New ESG regulations - some first reactions from market leaders

Brian Sommer Profile picture for user brianssommer March 25, 2024
Summary:
What new SEC guidelines are likely to mean in practice.

climate change

Last week’s news regarding new US Securities and Exchange Commission (SEC) guidelines on climate disclosures are already triggering comments. Our recent piece on this  laid out the basics of these new reporting requirements and the challenges businesses may face. 

For many large US-based firms, the new requirements take something that was previously optional or voluntary and is now mandatory. 

New rules, new responsibilities and granularity

The new SEC requirements are the latest group of reporting requirements to impact Finance, HR and other business leaders.

auditboard

I had a brief conversation with AuditBoard’s Judson Aiken, Senior Director of Risk & ESG solutions. We covered some of the potential impacts the new rules will have. 

One point he brought up was that the new rules will likely trigger increased time requirements for corporate accounting, operations and other personnel. He’s spot-on with that observation. He’s not just talking about the time required to collect, format and report newly mandated information. Instead, he is acknowledging that much of that new time requirement will go to researching and answering questions that the new greenhouse gas data will trigger. Aiken believes customers, suppliers and investors will react to the new data with a number of questions. The follow-up for these questions could be quite time-consuming as firms will have information gaps, data normalization issues and other challenges. 

For example, new carbon-consumption data might help a firm see how its transportation network is outdated and carbon inefficient. If the data can be made very granular, a firm could see which products, batches, jobs and plants are more or less carbon-neutral. (I even wrote about this issue in the book The Executives ESG Playbook.) 

The discussion is something called the Year Three problem. In Year One, a company will struggle just to collect the data needed for basic regulatory reports. In Year Two, the firm may be able to pull this data together faster but now executives have two years’ worth of information to compare/contrast. At that moment, you can imagine the array of questions that will originate within the firm, its investors, etc. as they look at the year over year changes. Unfortunately for the ESG reporting team, those questions will trigger lots of variance analysis, more investigations and requests for more, and more detailed data. By Year Three, the problem (and time requirements) will get even more significant.

Granular, real-time ESG data is the holy grail. It could be used to create highly precise insights into production methods, decisions as to where products should be made, the exact amounts of energy and other resources going into the manufacture and transportation of a product and more. Currently, this isn’t possible in many firms as, for example, electricity or natural gas consumption is only measured monthly and if this cost is ever attributed to specific products, batches or jobs, the information is too aggregated, averaged, allocated or old to be of any value.

Take for instance a product salesperson struggling to decide which product to sell to a prospective customer. If two somewhat similar products have very different energy requirements, then the environmentally favorable one should get the go-ahead. But, an absence of solid data makes that impossible. Likewise, information about how the raw materials will get sent to the plant and how the finished goods get to the customer is frequently too generic to be of any value. At best, some companies have carbon emissions data by shipping lanes but that might not take into the consideration the weights of other products on the same truck load. Even the type of delivery vehicle can be an issue that begs for more precise data. An EV powered delivery vehicle may not burn carbon-based fuels but they may wear out tires (a carbon intensive product) at an accelerated rate. 

Aiken also sees the role of an ESG Controller ascending in importance. The best of these will be steeped in the knowledge of accounting controls, data integrity, auditing, consolidations, cost accounting and other disciplines. Given similarities to the workflow, documentation, controls and other requirements that Sarbanes-Oxley imposed on accounting organizations, an ESG Controller may benefit from applying those same disciplines with these new SEC reporting requirements. I’d concur. 

More work ahead

Software firm Workiva just came out with a new report on the subject. The timing of this is fortuitous given the SEC’s recent announcement. Workiva’s survey collected feedback from 900 C-suite executives and 100 institutional investors. Some key statistics from that report include:

  • 74% of executives believe complying with new regulatory reporting requirements will be significantly more challenging in the next 12 months.
  • 67% of executives are concerned about their company's ability to comply with new regulatory reporting requirements.
  • More than nine in ten institutional investors (91%) say that the pending climate disclosure rules will likely help them make more informed investment decisions.
  • 94% of institutional investors agreeing third-party assurance is critical to a company's compliance efforts and for instilling investor confidence in business reporting.
  • 85% of executives and investors agree that ESG data should receive the same level of assurance as financial data

Steve Soter, a VP at Workiva, noted:

The new requirements will likely cause drastic changes to existing disclosure and audit processes. This is especially true for US public companies who have not already begun integrating their sustainability and financial reporting or auditing their sustainability disclosures. Notably, these new rules, softened from their original proposal, set a relatively low bar in comparison to other widely-accepted climate disclosure requirements, including standards established by ISSB and the disclosure requirements of the EU’s CSRD.

The SEC kept the requirement to disclose the impacts of climate by disaggregating the related financial statement line items in a financial statement footnote, which will therefore be subject to financial statement audit assurance. Hence, complying with these rules will inherently mean that changes in financial results now need to be viewed through the lens of climate impacts and documented in a way that will satisfy internal controls over financial reporting and withstand stringent external audit scrutiny.

In other words, a company won’t just report their carbon emissions, they must also explain how these will impact current and future line items in the firm’s financial statements. Auditors will be clocking in additional hours writing up extensive footnotes to the audited financial statements. 

And the courts are now involved

These new reporting requirements weren’t even a few days old when two fracking firms got a court to pause the enforcement of them. According to E&E News

Liberty Energy and Nomad Proppant Services had argued the rule would “occupy a significant portion of public companies’ SEC filings and subject them to increased enforcement and litigation.

The SEC had told the 5th Circuit that the companies’ request for a stay was premature, noting that the rule has yet to be published in the Federal Register and would not require any disclosures before March 2026 at the earliest.

The fracking companies pushed back, telling the court that they would be “irreparably harmed” without an emergency stay because the regulated community needs to begin preparing now to comply.

In yet another corner of the legal battle, the Sierra Club and the Sierra Club Foundation contend that the rule is too weak and won’t provide investors with enough information about companies’ potential exposures.

My take

Businesses that do work in other countries are likely having to deal with the carbon tracking and ESG requirements of other countries. The recent SEC reporting requirements are just another kind of reporting that companies, their IT systems and their accounting organizations (among others) will need to comply with. Whether pending litigation in the US triggers any sort of delay is not going to change the other global reporting requirements nor will it stop some shareholders, institutional investors and others from demanding that U.S. firms provide more data here. 

What U.S. based IT departments may want to consider is a new long-range systems plan and a review of the operational, supply chain, cost accounting and other systems that may need considerable functional enhancements to capture, process, store and report new carbon-related and ESG-related data elements. There may be significant issues to be handled eg, your plant only has one gas meter and natural gas usage gets allocated over all of the products, batches, product lines, etc. But what is needed are specialized meters at each step of the production process and systems to correctly assess the actual carbon output triggered by each unit of production.) and old systems were never designed for an ESG reality.

Accounting teams, which are often and notoriously overworked and understaffed, are not going to love more work being dumped on their shoulders. CFOs and Controllers need to get ahead of potential ESG staffing requirements and get the budget and headcount they will doubtlessly need. Failing to do so will likely trigger more attrition in a function that cannot afford any. 

Loading
A grey colored placeholder image