Public firms will be required to disclose more information under a proposed SEC rule, with likely far-reaching effects.
By Rachel Gerring, IPO Leader for EY Americas
The March 2022 release of the SEC's proposed climate disclosure rule is intended to provide investors with a more comprehensive understanding of the effects of climate change on the operations of publicly traded corporations.
However, the trickle-down effect of these restrictions, as well as the fast-changing expectations of the investment community, will very probably also affect privately held enterprises. Even businesses that have no plans for an initial public offering (IPO) in the foreseeable future may be impacted. Entrepreneurs and private business leaders with foresight should pay special attention to this issue and initiate reforms immediately to prepare for a future with greater openness.
New rules and fresh expectations
Due to the volume and type of comments received on the proposal, the SEC will likely not issue a final rule until late 2022 or early 2023. As drafted, the proposed guidelines would force corporations undergoing an initial public offering (IPO) in the United States to publish emissions statistics and related information in their S-1 filing. There is no exception or graduated disclosures granted to companies going public, particularly emerging growth companies, nor is there a transition time comparable to that for Section 404 compliance.
But it may not be significant.
Regardless of what is included in the final SEC rule, the investor community increasingly expects corporations to disclose climate-related information. Even if the SEC does not force IPO businesses to disclose climate information, investors will undoubtedly do so anyway. Disclosures, or lack thereof, may have an impact on a company's ability to market its IPO and set the public's perception of its offering.
Environmental, social, and governance (ESG) standards, which expand corporate accountability and goal-setting beyond financial performance, are driving this shift in expectations.
The ESG movement has become a priority for businesses in all sectors. The 2022 edition of the EY US CEO Survey, which featured a mix of public and private leaders, revealed that 82% of US chief executives view ESG as a value driver for their firm in the coming years, and practically all have formed a sustainability strategy.
In addition, 73 percent of US respondents claim they have adopted ESG for strategic reasons, such as competitive advantage and lower capital costs, and not due to regulatory pressure.
Three steps for effective openness
To prepare for this new reality, private enterprises — particularly those contemplating an IPO — must quickly advance on three crucial factors.
Start by strengthening your company's climate risk governance structure. This begins with assessing whether and how climate impacts your company's business model today, as well as how a transition to a lower carbon economy would affect your firm. Create a "climate vision" and relevant rules and procedures to support your strategic goals. Where is your company in terms of emissions today, and where do you hope to reach in five or ten years? Evaluate the climate expertise of your board and senior leadership team, and if necessary, recruit individuals with the skills and knowledge to assist in establishing a culture centred on transparency on emissions reductions. Lastly, choose a leader or team to drive your daily climate activities. Incorporating this into your broader corporate strategy and setting the appropriate tone from the top will prevent this from being a compartmentalised, ad hoc, and distinct climate effort.
Prepare for extensive emissions collection and reporting in accordance with the Greenhouse Gas (GHG) Protocol standards, the widely used global standard for greenhouse gas computation, which coincides with the SEC's proposed GHG emissions disclosure requirements in many respects. Focus on Scope 1 emissions (direct emissions, such as owned automobiles) and Scope 2 emissions (indirect emissions, like paid electricity/steam use). If your organisation is not already monitoring emissions data, it is time to start. Depending on your sector and activities, emissions monitoring and data collecting might be a complicated and time-consuming endeavour.
Many businesses have access to Scope 1 and Scope 2 emissions data, however this information is frequently uncollected or decentralised. Now, a structure for data collecting and analysis must be implemented. Companies should build a framework that encompasses all aspects of their business and is precise enough to withstand external scrutiny.
Eventually, even businesses that have no intention of becoming public will be affected, when publicly traded corporations begin reporting Scope 3 (indirect, including upstream and downstream) emissions, either because of rules or by choice.
If a private firm is part of the supply chain of a public company, its executives will be requested to produce specific emissions data for the public company's Scope 3 reporting sooner rather than later. It is the "entrance fee" for dealing with publicly traded corporations.
Additionally, data collection can necessitate investments in technology and tools. Beginning now permits a business to comprehend the scale of its endeavour, identify the necessary technologies, and stretch out investments over time.
Prepare a report on the impact of climate change on financial performance. Companies will be required to disclose the impact of climate on financial statement line items and give an annual climate "mini-MD&A."
Inaction is not an option.
This three-pronged strategy has its greatest challenge in overcoming inertia.
Some private companies are scared by the magnitude of the undertaking and unclear of where to start. Others may not recognise the evolution of the financial community and the SEC's stance on the matter.
The key is to stay abreast of developments, particularly with the SEC rule, and conduct a materiality analysis to see how the business could be affected. How would you need to respond if disclosure rules were implemented today?
Most crucial, begin immediately. Begin by defining an effective cross-functional plan for data collecting and reporting, then modify as information becomes more evident. If businesses are unable to release climate data at this time, they can at least increase transparency by formulating and discussing emission goals and governance structure.
The main line for private company leaders is straightforward: Now is the time to consider climate reporting and how it fits into your long-term business strategy, regardless of your IPO plans.