Get Ready for Climate Change…Disclosures, Part 2

ESG criteria are becoming increasingly popular in the market and in the world of business, and regulators are starting to follow suit. Their first topic of focus: climate change. Last week, we broke down the SEC’s proposed disclosure requirements for publicly traded companies in the US. This week, we examine exactly what those disclosures may be.

Climate Change Risk Disclosures

The first key goal of the proposed ESG disclosure is for companies to identify the specific risks that their business faces due to the effects of climate change, including adverse impacts from climate-related natural events like flooding or wildfires (physical risks) and efforts to meet carbon reduction goals being set by various governments and regulators (transition risks). Such disclosures could include the following:

• Disclosure of physical risks for the Company in the short-, mid-, and long-term horizon. This might include damage to the Company’s property in locations that are susceptible to wildfires, or at risk of flood damage due to the raising of sea levels.

• Disclosure of transition risks (or opportunities) for the Company in the short-, mid-, and long-term horizon. This might include the need to retire old equipment, invest in new equipment or technology that reduces emissions or utilizes renewable energy, or shift from operations and revenue streams that will be phased out (e.g., discontinuing sales of cars that use fossil fuels).

• Disclosure of the Company’s processes for identifying, assessing, and managing climate-related risks, as well as the oversight and governance by a Company’s management and board.

• Disclosure of how any identified climate-related risks might affect the Company’s strategy, business model, and outlook.

• Quantitative financial impact of any climate-related events and transition activities on the Company’s financial statements.

• If a Company has adopted a transition plan, disclosure of the metrics and targets to be used to meet the transition plan goals.

• If a Company has publicly set climate-related goals or targets, information about the details of those goals/targets, how the Company expects to achieve those goals/targets, and relevant data to show the Company’s progress towards those goals. If the Company’s plans include the purchase of carbon offsets or renewable energy credits, then details of those purchases must be disclosed as well.

• If a Company uses any scenario analysis or internal carbon prices for its operations, the description of those scenarios or prices and how they are determined.

Greenhouse Gas (GHG) Emission Disclosures

While the above disclosures around climate risk are important, the bulk of many companies’ efforts may occur around disclosing its greenhouse gas (GHG) emissions, which could include the following:

• Disclosure of the amount and intensity (i.e., amount per unit, $ of revenue/cost, etc.) of the Company’s Scope 1 and Scope 2 GHG emissions for a given financial reporting period. Scope 1 is defined as the GHG emissions directly produced by a Company’s own operations (e.g., its own manufacturing, or transportation using its own vehicles). Scope 2 is defined as emissions from the Company’s use of electricity.

• Disclosure of the amount and intensity of the Company’s Scope 3 GHG emissions. Scope 3 is far broader than Scopes 1 or 2, and relates to both upstream and downstream activities that occur outside of, but as a result of, the Company’s operations. Upstream activities refer to activities performed by vendors that provide input to the Company’s operations (e.g., manufacturers that create the materials used by the Company for its products). Downstream activities refer to activities that occur from the transport, purchase, or other use of the Company’s products (e.g., transportation of Company’s goods by a transportation provider, or customer use of cars purchased by a Company who is an auto manufacturer).

In order to make these disclosures, companies will be required to build processes and controls around the gathering of quantitative GHG data for these activities throughout its operations. Scope 1 and Scope 2 emissions may be easier to gather, being within operations that are under the Company’s control. Most companies outside of the manufacturing and energy industries may not even create significant GHG emissions within their operations. However, Scope 3 is expected to be a far more significant effort for most companies. First, the Company must map out and identify all of their various upstream and downstream activities that could result in GHG emissions. Then, the Company must work with its vendors and other external parties involved in determining how to gather that GHG emission data related to the Company; this will likely involve many smaller businesses that do not have the resources or processes available to gather such data.

Take a deep breath. You’ve now passed a course in upcoming ESG disclosures. Now you need to prove to the authorities that you’ve done so with adequate reporting. Next week, we’ll talk about attestation of climate change disclosure requirements.