The Great Disclosening!
...but then what?
As I write often, the world’s companies are focused on disclosures, and measuring carbon specifically has become one of the biggest challenges companies face today.
Stakeholders across consumers, employees, and shareholders are all waiting for this information to assess the company in new ways. But, of course, regulators are also waiting in the wings, with the EU CSRD coming in stages over the coming years and the upcoming climate change ruling from the SEC. So it is on that latter point that we begin.
As a reminder, the SEC’s draft proposal of the rule is comprised of three essential parts:
Scope 1 and Scope 2 need to be measured and reported.
Scope 3 needs to be reported if material or if the company has set goals around it.
The financial statement must account for material climate risk, the potential for extreme weather events, and transition activities.
Per a WSJ article, companies are expecting to spend $750,000 on average to comply with the SEC’s climate disclosure rule in its first year, with much of that on the complexities of Scope 3. However, it’s worth noting that the article only focuses on emissions disclosures, not climate risk, and not transition costs.
This lines up well with what I see dominating the activities today. While ESG is mainly data-driven, materiality and impact don’t solely come from one metric. For example, a beverage company must be sure to manage plastic packaging and water basins for both ESG risk and sustainability reasons. Its measurement of carbon may tell you how it’s transitioning away from oil-based plastic bottles, but if its local water basin dries up, the company is in serious trouble.
Disclosures are about uncovering more than the data.
Observationally, this “Great Disclosening” (can I call it that?) will meet regulatory and stakeholder pressures around climate change. This is why the title of the WSJ article linked above is SEC’s Climate-Disclosure Rule Isn’t Here, but It May as Well Be, Many Businesses Say.
You can feel the fear of regulatory burden in that title, and the pressure is already here. The EU has already signed its CSRD with a plan for a staged rollout starting in January 2024, and there is way more to disclose under that regulation, which 10,000 non-EU companies will have to adhere to. Still, US companies may have hope as the EU may not require companies to disclose, depending on the SEC’s final rule. Underneath these regulations are the need for stakeholders, including shareholders, to clearly understand the company’s environmental footprint because decisions are made around that information.
Some companies may be mired in this reporting as a disclosure exercise, which it isn’t. While I’ve observed little correlation between disclosures and action, a study from 2019 focused on the UK Companies Act (2013) may help. The Act mandated UK-incorporated companies to report GHG emissions in their annual reports. By 2019, there were improvements in emissions of around 18%. There is action to be taken off these metrics that companies must be ready for next. Companies must build on disclosures and move to action.
First, hidden under disclosures are material risks that the company must mitigate. Companies must run through a materiality matrix exercise and look at standards like SASB/VRF and GRI to determine what ESG metrics might be even more material than carbon. Disclosures alone do not surface material risk; analysis does. Addressing material environmental issues appeases SRI, Impact, and ESG investors because your company manages the impact on the company and out to the world (double materiality). It’s worth noting that there may be opportunities here, too!
Second, companies must look past the disclosures to what they will do to transition. That $750,000 is a pittance compared to the cost of the needed work. Per McKinsey, there is $225T needed by 2050 (or $9.2T annually) to meet the Network for Greening the Financial System (NGFS) hypothetical simulation for net zero. As a result, after disclosures come likely more regulation, government incentives, and stakeholder pressure to engage in the transition. Companies must ask themselves what part of that $9.2T transition cost will be theirs.
Focus on climate risk internally and across the value chain.
These two things are only part of the picture past carbon disclosures. None of the costs listed above include adaptation to extreme weather, biodiversity loss, and long-term damage that companies must deal with, including in their employees’ communities. Remember, if employees aren’t safe, they can’t work! And so, let’s wrap up with a look at climate risk (note: this part is very US-centric, but it should help you think through climate risk, no matter where you live or work).
Over the weekend, Michael Girdley, who I do not know, but who works between investing and operations, tweeted about why he’s not moving out of the US. It primarily centered on the country’s unique geographical features, but as I read, I became concerned. To be fair to Girdley, this wasn’t his intent, but running through his list reminded me of the climate risks that may be directly or indirectly (think supply chain/logistics) related to companies, the country, and its citizens.
The Mississippi River system
This waterway represents a critical logistics line stretching well into the country beyond the main river. This year, the snowpacks in the Minnesota water basin sat at record highs. As that snowpack is melting, the river is flooding, disrupting barge traffic in certain areas.
This comes after a year when the river dried up so much it also disrupted barge traffic.
For companies working on shipping their goods around, diversifying your logistics options, even within the country, is something to investigate.Prime Farmland (and its relation to the Mississippi River)
Besides the flooding and droughts, 2022 was about 1.4 degrees warmer than the 20th-century average, leading to extreme heat in the US. This put a severe strain on farmers. Bizarrely, we even saw 2,000 head of cattle die in the intense heat of June 2022.
This is a challenging material issue for farmers and food companies. As drought-resistant crops can be developed, science may play a role, but consumer demand might stray away from GMOs (Genetically Modified Organisms).
Further, we may see a migration of crops towards other geographies as the climate shifts.Great Lakes
Touted as the largest freshwater system in the world, even that is starting to change. Extreme heat is leading to algae blooms and bacteria-polluted drinking water.
For companies whose workers live along the coastal areas of the lakes, working with local governments on water quality will ensure your workers remain healthy.
Meanwhile, algae blooms aren’t great for shipping, either.Barrier Islands
Along the East Coast of the US are islands that can bring the cost of goods from the Atlantic into the Gulf of Mexico. This virtual coastal river is threatened as the barrier islands are at risk. The Washington Post’s excellent website, aptly named On the Edge of Retreat, covers this problem well.
States must consider tourism impacts and resident safety. Companies moving goods on this virtual coastal river need to be aware of disruption, especially during Atlantic Hurricane season. None of this should be news to the states and companies along the east coast.Size (see 8)
Energy Reserves and Production
I’m tempted to skip this one, but the US’s ability to produce Oil and Natural Gas is listed here, plus “…wind and solar.” It would be great if we could focus on the transition from one to the other via the Inflation Reduction Act and, hopefully, new regulatory actions.
We can’t immediately switch legacy energy off, but we must move off as quickly and responsibly as possible. In fact, the US is the 2nd largest GHG emitting country in the world, only behind China. 91% of the US’s emissions come from energy (as of 2019).Ports (see 8)
Large Coastline
The coastline of the US is unique in that it is large and bridges the West and East well. Yet, the sea-level rise along the southern coastline of the US seems to be rising faster than in other areas of the world. These rates are already outpacing the scenarios for extreme greenhouse gas emissions.
We also saw how quickly COVID impacted the port of Los Angeles and created supply chain constraints. The ports can be bottlenecks during a crisis.
Companies need to consider not only the one-off extreme coastal weather events, long-term climate risk impacts, and other social issues in their operations.
There are other things on Girdley’s list from here, but looking at these eight issues shows how companies need to adapt to climate risk and where to consider stakeholders (E and S together). A country’s greatest geographic assets can quickly become liabilities with climate change, and we’re already seeing it after a tumultuous 2022.
Moving beyond The Great Disclosening
Companies need to be focused on disclosures to meet regulations and assess their starting point. Still, companies must remember that disclosures are not the end state, nor should disclosures get in the way of having an impact. If companies don’t plan transition strategies now, that disclosure report will look awfully consistent in the coming years as the coming won’t be making improvements.
In the meantime, if companies aren’t mitigating risks and adapting to climate change, their ability to impact and transition will be woefully behind. Without holistic and parallel approaches to ESG issues, all that may be left of the company is a ledger recording its carbon emissions but little else.