Climate change may well be the world’s most important, and most urgent, challenge. Addressing global warming, greenhouse gases, and sustainability requires the collective efforts of individuals, organizations, and governments. Now, thanks to new ESG rules and disclosure requirements by the Securities and Exchange Commission (SEC) “aimed at enhancing and standardizing climate-related disclosures for investors,” most US-based businesses and investment fund managers will be required to make a more substantial effort to report on their environmental impact and inform investors about the risks of climate change to their business and financial results.
These new disclosure rules are designed to ensure that investors understand the risks of climate change and the efforts companies and investment funds are making to address them. Complying with these rules will require concentrated effort and specialized expertise. In this blog post, we’ll break down what the new requirements will mean for businesses and fund managers.
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What the SEC climate disclosure rule means for businesses
The SEC first issued a proposed ESG disclosures rule in March 2022 that would require public companies to disclose their greenhouse gas (GHG) emissions and other climate change risks. Let’s look at the implications of the new rule for publicly traded companies first.
The rule affects all companies registered in the US.
The mandate requires companies to disclose how their board and management are dealing with oversight and governance of climate-related risks in general. They’ll also need to identify and disclose any specific, material climate-related risks (both now and future) and articulate their impact on financial performance and strategy.
Perhaps the most challenging element of the new disclosure requirements concerns comprehensive reporting of greenhouse gas (GHG) emissions. While all companies will need to disclose Scope 1 and Scope 2 emissions, larger companies with an IPO of over $75 million would also need to disclose Scope 3 emissions. Here’s a quick breakdown of the scope definitions:
- Direct “Scope 1” emissions result directly from your facilities and vehicles.
- Indirect “Scope 2” emissions are produced by the suppliers of the energy you purchase and consume.
- Upstream and downstream “Scope 3” emissions are those that arise from suppliers and customers in your value chain.
Final publication of climate disclosures is said to be published by the end of 2023. The timetable for implementation of these requirements varies by company size:
- “Large, accelerated filers” (defined as companies with an initial public float of $700 million-plus) will have to make all proposed disclosures including Scope 1 and Scope 2 GHG emissions for fiscal year 2023 and will be required to disclose Scope 3 emissions for fiscal year 2024.
- “Accelerated filers” (companies with an initial public float of $75 million to $699 million) will begin reporting their Scope 1 and Scope 2 emissions for fiscal year 2024 and Scope 3 emissions beginning with fiscal year 2025.
- “Smaller reporting companies” (defined as those with an initial public float of less than $75 million) will begin reporting their Scope 1 and Scope 2 emissions for fiscal year 2025 and Scope 3 emissions beginning with fiscal year 2025 and are exempted from filing Scope 3 emissions.
Investors need more consistent, comparable, and decision-useful data about the climate risk of companies that they invest in.
This rule follows the Task Force on Climate-related Financial Disclosures (TCFD) framework and recommends using the GHG protocol or other universally accepted emissions calculations. Businesses will need to submit annual reports to the SEC after the disclosure rule is formalized.
What the SEC climate disclosure rule means for investment fund managers
Environmental, social, and governance (ESG) factors are becoming more central to investment management. According to US-based investment manager Capital Group, 89% of global investors use ESG issues when making investment decisions, and 28% of them say that “ESG investing is central to our investment approach.” Environmental issues account for most of the focus, and investors want more insight into the climate risks associated with their holdings.
Following closely on the heels of the proposed climate disclosure rule for companies, the SEC issued a proposal to enhance ESG disclosure requirements for investment fund managers. The goal is to improve the consistency, transparency, and comparability of investment funds marketed as having an ESG focus. Let’s take a closer look at the details:
The new SEC proposal applies to all funds that are marketed as ESG funds. It requires more, and more rigorous, disclosures by registered investment companies, business development companies, registered investment advisers, and some unregistered advisors.
Asset managers of ESG funds will need to make additional disclosures that shed light on the nature of the funds, including registration statements, prospectuses, reports, and advisory brochures. The actual disclosure rules vary by type of ESG fund:
- Integration funds, which combine ESG factors with non-ESG factors, will need to disclose exactly how ESG factors are used in the investment process.
- ESG-Focused Funds — those that are explicitly focused on ESG considerations — will have to provide more detailed disclosures and include what the SEC calls a “standardized ESG strategy overview table.”
- Impact funds — funds that seek a particular ESG impact, like a focus on renewable energy or sustainable development — will be required to disclose how they measure progress on their specific objectives.
For example, ESG funds that focus on the environment will have to disclose the GHG emissions associated with their investments (which means the new disclosure requirements for companies will be vital to enable asset managers to provide this level of granular information). Moreover, for ESG funds that have proxy voting mechanisms, asset managers will need to provide additional information on how proxy voting takes place and what methodology is used when factoring in GHG emissions.
These disclosures were initially proposed in May 2022. However, the compliance timeframe is still being determined.
The new rules are driven by the reality that investment managers define ESG criteria in very different ways and report on ESG criteria in very different ways. The lack of a common disclosure framework for ESG investment is a problem for investors — for one thing, it becomes very difficult to compare funds according to their ESG criteria. These new disclosures should provide an easy way for asset managers to demonstrate the ESG focus of their funds for audit and investment purposes.
After the SEC disclosure is formalized, funds that fall under its jurisdiction will need to submit reports to the SEC annually.
Disclosure is an opportunity to build trust and your brand
The new SEC mandates for businesses and investment fund managers embrace the reporting framework outlined by the Task Force on Climate-Related Disclosures and the Greenhouse Gas Protocol. If your company has already begun measuring your GHG emissions using these frameworks, you’ll have a head start.
The need for the new rules is clear and their value to society and to your business is unambiguous. By creating the mechanisms for gathering the required data, you’ll be in a position to give investors (and other constituencies) a better, more useful understanding of climate change risks and how you’re addressing them.
For many companies, addressing climate-related risks and the new disclosure requirements presents an opportunity to enhance your brand reputation for trust and straight-dealing. It may also lead to new marketing opportunities for companies that can tell a compelling story about their effective efforts to mitigate climate change — another way to demonstrate your commitment to social responsibility.
To learn more about ESG requirements your organization needs to be aware of, and the means to manage your ESG program, learn more about the OneTrust ESG & Sustainability Cloud today.