A U.S. regulatory effort aimed at bringing clarity for investors regarding companies’ environmental claims has only gotten murkier even as international directives on sustainability reporting come closer to reality. As we await the outcome of a court case over the SEC’s new climate disclosure rules, few companies are spending this time relaxing and even fewer are abandoning their ESG commitments. They can’t afford to, observers say. CCI’s Jennifer L. Gaskin reports.
Just hours after the March 6 vote that finalized them, the SEC’s new climate risk disclosure rules drew their first lawsuit. That claim and several others have since been consolidated before the St. Louis-based 8th Circuit, a conservative-leaning panel, and the SEC agreed to put its rules on hold pending the outcome of the judicial process.
This interregnum may or may not conclude with SEC registrants facing new compliance burdens. But even if the commission’s rules never go into effect, the notion that American companies should view environmental, social and governance (ESG) factors as irrelevant or even problematic is foolish at best, many observers say. Consider the proliferation of international frameworks, including the European Union’s Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CS3D) and the International Sustainability Standards Board’s voluntary framework, U.S. state-level climate reporting legislation, including California’s sweeping laws (which are facing their own legal challenges), and pressure from shareholders and other stakeholders.
Indeed, much of Corporate America seems poised to begin reporting ESG-related data that would more than satisfy the SEC’s rules. As the World Resources Initiative recently declared, “Corporate Climate Disclosure Has Passed a Tipping Point. Companies Need to Catch Up.”
“Companies may be new at assessing materiality specifically related to GHG emissions but are likely well-versed in materiality determinations generally.”
Caroline Magee, of counsel at Arnall Golden Gregory
SEC’s disputed climate risk disclosure regulation
Passed by a 3-2 vote along partisan lines, the SEC’s rules mandate material Scope 1 and Scope 2 greenhouse gas (GHG) emissions reporting by large accelerated filers and accelerated filers only, which accounts for 44% of all registrants, according to SEC data, while all registrants would have to make certain other climate-related disclosures.
Notably excluded from the final rule was disclosure of indirect upstream and downstream GHG emissions, also known as Scope 3, which account for as much as 95% of some companies’ total carbon impact, PwC estimates.
Other major changes included:
- Adding a materiality qualifier for companies that must report their emissions.
- Modifying assurance requirements for emissions reporting such that accelerated filers have to provide only limited assurance while large accelerated filers will have a longer phase-in period; large accelerated filers account for about 34% of all filers, the SEC said, meaning that just over one-third of all registrants would face the maximum reporting obligation, assuming the rules go into effect as-is.
- Removing a mandate for companies to describe board members’ climate expertise.
Materiality injects a degree of subjectivity that may run counter to the notion that these rules are intended to provide an apples-to-apples comparison for investors, but experts indicated that corporate leaders have long been expected to make materiality determinations across their businesses.
“The addition of a materiality qualifier for Scope 1 and Scope 2 GHG emissions disclosures brings this type of disclosure into line with other materiality-based SEC disclosures and is likely to be intelligible to investors for the same reason,” said Caroline Magee, of counsel at Arnall Golden Gregory’s Atlanta office. “Companies may be new at assessing materiality specifically related to GHG emissions but are likely well-versed in materiality determinations generally.”
Materiality questions also speak to broader cultural issues within companies, said Ryan Rodriguez, ESG senior group supervisor at contractor and supplier information management platform ISN, meaning some of these conversations are likely already ongoing regardless of whether the SEC’s rules apply.
“One of the key things to highlight there is materiality assessments are extremely important for organizations regardless of whether they’re public or private or they’re big or they’re small,” Rodriguez said. “You really have to understand what values your company and your company stakeholders place on various ESG topics, not just for greenhouse gas emissions.”
Still, he says, even within organizations, decision-makers don’t always see eye-to-eye, so disputes may be inevitable as companies grapple with whether their climate impact is material and must be reported under the SEC’s rules.
“You could say I’ve got all of these greenhouse gas emissions that are a result of my business,” Rodriguez said, “but one person may view that very differently than a second, even between board members or between executives at the same organization.”
