I’ve added a new section to the newsletter called ESG Events and Content, available via the homepage. There, I’ll post upcoming events of interest and new content, like the one in this newsletter from the Athena Alliance. Thanks!
After two years of waiting and anticipation, the SEC climate rules have finally passed. Whether you are an activist or an ESG skeptic (and you probably aren’t the latter if you subscribe), you have something to cheer about and to be upset about.
This week, I’m taking a different approach and will unpack my opinion about the rule using the summary bullets from the SEC website. I will reorder and collect them and provide commentary on what I see inside these rules.
But before we go further, remember that, unlike the EU Commission, the SEC is focused on ensuring comparable and quality data from companies to investors, using the definition of materiality outlined by the US Supreme Court from TSC Industries v. Northway in 1976.
Information is material if there is “a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote,” or “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
For activists, this is a reminder that the SEC does not have the job of driving impact from the company to the world and its people but on material issues. If something is material, companies should be reporting it already. This is one of the points that dissenting SEC Commissioner Hester Pierce made, including a ‘where does it end?’ type moment in her questioning of the rule. In her published dissent, she writes:
Our existing disclosure regime already requires companies to inform investors about material risks and trends—including those related to climate—by empowering companies to tell their unique story to investors.
Still, this point doesn’t land in the face of reality. The SEC points out that investors want information the board isn’t providing today, which is generally an indictment on inactive boards. Simply put, the story isn’t being told.
On the other hand, if you are looking for a rule that delivers change, I recommend looking at policies like the passed US Inflation Reduction Act and Bipartisan Infrastructure Law or the EU’s CSDDD, which has not yet been passed. Rules and frameworks like the SEC’s climate rule, CSRD, and ISSB are about driving comparable information, which is all you will get in the end. However, there are always behaviors these rules drive; it is a matter of knowing where to look.
With that, let’s jump in.
Are energy companies in the crosshairs?
For large accelerated filers (LAFs) and accelerated filers (AFs) that are not otherwise exempted, information about material Scope 1 emissions and/or Scope 2 emissions
For those required to disclose Scope 1 and/or Scope 2 emissions, an assurance report at the limited assurance level, which, for an LAF, following an additional transition period, will be at the reasonable assurance level
This is the most interesting set of points, but it is overlooked for not including Scope 3. The addition of ‘material’ is what makes it compelling. Ask yourself this question: If most companies have emissions in Scope 3, which companies are Scope 1 and 2 material for?
As a reminder, Scope 1 emissions are caused by what you burn directly, and Scope 2 emissions are where you pay others to burn something, typically your energy utilities. In most cases, both types of emissions intersect directly with energy companies, whether through their core business model or the pressure companies will put on them. The transition to clean energy is a material transition risk for a utility company. If any future carbon tax or policy favors renewables, this may be a financial risk to a utility company’s customers.
Of course, other industries, such as steel manufacturers, construction, and transportation, have high Scope 1 and 2 emissions. But there’s no denying that the energy industry is the most significant contributor here. Financial services firms understand this connection.
Recently, the WSJ declared Step Aside, ESG. BlackRock Is Doing ‘Transition Investing’ Now. The article covered how BlackRock is focusing on opportunities in the energy transition. If you read their Investment Stewardship Global Principles, you will find the following statements:
Our research shows that the low-carbon transition is a structural shift in the global economy that will be shaped by changes in government policies, technology, and consumer preferences, which may be material for many companies…
Consistent with the ISSB standards, we are better able to assess preparedness for the low-carbon transition when companies disclose short-, medium- and long-term targets, ideally science-based where these are available for their sector, for scope 1 and 2 greenhouse gas emissions (GHG) reductions and to demonstrate how their targets are consistent with the long-term financial interests of their investors.
It seems BlackRock’s opinion isn’t far removed from the SEC.
Taking off my ESG hat for a second, one of my complaints about global disclosures has been that they diffuse the responsibility of carbon accounting across multiple industries when we need to decarbonize the highest offenders through public-private partnerships, investor engagement, and policy. I don’t think the SEC intended to accelerate a renewable transition here. Still, explicitly calling out the material Scope 1 and 2 emissions will undoubtedly spotlight energy companies.
But before any anti-ESG litigants latch on to this focus, you’d be wise to learn about materiality first, as this consideration is pecuniary.
Stop ignoring climate-related risks!
Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition
The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook
If, as part of its strategy, a registrant has undertaken activities to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that directly result from such mitigation or adaptation activities
Specified disclosures regarding a registrant’s activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices
The capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds, disclosed in a note to the financial statements
If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements
Over the past two years, my job has been to talk to companies about ESG topics, mostly aligned with disclosures and reporting. I’ve spoken with at least 300 companies during that time, and the vast majority are only focused on carbon accounting, material or not, and hardly any focus on climate risk.
Yet, here we find four bullet points on climate-related risks and two for disclosing the costs of extreme weather events.
ICYMI: Climate risk is a material risk! If one set of disclosures necessitates action, it is this set. Perhaps that is why companies are largely ignoring it.
Climate risk can impact a company in two primary ways. First, there are long-term or chronic changes, like potentially the drought in the Panama Canal. This example could be a systemic change that impacts global shipping in the short and long term. Second, there are short-term or acute extreme weather events, like the Texas panhandle fire, which Xcel Energy says may have started at one of their facilities. Their risk may be in fines and litigation, as we saw in Warren Buffett’s observation of the topic last week.
I recommend reading about acute and chronic physical risks in the TCFD documentation to learn more.
I’m going to be brutally honest here. If your company isn’t looking at its climate risks, you will have a disaster that disrupts your operations, which is a material issue. I can’t entirely agree with Pierce’s assumptions that we should rely on companies to disclose it already. Yes, they should, but most have boilerplate callouts on climate risk in their 10-Ks, clearly pointing to a flimsy or non-existent strategy. How do I know? Again…300 companies in 2 years…
Speaking of which 👇
You’re bad at Governance and should feel bad!
Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks
Any processes the registrant has for identifying, assessing, and managing material climate-related risks and, if the registrant is managing those risks, whether and how any such processes are integrated into the registrant’s overall risk management system or processes
Governance requires quality change management. ESG (and technology) topics need board-level attention. Post-2020, a company's issues are no longer the same, as the world is a complex mess of interconnected risks, whether you pay attention to ESG or not.
This is a warning to boards that, as with cybersecurity attention, which the SEC has also weighed in on through oversight, you need someone paying attention and doing the work to mitigate the risk. Understanding what the company is doing is valuable for investors and stakeholders.
Even though Scope 3 emissions were missed in the rule, this one has value chain implications. Outside of carbon, there is no Scope 3 perspective, but companies are connected through their value chain in several material ways, including climate risk. Procurement teams should pay attention to material climate risk in their supply chain. Sales teams should push their operational teams to understand this risk as it can be a differentiated value proposition. For example, planning around long-term logistical shifts to ensure suppliers and customers can receive goods builds long-term resilience.
Special Note: Athena Alliance launches AI Governance Playbook!
Authored by senior women executives and board members, and with the input of a broad range of stakeholders, the playbook lends a critical voice that has heretofore been insufficiently included in shaping the conversation around AI governance.
This playbook intertwines ethical, regulatory, risk, and strategic considerations with a strong emphasis on long-term value creation, responsible stewardship, effective talent oversight, and holistic situational awareness.
Your climate-related goals have costs.
Information about a registrant’s climate-related targets or goals, if any, that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition. Disclosures would include material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal
According to the bullet, this is how the company’s stated environmental goals materially intersect with the business, operations, or finances. Ask yourself this: Do these goals intersect materially, or are they ambitious statements? Are companies meeting these goals through universal, table stakes changes, or are they undertaking the hard work to shift materially?
Here, the confusion about ESG and ‘doing well by doing good’ raises its head, looks around and nods approvingly at the mess it's made. Many of these goals are concessionary as they attempt to save the world.
Honestly, this bullet intersects with my upcoming book, ESG Mindset. In the book, I argue that a material approach is needed before you attempt to save the world.
Still, SEC Commissioner Peirce and anti-ESG advocates should love this one because it could point out the financial concessions a company is making to meet its goals and refocus companies on more material transitions.
Carbon offsets and RECs?
The capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (RECs) if used as a material component of a registrant’s plans to achieve its disclosed climate-related targets or goals, disclosed in a note to the financial statements
I can’t figure out this one because I don’t see how carbon offsets or RECs can materially impact goals unless a carbon tax is in play. Still, in the comments, I would like to hear your opinion on this intersection. This bullet may relate again to the energy industry and those high Scope 1 and 2 emitters.
Summary: More curious than anything
While many aren’t happy with the rule, others seem content that environmental disclosures have at least been enshrined in an SEC rule.
I’m curious to see how the rule's framing drives attention to material issues in a way that the markets and boards have ignored.
In other words, this rule is more ESG than sustainability. Companies would do well to shift their mindsets to last long enough to have even a chance at saving the world.