The SEC climate disclosure rule has been proposed but is currently in the negotiation and internal debate phase before its adoption, leaving the business community in anticipation. The proposed rule represents a significant stride in addressing climate-related risks and enhancing transparency for investors. Many companies are adopting a "wait-and-see" approach, hesitant to take concrete steps until the final rule is announced. While the urge to wait may seem reasonable, it can expose companies to a range of risks and challenges with far-reaching consequences. In this blog post, we will explore the implications of a reactive approach to climate reporting, as opposed to a proactive one, and what business leaders can do now.
From Voluntary to Regulated Reporting
We are in the midst of a transition from voluntary to regulated reporting. Climate information is set to become a mandatory component of companies' annual 10-K filings—and the shift from voluntary to mandatory reporting should not be taken lightly. It requires formal sign-offs by board members, CEOs, and CFOs. With the possibility of auditors scrutinizing the integrity of these reports, robust internal controls over climate-related information are no longer a choice—they're essential. This underscores the importance of governance frameworks that prioritize accuracy, traceability, and completeness. Climate reporting is no longer a nice-to-have; it's a core element of corporate accountability that will impact a company's standing in the market.
"As we move from a voluntary to a regulated reporting environment, companies will need to focus on ensuring that the data they are reporting is sound and backed by appropriate procedures and controls so companies are able to show how they derived the information they are reporting to investors." "Building strong internal controls over climate information will help ensure the information reported is complete and accurate. Companies will necessarily be much more focused on the integrity of their climate data as they move from disclosing in voluntary sustainability reports to SEC filings." - Kristina Wyatt, Chief Sustainability Officer at Persefoni
Risks of Non-Compliance
Non-compliance with evolving regulatory standards poses multifaceted challenges for businesses. Beyond potential fines and legal actions by regulatory bodies like the SEC, failure to meet reporting obligations can swiftly erode market trust, impact stock prices, and trigger adverse investor reactions. Moreover, the growing emphasis on ESG factors magnifies reputational risks, as companies risk public scrutiny and backlash for inadequate climate reporting.
Legal and Regulatory Risks
Non-compliance carries legal and regulatory repercussions. The SEC has the authority to impose fines and initiate legal actions against companies that fail to report in line with the new rules. These actions don't just pose a financial burden; they also have lasting consequences on a company's reputation and credibility in the market.
The SEC, armed with enforcement authority, can impose fines that, in previous cases related to financial disclosures, have reached into the millions of dollars. Beyond its enforcement authority, the SEC can also issue comments to companies asking about its disclosures in the filing review process. Those comments are made public and can lead to further questions from investors and shareholders. Moreover, failure to clear comments can affect a company's ability to easily raise capital in public offerings. Private parties can also bring lawsuits against the company if the information disclosed violates the antifraud provisions of the securities laws.
Financial markets do not respond kindly to regulatory missteps. Non-compliance can trigger volatile market reactions, potentially impacting stock prices overnight. Furthermore, the costs incurred from responding to SEC inquiries and investigations can be substantial. These issues collectively can result in a loss of investor trust, making capital acquisition a challenging endeavor.
Companies know SEC climate regulation is coming. Failure to prepare to comply is akin to unnecessarily poking a hornet's nest of risk. The legal and reputational costs related to SEC inquiries can run into hundreds of thousands of dollars, sometimes even millions. Moreover, investors are increasingly likely to put money toward companies with transparent climate reporting. All these factors point to a new reality: a company’s ability to attract capital and expand its operations will, to some degree, rely on its ability to meet the compliance requirements of new climate reporting standards.
Anticipating and Addressing Operational Challenges
Companies should pay attention to the operational complexities of preparing to report. Gathering the requisite data and documentation can be an arduous task without established processes and procedures. Companies must also implement internal controls and monitoring systems, all of which are better done in a considered and deliberate manner.
The operational intricacies of compiling climate disclosures cannot be overstated. Companies that have not laid the groundwork for data collection and internal controls might find themselves scrambling. According to a report by the CDP, over 50% of companies face challenges in collecting the data needed for climate reporting. Lack of adequate preparation can cause operational hiccups, misallocation of resources, and significant disruptions to business as usual—so it’s important to start building a system now.
The court of public opinion waits for no one. Negative media coverage and a decline in stakeholder trust can tarnish a company's brand image. In an era where Environmental, Social, and Governance (ESG) considerations are gaining increasing influence, reputational risks have intensified.
As consumer and investor focus sharpens on ESG factors, the reputational risks of non-compliance escalate exponentially. A refusal to issue climate reporting can result in negative media coverage, social media backlash, and a plummeting public perception. According to a 2020 survey by Deloitte, nearly 40% of consumers have stopped or lessened a business relationship because of the company’s ethical behavior, and climate reporting falls under this umbrella.
Key Considerations for Businesses
A crucial aspect of successful climate reporting lies in the meticulous and timely gathering of data. Starting early not only mitigates errors but also establishes a solid foundation for compliance, safeguarding against potential discrepancies and reinforcing trust in reporting integrity.
The Time Factor in Data Gathering
Data gathering can be a time-consuming process that demands careful planning and execution. Starting early enables companies to establish robust controls and put systems of record in place, reducing the risk of errors and ensuring compliance.
The clock is ticking, and the importance of early data gathering cannot be overstated. Companies that start later are more susceptible to errors, discrepancies, and inconsistencies in their reports. Building a solid system early on safeguards against these pitfalls and lays the foundation for ongoing compliance.
The Ability to Show Your Work
Having a transparent reporting process isn't just a regulatory requirement; it's a business imperative. Whether it's an SEC investigation, a filing review process, or allegations of greenwashing, companies must be able to "show their work." Recall the Enron scandal; inadequate reporting had disastrous effects on the company and its stock price. Investors and regulators alike are looking for clear, consistent, and traceable information to instill confidence in your climate reporting.
Transparency is the order of the day. Financial regulators and investors are demanding to see the ‘math behind the conclusion,’ so to speak. Companies must be prepared to provide clear, auditable trails for their climate disclosures, or risk financial and reputational consequences.
Beyond Compliance: Building Investor Confidence and Trust
The SEC's approach aims to provide a standardized framework for reporting on climate-related financial risks, responding to the industry's plea for clarity amid the current landscape of varied ESG disclosure standards. This move towards harmonization reflects the SEC's commitment to addressing investor demands for consistent, comparable, and reliable information on climate and broader ESG issues. Proactive reporting builds investor confidence and trust, putting companies in a better position to raise capital and enhance shareholder value.
Compliance isn't the endgame; it's the starting point. Investor calls for transparency are reaching an all-time high. A 2021 PwC survey found that 83% of investors want companies to disclose more information on their ESG frameworks. By embracing these changes proactively, companies can not only meet regulatory requirements but also enhance their own reputation and attractiveness to a new generation of climate-conscious investors.
Seizing the Opportunity: A Proactive Approach to Climate Reporting
Waiting for the SEC's final rule on climate disclosure can carry an array of risks—legal, financial, operational, and reputational. A proactive approach to climate reporting not only helps mitigate these risks, but also offers companies the opportunity to demonstrate leadership in corporate responsibility and sustainability.
As we await the final rule, the question is not whether you can afford to invest in comprehensive climate reporting, but whether you can afford not to. With looming regulations, now is the time to take action.