The U.S. Chamber of Commerce is one of the main participants in both the SEC lawsuit and the lawsuit California is facing over its climate disclosure and financial reporting laws, accusing both entities of overreach. Those cases are ongoing as of this writing, though it’s noteworthy that in its complaint over the California laws, the Chamber of Commerce suggested that a federal body would be better-suited to regulate these matters, but when one such body attempted to do so, it was also met with a lawsuit.
Still, the organization, which did not respond to an emailed request for comment, has said it supports a “framework for disclosure of material climate risks and emissions,” which suggests the broader business community favors some degree of regulation-driven transparency in climate-related reporting.
Indeed, while the omission of Scope 3 reporting requirements was met with relief by many in the corporate community, FTI Consulting’s Miriam Wrobel, who leads the consultancy’s ESG practice, says that factor alone does not mean the drive to build ESG programs has slowed.
“While there is some relief on the regulatory side, where there is no relief is in being able to demonstrate to investor stakeholders and supply chain partners and customers how companies are performing and measuring all sorts of topics within ESG,” Wrobel said. “The industry is really moving forward, getting data in order and being able to report at a level that would withstand an audit, should an audit or attestation need to happen.”
For some companies, the SEC pause may have no effect at all, says Tom Willman, regulatory lead at Clarity AI, a sustainability tech provider.
“You have one camp that were probably already reporting this information, whether that be because it’s their view that it’s good business, because they have suppliers or customers that demand this data, or even, increasingly, that they’re captured by other regulations, either within or outside the U.S., that mandate the reporting of some of these things,” said Willman, a former regulator at the UK’s Financial Conduct Authority and the International Organization of Securities Commissions. “And for those companies, not much really changes, there was still a bit of a lead time before the SEC rule came in and they’ll continue to report that data, and potentially a larger population will actually come into the scope of things like CSRD and the California climate rules over the coming years.”
Board members’ climate expertise
This was a welcome change for Caroline Magee, of counsel at Arnall Golden Gregory’s Atlanta office, and Rebecca Davis, a partner there, who both said the change was necessary to ensure the rules are focused on the right things.
“The expertise of the board members do not necessarily implicate the bottom line,” Davis said. “Also, there are vast differences in the makeups of boards and their expertise in certain areas. The requirement would have muddied comparability rather than clarified it.”
Magee agrees and argues that, at least in that instance, the proposed rules were a step too far.
“You could have a board member with a Ph.D. in climate risk, but if the governance structures don’t allow the board and management to leverage that expertise, does the resume of a board member really help investors weigh how a company is handling climate risk?” she said. “In my opinion, the SEC was too prescriptive in the proposed rule, pushing companies to report line items that don’t necessarily provide meaningful information to investors about a company’s data-gathering and actions related to climate risk. The SEC was inching closer to pushing boards toward certain structures and personnel, so pulling back on some of these disclosure requirements re-centers the SEC on its investor and securities markets focus.”
Sehrish Siddiqui, a member in the Memphis office of Bass, Berry & Sims, says the change should help ensure discussions over board composition are organic.
“By not requiring disclosure of climate and cybersecurity expertise, companies may feel more comfortable recruiting board members based on needs specific to a company,” she said. “Companies can recruit board members based on desired expertise – whether that be financial, executive, climate, cybersecurity or other background – without worrying about how disclosure (or lack thereof) around climate or cybersecurity expertise would look.”
“We’re seeing a lot of similarities with GDPR, and we’re counseling clients to think of it as a very similar phenomenon that requires the same level of attention.”
Miriam Wrobel, FTI Consulting’s ESG practice lead
Deja vu all over again?
The SEC isn’t the only game in town when it comes to ESG-related regulations and directives. Indeed, the commission is well behind other authorities on this issue, including the European Union (EU) and the state of California, both of which have issued much more sweeping rules regarding climate risk reporting. And the ISSB’s voluntary framework is also helping keep climate and ESG top of mind for corporate leaders.
