By Nana Yaa Asante-Darko  |  Originally Published on FactSet, April 21, 2022

The U.S. Securities and Exchange Commission’s (SEC’s) highly anticipated proposal on climate disclosure spells out expanded rules on what companies would be required to report regarding the climate risks they face. Although the rule change (expected to be approved later this year) is a significant advance on the guidance the SEC issued in 2010, it will be much less burdensome relative to rules in other leading economies.

Unsurprisingly, the proposed rule change garnered an array of responses, including resistance from one SEC commissioner and those already exploring avenues for litigation. For public companies, asset managers, and investors, the best path forward would seem to be understanding the depth and breadth of the rule—and preparing for compliance when the rule is passed.

Entelligent’s commentary has been cited twice in the proposed climate-related disclosure regulation, leading us to offer the following insights and guidance.

Major Highlights

Climate change risk is a systemic risk that also translates into various enterprise risks. Investors need to understand how it permeates every aspect of their business process and prepare accordingly. Previously, we broke down climate change risks into transition risk and physical risk and discussed how investors could amend their strategies. The arrival of this rule is very much in the interest of investors and registrants alike (even though some companies might say otherwise).

Investors need to understand how climate change risk permeates every aspect of their business process and prepare accordingly.

The proposed rule has been fashioned after and aligns with the recommendations of the Task Force on Climate-Related Financial Disclosure (TCFD) and the Greenhouse Gas (GHG) Protocol. “Building on the TCFD framework should enable companies to leverage the framework with which many investors and issuers are already familiar, which should help to mitigate both the compliance burden for issuers and any burdens faced by investors in analyzing and comparing the new proposed disclosures,” the proposal states.

Prior to the proposal, we had emphasized that it was critical to understand the TCFD recommendations, particularly on why climate disclosure is important, the compliance value of the TCFD, and the structure of the TCFD. The SEC said the wording of the proposed rule was intended to facilitate consistency and comparability. In our earlier work concerning the TCFD, we explicitly focused on the underlying principles and how investors can begin to integrate them to ensure comparability and consistency.

The proposal shows that the SEC would require disclosure related to:

  1. Governance of climate-related risks and relevant risk management processes
  2. How climate-related risks have had or are likely to have a material impact on business operations over the short-, medium-, and long-term
  3. How climate-related risks have affected or are likely to impact strategy, business models, and outlook
  4. How climate-related events such as severe weather and climate transition affect financial estimates and statements

We have written previously about the TCFD’s four pillars and the six steps in the climate disclosure process most important to investors. We explained how investors could satisfy the four main requirements in the SEC’s proposal by following the four pillars and six steps of disclosure.

The SEC would require companies to disclose the tools, assumptions, parameters, and analytical choices used to assess climate risk.

Regarding the usage of scenario analysis, the establishment of transition plans, and the setting of goals and targets such as net-zero, the SEC would require companies to disclose the tools, assumptions, parameters, and analytical choices used to assess climate risk. This is key. We expect the resulting increase in data to provide a growing pool of information with valuable decision-making potential for investors and asset owners.

The disclosure of emissions information is slated to closely follow the guidelines established by the GHG Protocol. Making disclosures on emissions demands that companies understand the various metrics at play and how they are calculated. We previously reviewed the TCFD metrics and some alternatives.

Discussion of financial disclosures and those related to climate cannot be made without considering audits, particularly because there are not yet generally accepted accounting standards to gauge the veracity of disclosures. There will be a heavy reliance on the processes of the TCFD and the GHG Protocol.

The SEC is expected to require certain companies to provide attested disclosures of Scopes 1 and 2 emissions and even Scope 3, where they are available. This will boost pressure on companies to include climate change disclosures in financial audits and result in the creation of an entirely separate audit process for climate risk disclosures. With the creation of the International Sustainability Standards Board (ISSB) by the International Financial Reporting Standards (IFRS), this is likely to happen sooner rather than later.

Conclusion

The SEC is on the right path and its decision to follow the TCFD’s direction is well-informed and serves the interests of market participants. Asset managers, investors, and companies should be proactive by immediately reviewing the TCFD’s recommendations.

Article Reposted with Permission from FactSet.