the ones they can report positive performance on. Companies should also provide details on the inputs and outputs used to calculate metrics like emissions data or financial estimates of climate-related risk. Providing these assumptions and process details creates added context and clarity needed to properly understand how they arrived at these reported values.
This level of transparency can be achieved by focusing on three prominent topics discussed in the proposed regulations: Materiality, Scope 3 Emissions and Financial Calculations.
- Materiality: Currently, the disclosure of material issues is left to the company’s discretion. In our opinion, the SEC should prescribe process guidelines for how material issues are identified. Only through a thorough stakeholder engagement exercise can all materially relevant issues be identified. By requiring this process instead of leaving it up to the reporting entity to sufficiently list the issues, we can reduce gaps in the analysis and promote greater transparency regarding the actions undertaken to arrive at those conclusions.
- Scope 3 Emissions: Protocols for disclosing scope 3 emissions must include detailed information on both the inputs (i.e., materials or products purchased from suppliers) and outputs (i.e., materials or products sold, waste created). Not accounting for the inputs and assumptions (hidden or otherwise) could create discrepancies between emissions calculations and the final, reported emissions numbers. Additionally, simply stating one value for Scope 3 emissions does nothing to articulate the interactions along a company’s value chain that contribute to this Scope 3 value.
- Financial Calculations: Similarly, asking for a single, quantified financial value regarding how ESG issues may impact future profitability could result in manipulated and misrepresented data. It could also increase the confusion and skepticism in the markets due to a lack of supporting detail. Listing key assumptions, secondary data points, and any methodologies used to support quantitative results would reduce the uncertainty and increase transparency.
It is our stance that providing investors and other stakeholders with greater detail regarding the processes, key inputs, and internal controls used to determine a company’s performance data will positively influence the system of reporting as a whole. It will also go a long way in promoting “Consistent, comparable, and reliable reporting” as said by the SEC regarding their intentions with these proposals. Increasing the depth and transparency of corporate ESG disclosure will be a critical component in eliminating greenwashing. The full extent of our commentary can be found directly on the SEC’s website.
Rome wasn’t built in a day- Why Commenting on the SEC’s Proposed Regulations is so important:
Many comments were made on the SEC’s proposed regulation, with interest from the likes of all-too popular “Impact Investor” Blackrock, as well as political representatives who still view the issue of climate change as a ‘Right vs Left’ debate. Some expressed a very critical view, suggesting that these disclosures will bring an undue burden and extreme costs for businesses. However, we believe that these regulations need to be celebrated! They are the first steps in a long journey towards implementing ESG regulations that will account for all the challenges this space presents. Educating the market and creating effective behavioral changes will take some time. There will be some trial and error, but as the old adage goes, ‘Rome wasn’t built in a day.’ Looking at the state of ESG in the EU reveals that progression in this space takes times. The EU Council and European Parliament announced earlier this week (June 2022) that they have reached an agreement on the Corporate Sustainability Reporting Directive (CSRD) rules. This regulation has been in the making for years, aimed to update the Non-Financial Reporting Directive (NFRD) from 2014. The EU is much further ahead in these developments, and as we’d expect, the SEC’s proposals will likely take some time to pass through our legislative process, but you can see that by setting the bar high and establishing a solid base, we can create an effective and valuable reporting system. Therefore, with our comments, it is our objective to instill these values and ensure that the baseline we establish now sets us up for success in the future. If done right, we can enable better reporting processes, data collection, and metrics calculations, with the ultimate goal of providing important context and useful insight to all stakeholders.
What will the new SEC regulations mean for US Based companies?
According to the SEC, public comments will be finalized in late September, with formal SEC guidance enacted as early as October of this year. The goal then is to have large accelerated filers report on these elements starting in 2023, with all companies being expected to report by 2024. This means that public entities (and their private counterparts/partners) will need to begin developing these capabilities now in order to be fully prepared to report by 2023. Failure to do so will result in SEC sanctions and investigations, which have already been issued at major companies like Deutche Bank and Tesla.
For U.S. Based companies, the finalization of these proposals will dictate what companies need to include in their non-financial reporting. These reports will be much more structured than what is currently required. In addition, they will need to include supporting data and documentation to back up the claims they are making in these reports. This means new procedures for measuring, storing, and sharing data as well as new data structures that will enable the use of these new data types. For some, this will mean identifying the internal functional areas that can support these new processes. For others, it means building out new departments entirely. Without internal consensus and a dedicated team of employees, you will be sure to run into some trouble.
Private companies should also be prepared to report on their ESG efforts. Any private company that works with a public entity will be called upon to report their ESG practices and emissions levels to round out scope 3. Some companies have already begun adding ESG criteria to their supplier requirements, as a lot of their emissions are tied up in the value chain. Reducing that footprint or achieving a net-zero strategy, for most public companies, will rely heavily on working with suppliers and partners whose ESG priorities align with theirs. Private companies should be aware that developing these ESG capabilities and having this information on hand, will be crucial for winning procurement bids and renewing contracts with major public brands.
As the EU Parliament’s lead negotiator Pascal Durand said: “Today, information on a company’s impact on the environment, human rights, and work ethics is patchy, unreliable, and easily abused. Some companies do not report. Others report on what they want. Investors, consumers, and shareholders are at loss. From now on, having a clean human rights record will be just as important as having a clean balance sheet.” It is with this sentiment that we welcome in a new era of corporate transparency and reporting. One in which all stakeholders can make effective judgements on a company’s non-financial performance, and investors care about an investment’s ESG rating just as much as they care about its ROI.
If you have any questions about the ESG regulatory state of affairs, our stance on the SEC’s recent proposals, or if you want to learn how your company can start preparing for these reporting requirements, feel free to send us an email.