While California’s rules have been challenged in court, the EU is expected to go a step further, advancing its Corporate Sustainability Due Diligence Directive (abbreviated either as CSDDD or CS3D), which requires covered companies “and their upstream and downstream partners, including supply, production and distribution to prevent, end or mitigate their adverse impact on human rights and the environment.” Among other requirements, the CS3D will require in-scope entities to address child labor, slavery, biodiversity loss and pollution throughout their entire chain of activities.
CS3D remains a way’s off, but its companion piece, CSRD, is looming. It’s been estimated that about 3,000 American companies will have to follow the CSRD, and compliance dates are phased in starting next year. As it did with consumer data privacy, the EU is poised to set a global standard for corporate climate impact reporting.
“We’re seeing a lot of similarities with GDPR,” Wrobel said, “and we’re counseling clients to think of it as a very similar phenomenon that requires the same level of attention.”
The first compliance date for CSRD reporting is in 2025, but many more companies will face the requirements starting in 2026, which would appear to give them a long time to get their ESG metrics in order. But the systems and processes required to do that kind of reporting may not exist in every organization. In fact, Wrobel estimates that a company could need at least 18 months to properly prepare for CSRD reporting.
“Right now, a big piece of this is that a lot of these metrics have never been reported formally before,” Wrobel said. “If anything, they would have been in a sustainability report or communication to investors, but companies do not have the same infrastructure to report on these metrics that they do on financial data.”
And for organizations that aren’t already gathering or reporting the data, a deep dive into all operations is required, Willman said, which may be painful initially.
“[For companies] that are new or first-time reporters or thinking about these issues for the first time, I think it’s fair to say it can be quite a daunting task when you first look at it,” he said. “These may be issues or data points or metrics or key performance indicators that have never been considered by companies before. And it may be that it will require quite an intrusive look at a business’s operations or its relationships with suppliers or value chains.”
But ESG reporting doesn’t remain a daunting task forever, he says.
“It’s never too early to get started on this, even if it’s just an internal exercise to think about how you’ll go about doing this whenever those regulatory requirements come in,” Willman said. “It’s the kind of thing that does get easier with practice and will improve over time.”
Good ESG reporting should link to strategy & values
All of this mandated reporting requires companies to have an in-depth understanding of a host of ESG-related metrics, which suggests that the death of ESG as a corporate topic or investment strategy was overblown, to say the least. That’s not to say some of the arguments against ESG — or at least against the term itself — aren’t valid. Its expansiveness, for example, has drawn a lot of critique, much of it warranted as business concepts made their way into the public sphere, says Alison Taylor, an author and NYU business professor.
“A lot of how sustainability and corporate ‘speaking up’ has evolved in the last decade has involved exaggerated commitments, leaders suggesting they can advocate for and represent ‘stakeholders’ and overall overreach into questions that in an ideal world,” Taylor said, “we would decide via fair, transparent, democratic processes.”
“Really try to explain, like, ‘We have a DEI initiative because we think it is good for our employees to have an engaged workforce that feels they can bring their best selves to work. That’s good for the bottom line because it reduces turnover or increases productivity’ or whatever it is. Try to articulate your initiatives in the context of driving value for the company as opposed to, we set a quota and that’s about it. Or, you know, now we have a climate target. Well, talk about why that climate target is the right thing for your business.”
Jon Solorzano, co-head of Vinson & Elkins’ ESG practice
For some companies, ESG’s shine may be wearing off, at least as an investment practice, but that doesn’t mean it’s going anywhere.
“‘ESG’ … as a one-size-fits-all set of investment litmus tests or as a corporate marketing brand has lost some real luster,” said Dian Zhang, a Gartner researcher. “It increasingly makes sense for companies to talk about specific value-creating environmental and social efforts without wrapping it all in the banner of ESG. And investors may become more focused on specific aspects within the ESG umbrella, such as an organization’s resilience to climate change or its ability to improve supply chain management to mitigate human capital, environmental and geopolitical risks.”
