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SEC Issues Proposed Rules for Climate and ESG Risk Disclosures in Financial Statements

Russ Hissom's picture
Owner Utility Accounting Education Specialists - utilityeducation.com

Russ is the owner of Utility Accounting Education Specialists a firm that provides power utilities consulting services and online/on-demand courses on accounting, finance, FERC best-practices,...

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  • Mar 28, 2022
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SEC proposed climate and ESG risk disclosures

On March 20, 2022, the Securities and Exchange Commission (SEC) released a 506-page report on proposed climate and Environmental, Social, and Governance (ESG) disclosures for SEC-regulated organizations.

The regulations will add another layer of disclosure requirements to SEC registrants and cover disclosures related to the regulated entity’s business practices and, in some cases, the practices of the entity’s supply chain suppliers with which they do business. Most of the disclosures are effective for 2024 reporting, so there is time to develop business processes to measure the required disclosures and develop a reporting framework to use in reporting in stand-along reports and the financial statements.

Public comments are due through May 20, 2022, to the SEC. Instructions on filing comments are found at this link.

Article Takeaways

1. The SEC has issued proposed disclosures regarding efforts by organizations towards managing and mitigating climate-related targets

2. The disclosures cover a wide range, including Board and management oversight of climate-related goals, organization spend on managing climate goals, and GHG emissions data

3. The disclosures will be in the financial statements and subject to audit by the organization’s external audit firm

4. The public may comment on the disclosures through May 20, 2022

This article is an overview of the proposed disclosures. As these are proposed disclosures, the public has 60 days to comment on the requirements before final edits and issue by the SEC.

SEC ESG reporting requirements

The primary reporting requirements fall into these categories:

1. Disclosure of climate-related risks

2. Disclosure regarding climate-related impacts on strategy and business outlook

3. Governance disclosures

4. Risk management disclosures

5. Financial statement metrics

6. GHG emissions metrics

7. Attestation of Scope 1 and Scope 2 emissions disclosures

The remainder of this article highlights some of the proposed disclosures. Use this information as a reference and for forming any questions or comments you may have to address to the SEC before the conclusion of the comment period on May 20, 2022.

Disclosure of climate-related risks

The SEC disclosure requirements revolve around developing a reporting framework for ESG disclosures. The framework references is that of the Task Force on Climate-Related Financial Disclosure (TCFD). The TCFD reporting framework is made up of four main tenants:

Insert class graphic

Other considerations are some of the Sustainability Accounting Standards Board (SASB) standards.

Disclosures Regarding Climate-Related Impacts on Strategy, Business Model, and Outlook

The proposed regulations would require climate-related impact disclosures in this area regarding:

1. Business operations, including the types and location of its operations

2. Products or services

3. Suppliers and other parties in its value chain

4. Activities to mitigate or adapt to climate-related risks, including the adoption of new technologies or processes

5. Expenditures for research and development

6. The time horizon for each described impact

7. How an organization has considered the identified impacts as part of its business strategy, financial planning, and capital allocation.

8. An organization would be required to provide both current and forward-looking disclosures that “facilitate an understanding of whether the implications of the identified climate-related risks have been integrated into the registrant’s business model or strategy, including how resources are being used to mitigate climate-related risks.”

Several additional disclosures are detailed in this section of the proposed disclosure rules.

Coal power plant

Coal-fired power plant

Governance disclosures

The proposed regulations would require disclosures in governance and board oversight of climate-related risks and management’s role in assessing and managing those risks. The SEC asserts that climate-related issues should garner the same attention as other financially material matters. The suggested reporting format is the TCFD framework. Highlights include:

1. Designating and disclosing the board members or committees responsible for oversight of climate-related risks

2. Disclosing whether any Board members have expertise in climate-related risks and their qualifications

3. Disclosing the processes and frequency of climate-related risk discussions

4. Disclosing how the Board considers climate-related risks as part of its business strategy, risk management, and financial oversight

5. Disclosing how the Board sets climate-related targets or goals and how it oversees progress against those targets or goals (an example target listed is achieving net-zero carbon emissions by 2050)

Similar disclosures would be required for management oversight of climate-related risks.

Disclosure of processes for identifying, assessing, and managing climate-related risks

An area of disclosure includes processes related to tying the financial statements to climate-related metrics. These disclosures include:

1. Disclosing two years of metrics tied to balance sheet and income statement accounts

2. Providing a narrative discussion of whether and how any of its identified climate-related risks have affected or could affect the organization’s financial statements - these include physical risks, such as extreme weather

3. Discussing the positive and negative impacts involved with climate-related events

4. Disclosing amounts expensed and capitalized on climate-related efforts

5. Disclosing amounts spent on “transition” activities (activities to move to zero net emissions) to reduce GHG emissions

As the metrics in this section will be in the financial statements of the organization, the amounts reported and disclosure will become part of the annual financial audit of the organization.

Other metrics and targets disclosures

The proposed rules have additional metrics disclosures, including:

1. Disclosing the organization’s GHG emissions for the most recent fiscal year

2. Disclosing Scope 1 and Scope 2 emissions (direct emissions and indirect emissions from power purchases)

3. Disclosing Scope 3 emissions - Indirect emissions generated by a company’s suppliers and customers must be disclosed if material to an organization’s performance or if the organization has set targets for reducing emissions.

4. Providing certain information about service providers

5. Information about climate-related targets or goals

There would be a safe harbor regarding disclosure of Scope 3 emissions for smaller organizations.

What will this do to the desire to become a public company and the impact on issuing debt?

The proposed SEC climate-related disclosures represent another reporting layer for SEC registrants for debt securities or stock. While large organizations have the resources to develop in-house processes to compile and report on the data, smaller organizations have to weigh the cost and benefit of the disclosure requirements.

The SEC recognized that this would impact smaller entities, which it clarifies as those with less than $5 million of assets or debt issues of less than $5 million. The SEC estimated that there are 1,000 such entities. The SEC offered a longer-implementation period for these organizations, but not an exemption from reporting, except for Scope 3 emission reporting.

Smaller organizations without the resources will need to turn to outside firms to help comply with the requirements. While good for consulting firms, it is another cost of business for the smaller organization to include in being a public company. It remains to be seen what unintended consequences the proposed SEC regulation will have on the public company environment.

 

About Russ Hissom - Article Author

Russ is the owner of Utility Accounting Education Specialists. Russ is passionate about the Electric and Telecom Industries and his goal is to share industry best-practices to help better your business and enhance your career knowledge. He has over 35 years serving electric investor-owned and public power utilities, electric cooperatives, and telecom providers as a past partner in a national public accounting and consulting firm's energy practice. Russ was named one of the 2021 Top Voices in the Energy Central Community by EnergyBiz Network.

Find out more about about Utility Accounting Education Specialists here or you can reach Russ at russ.hissom@utilityeducation.com

Discussions
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Matt Chester's picture
Matt Chester on Mar 28, 2022

Do you have a sense of which types of companies this is going to be the biggest lift for them to address? 

Russ Hissom's picture
Russ Hissom on Mar 28, 2022

Thanks for your question, Matt. Larger companies will have the in-house resources to address this, but the mid-sized and smaller utilities may find this a costly implementation process. There will be a need for these entities to seek outside consultants to assist with implementation. The standards will require new business processes that the mid/smaller entities do not have in place more have the resources to comply. 

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