Environment, Social, and Governance (ESG) regulations and stakeholder pressures are increasing every year. With the passing of the US SEC (Securities and Exchange Commission) climate disclosure rules, states like California taking legislative climate action, and growing international pressures, these regulations are becoming more and more complex for companies to navigate.
New ESG Regulations in the US
New ESG regulations in the United States focus heavily on disclosing greenhouse gas (GHG) emissions and the financial impacts associated with climate change.
These new rulings are anticipated to have a widespread impact across industries and their value chains. Four examples of influential regulations in the US include:
1. US Federal Acquisition Regulation (FAR)
This was proposed in November 2022, but has not yet been approved or enacted. It requires large contractors to the US government (those that generate $7.5 million per year or more) to report their Scopes 1, 2, and 3 GHG emissions, identify and calculate their climate-related financial risks, have SBTi (Science Based Target Initiative) validated GHG reduction targets, and disclose through annual CDP (Carbon Disclosure Project) reporting.
2. US Securities and Exchange Commission’s Climate-Related Disclosure Ruling
This ruling, passed in March 2024, is currently stayed as it undergoes review by the Eight Circuit Court of Appeals. Despite this, it remains a prominent topic in the news due to its broad reach within the US. The regulation consists of two main reporting components: first is the qualitative description of climate-related impacts, and the second is the quantitative disclosure of emissions data. The requirements and timing vary according to the size and filing status of the company.
The first component of the ruling requires relevant filers to provide details on climate-related risks and mitigation efforts, along with oversight by senior management and their board. Capital costs related to severe weather events and natural conditions are also to be disclosed, as well as costs associated with carbon offsets and renewable energy certificates.
The second aspect of reporting, which is due later and applies to certain Large (LAFs) and Accelerated Filers (AFs), is the requirement to disclose emissions. While the scope 3 emissions reporting aspect was dropped, the requirement to disclose scopes 1 and 2 remain. As time progresses and companies mature, there are levels of assurance that will be required. For example, Large Accelerated Filers and Accelerated Filers will both be required to have “limited assurance” of their data at some point, however, LAFs will be required to progress to “reasonable assurance” by 2033. There is no current expectation of reasonable assurance for accelerated filers at this time.
3. California SB253 - Climate Corporate Data Accountability Act (CCDAA)
There is a saying, “As California goes, so goes the nation.” With an economy larger than many small countries, the weight and impact of the state’s two new climate bills is anticipated to be quite significant.
Senate Bill 253 is the Climate Corporate Data Accountability Act, which was signed into law in October 2023. It addresses both public and private companies generating more than a billion U.S. dollars in revenue per year, and they conduct business within California. The key requirement is that companies are expected to calculate and disclose their GHG emissions according to scopes 1, 2, and 3 annually. It also requires third party assurance of that data.
4. Senate Bill 261 is the Climate Related Financial Risk Act (CRFRA)
Also signed into law in October 2023, SB261 has a smaller threshold, it too targets both public and privately held companies. This bill targets companies that generate a half-billion or more in revenue per year and conduct business in California. It requires companies to report climate-related financial risks and measures to mitigate and adapt to that risk in alignment with the Task Force on Climate-Related Financial Disclosures (TCFD) or its predecessors.
New ESG Regulations in the EU (European Union)
The EU (European Union) has also been consistently in the headlines for its roll out of multiple new ESG-related regulations. This new approach to reporting is marking a shift in the ESG landscape for companies as the latest regulations require more extensive data collection on both companies’ own operations and their supply chains. There are three important regulations to be aware of:
1. EU Corporate Sustainability Due Diligence Directive (CSDDD)
CSDDD is currently going through the approval process and is likely to be adopted by the EU in 2024. This focuses on establishing due diligence practices to address environmental and human rights impacts over upstream and downstream business partners and a transition plan for climate change mitigation. The earliest compliance date for CSDDD will be in 2027.