Companies should be able to provide specifics about their ESG-related values and strategies, whether that’s emissions numbers or diversity targets, says Jon Solorzano, the co-head of Vinson & Elkins’ ESG practice.
“Don’t just go off and chase sound bites or chase press releases,” Solorzano said. “Really try to explain, like, ‘We have a DEI initiative because we think it is good for our employees to have an engaged workforce that feels they can bring their best selves to work. That’s good for the bottom line because it reduces turnover or increases productivity’ or whatever it is. Try to articulate your initiatives in the context of driving value for the company as opposed to, we set a quota and that’s about it. Or, you know, now we have a climate target. Well, talk about why that climate target is the right thing for your business.”
In short: Don’t have an ESG program just because the company next door does.
“I do see legitimate criticisms when a company makes statements it cannot back up or when a company pursues an environmental or social objective without linking it to its core mission or strategy,” Wrobel said. “The best ESG programs are backed by data and are integral to the long-term health of the company and the persistence of resilient markets.”
The future of ESG
Even companies that aren’t subject to government-mandated reporting would be wise to invest in their ESG programs, as stakeholders of all sorts — investors, employees, consumers and others — are watching, and expanding regulations may mean you could be implicated in the future. No matter what happens in the 8th Circuit, ESG will remain a central concern for U.S. compliance, risk and governance professionals.
“Boards and management teams will be well-served to ensure that their companies remain prepared to move forward if and when required, remaining abreast of the legal developments will be important, but monitoring a company’s preparedness will also be vital,” said Patrick Niemann, leader of the EY Center for Board Matters Audit Committee Forum. “While the specific actions taken by individual companies will differ, this remains an important focus for boards and management teams, and for many companies, taking the foot completely off the pedal could prove costly.”
“I’d like to see a much more honest discussion of these limitations and trade-offs and a clearer discussion about what problems can be solved via market mechanisms and what problems are about ethical guardrails to manage and account for negative impacts.”
Alison Taylor, author and NYU business professor
And this is far from an esoteric conversation, experts say, as the risks of climate change are all around us — in the form of extreme weather, for example.
“The safe course of action is to prepare a company’s internal processes and anticipate any necessary software and training needs to support not only compliance with disclosure rules that are in flux, but to meaningfully assess a company’s climate-related risks.” Magee said. “When it comes to tangible climate risk — physical risk, energy transition risk, regulatory risk, investment risk — reporting may be the least of a company’s concerns.”’
For some companies, vocabulary changes have been in order, with the Wall Street Journal reporting that many are eliminating the term ESG in favor of phrases like “responsible business,” though there is little consensus as to what, if anything, “ESG” should evolve into.
“Maybe I would call it ‘GEMS’ — governance, environmental, market and social — so that it encompasses market forces impacting a company’s risks that fall outside of the typical ESG categories, like currency risks, supply and demand changes, etc.,” said Norton Rose Fulbright partner Rachel Roosth. “I think focusing on the idea that these factors relate to a company’s financial risks helps increase the understanding that ESG is more than a ‘do-gooder’ concept.”
Regardless of what it’s called, Taylor says, a serious conversation about the issues the term represents is crucial.
“I do think we will see more focused, specific efforts targeting particular problems and more recognitions of the very real trade-offs that can arise (think of the human rights risks around renewable energy, or the even simpler point that if you close a factory, you reduce emissions but also put people out of work),” she said. “I’d like to see a much more honest discussion of these limitations and trade-offs and a clearer discussion about what problems can be solved via market mechanisms and what problems are about ethical guardrails to manage and account for negative impacts.”
And many companies will remain devoted to the principles even if they find another label, Rodriguez said, particularly if they value corporate social responsibility.
“I think organizations are going to continue to want to brag on their efforts in the ESG space, even if ESG takes on a new name,” he said. “You can call it whatever you want, but in the end, having a socially responsible organization is going to go a long way in terms of those companies being able to be good stewards of their community, being able to serve their employees well, attract new talent and retain existing talent at their organizations.”
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