In the evolution of corporate climate action, 2022 may be the year of transparency.
Last year brought more massively destructive hurricanes, tornadoes, wildfires, and floods, forcing businesses to grapple with the threat of climate change to their operations, their supply chains, and the economy.
At the same time, investor appetite has surged for companies with sustainability bona fides. Net inflows into Environmental, Social, and Governance (ESG) funds hit record highs in 2021.
With climate risks rising and investors clambering for ESG opportunities, SEC Chairman Gary Gensler has called climate disclosure rules a “top priority” for the agency. Although they’ll only affect public companies, the push for transparency also aligns with the SEC’s plans to require private companies to disclose more information on their finances and operations. Meanwhile, institutional investors want to overhaul annual report and proxy statement disclosures to include ESG information.
The G7 is moving to make climate disclosures mandatory, with France, the UK, and Japan in various stages of rolling out requirements. Starting this year, over 1,300 of the largest UK-registered public companies, including banks and insurers, as well as private companies with over 500 employees and £500 million in revenue, will face mandatory disclosure of climate-related financial information.
This rising demand for climate transparency presents costs and challenges, but many finance decision makers see the trend as an opportunity to stand out as leaders.
“This rising demand for climate transparency presents costs and challenges, but many finance decision makers see the trend as an opportunity to stand out as leaders.”
A diverse and growing number of companies are differentiating themselves by sharing sustainability performance metrics. Case in point: certified B Corporations. These companies must meet high standards in areas from employee benefits offerings and charitable giving to supply chain practices and raw materials. Larger B Corps must also undergo an ESG risk analysis and publicly share performance each year.
In 2020, the number of B Corps grew by 20 percent, with bigger companies making up an increasingly larger part of the cohort. Why? In addition to wanting to do good, transparency around sustainability provides a powerful competitive advantage. One example is A-to-Z Wineworks, the world’s first B Corp winery.
“It’s a way to separate ourselves when someone looks at a wine shelf,” says CEO Amy Prosenjak. The differentiation, she adds, helps the company recruit and retain talented employees.
With that in mind, here’s a short guide to climate disclosures in 2022 and why they matter for business leaders.
1. WHY ARE REGULATORS FOCUSING ON CLIMATE DISCLOSURES NOW?
The climate crisis has spawned new financial risks, rallying companies around the world to reduce greenhouse gas emissions and join the fight against climate change.
Since you can’t manage what you don’t measure, as the famous Peter Drucker saying goes, one of the first steps is to get a handle on companies’ climate impact.
In 2021, more than 13,000 companies representing over 64 percent of global market capitalization disclosed data on climate change, water security, and deforestation via environmental reporting non-profit CDP. That was a 37 percent increase over 2020. In the US, an estimated 95 percent of companies in the S&P 500 release voluntary reports with ESG metrics.
Although the numbers are impressive, the ESG factors reported can vary widely. Some company reports may focus on recycling efforts or energy efficiency measures but may not even report climate data such as greenhouse gas emissions. That reality underscores the core problem: a lack of consistent, reliable, and comparable information. Regulators want apples-to-apples comparisons for companies, investors, and consumers.
2. DO CLIMATE DISCLOSURE STANDARDS EXIST YET?
Yes, standards exist. But, there’s no single universally recognized set. Instead, there’s a multitude of them, which creates confusion.
In the wake of last year’s UN climate summit COP26, the new International Sustainability Standards Board (ISSB) was formed to tackle the problem. Their work has just begun, but the board aims to guide companies on making globally consistent and comparable sustainability disclosures. The word “sustainability” can be somewhat of a catch-all term. So the ISSB will first prioritize creating standards for climate risk reporting. Companies will be required to use a thorough framework for monitoring and reporting greenhouse gas emissions based on current frameworks developed by the Task Force on Climate-Related Financial Disclosures (TCFD) and others.
It took decades for the globally recognized Generally Accepted Accounting Principles (GAAP) to be finalized. But with just 10 years left to reverse climate change, there is an urgent need to agree upon universal standards.
3. WHAT WILL THE SEC’S NEW DISCLOSURE REQUIREMENTS COVER?
At this point, the SEC’s ESG Subcommittee has recommended standards requiring corporate issuers to disclose material ESG risks.
Climate disclosures fit into the “E” portion of ESG. Companies currently publishing voluntary reports often include data on the greenhouse gas emissions related to their operations and how much renewable energy they use to meet their power needs.
It’s easy to assume “climate disclosure” includes accounting for the carbon footprint of its own operations. But one question is if the SEC will define carbon footprint more broadly than that. Will it require disclosing so-called scope 3 emissions—those tied to a company’s supply chain and product life cycle?
Scientists also say they’d like the new SEC rules to require companies to use climate risk models accepted by the mainstream scientific community. This is where identifying climate-related financial risk comes in.
4. WHAT IS CLIMATE-RELATED FINANCIAL RISK?
Climate risk falls into two categories:
1. Physical risks are threats from events like hurricanes, droughts, and rising sea levels.
2. Transition risks are risks a company may face from technology and policy changes. Think auto manufacturers facing a potential ban on the sale of gas-powered vehicles.
In the future, the SEC may also move to address the “S” in ESG. Chairman Gensler has said the commission will consider human capital disclosures down the road. This could include reporting on workforce turnover, skills and development training, compensation, benefits, and employee demographics like diversity, health, and safety.
5. HOW SHOULD FINANCE LEADERS PREPARE
CFOs are increasingly seen as sustainability leaders in the enterprise. They should be proactively integrating ESG into their strategy, operations, and overall strategic decision making.
Regardless of an organization’s size or whether it’s public or private, if they are not already voluntarily reporting on climate risk, getting a framework in place now is a smart strategy.
“Regardless of an organization’s size or whether it’s public or private, if they are not already voluntarily reporting on climate risk, getting a framework in place now is a smart strategy.”
A number of independent organizations provide climate reporting frameworks companies can adopt for reporting needs. Elements of these frameworks will likely inform the SEC’s requirements:
Research shows a strong connection between a company’s climate disclosure and financial performance. Companies with high disclosure scores have outperformed reference indexes by an average of 5.3 percent per year over a seven-year period.
Business leaders can view the shift toward transparency as a cost or an opportunity. Executives should be preparing for the unexpected while asking themselves: How is my company preparing for increased climate disclosures?
So, whether at the behest of the SEC, investors, customers, employees, or other stakeholders, those companies getting a jump on climate change disclosures will be the best positioned to thrive in the low-carbon economy speeding toward us faster than ever before.