2. EU Carbon Border Adjustment Mechanism (CBAM)
Passed in October 2023, CBAM requires an import tax on carbon emissions associated with products entering the EU. The goal is to help reduce greenhouse gas emissions by at least 55% by 2030 from the levels of 1990.
3. Corporate Sustainability Reporting Directive (CSRD)
This is one of the most talked about regulations in the EU, and it will expect companies to disclose over 1,000 data points. It is anticipated to cover around 50,000 companies, including about 10,000 companies outside of the EU. This Directive also requires companies to a double materiality assessment and assume climate is material unless can approve otherwise.
Where to Begin
With all these regulatory changes in the US and abroad, how do you respond as a company, and where should you begin?
This four-step process is a good place to start:
The steps in this four-step process we present all revolve around the central idea of materiality, which is about identifying those financial, social and environmental issues that are most relevant to your company.
Understanding Materiality
Materiality is the cornerstone of effective disclosures for companies from both a financial and ESG perspective. It involves determining which risks and impacts are most relevant and impactful to your company. This understanding is crucial for aligning with current and emerging regulations.
There are two types of materiality: single, which focuses on financial impacts alone, and double, which considers both financial and broader societal impacts. In either case, conducting an ESG-related materiality assessment can take several months. However, conducting such an assessment is an essential first step and involves engaging a range of affected stakeholders, including those who are users of financial and sustainability reports.
Step 1: Evaluate Disclosure Requirements
Once your materiality assessment is complete and your team, including senior leaders and other important internal stakeholders, understand the material topics, the next step is to evaluate disclosure requirements. These can be regulatory driven, stakeholder driven, or a bit of both.
Step 2: Conduct Readiness Screening
The second step is to evaluate how prepared you are to meet these requirements. This is called a readiness screening. The goal is to identify gaps between your existing practices and the practices necessary to ensure you will be ready to meet the disclosure requirements. From there, you can develop an action plan to fill these gaps.
Step 3: Calculate Emissions
The third step is to calculate emissions and create an inventory management plan. This involves gathering and reporting applicable data necessary to calculate your scope 1, 2, and 3 GHG emissions.
An inventory management plan is like a standard operating procedure for emissions calculations – it identifies the information needed, the stakeholders involved, and the process for maintaining the data. This prepares companies for auditing and verification of their information, a requirement for many ESG regulations.
Step 4: Disclosure
The final phase of the process involves disclosure, which includes both the technical aspects of submitting information to appropriate portals and agencies, and the strategic use of that information to influence stakeholders. Internally, this involves making climate data available to inform decision-making and to inspire and motivate employees and business partners. Externally, this means collaborating with various departments such as marketing, communications, and investor relations to communicate climate data through sustainability reports, ESG reports, or other means of communication.
Moving Forward: Your Course of Action
With a better understanding of what it takes to be ready for these ESG regulations, now is the time to start preparing your organization and mapping out actionable next steps. Here is what you can do to ready yourself and your company for these ESG Regulations:
- Identify where you are currently on your ESG journey. Not every company is going to be in the same place, but more importantly, you need to keep moving forward. It is not permissible for companies to remain stagnant.
- Create and educate cross functional teams. Be sure to bring in groups such as finance, operations, risk, procurement, and others as necessary to work on emissions, assessing climate-related risks and opportunities, and other regulatory requirements.
- Establish internal timelines. Ensure your materials are prepared in a timely manner and in accordance with the organization's legal obligations.
- Review and update your program periodically. Over time, companies will need to reassess where they are on their journey. Over time, companies will need to reassess where they are on their journey. This could mean updating their materiality assessment, re-evaluating their emissions performance and goals, or adjusting certain strategies.
- Routinely evaluate potential gaps. Ensure that your team continues to monitor and close out those gaps. Ensure your team continues to monitor and close those gaps.
Embracing ESG regulations will be essential for long-term success. By staying informed and proactive, companies can navigate complexities, mitigate risks, and thrive in the sustainable economy of the future.
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