Strong leadership is essential to any well-run company. Climate change represents a significant and increasingly critical risk for many companies. As such, the SEC’s climate proposal includes requirements that companies tell their shareholders and investors about the board’s role in overseeing, and management’s role in managing the company’s climate-related risks. In a word, this is governance. Here’s what you need to know about climate governance, including how to build a resilient internal structure, what’s required, and the responsibilities governing bodies tackle relating to climate.
What is Governance? Why Does it Matter?
Climate risk governance refers to the management and oversight of climate-related risks by organizations, including companies, governments, and other entities. Climate risks refer to the potential negative impacts of climate change, such as physical risks from extreme weather events and the transition risks associated with the shift to a low-carbon economy.
Good governance is a core foundation of climate disclosure and the first of the Task Force on Climate-related Financial Disclosures’ (TCFD) four pillars. It reflects how companies oversee and manage their climate-related financial disclosures. Disclosure of a company’s governance informs shareholders and investors about the extent to which a company is adequately addressing its l climate-related financial risks Such disclosures can give investors insight into the extent to which senior leaders in the company, including management and the board of directors, consider climate-related issues in their decision-making processes. Additionally, governance disclosure enables investors to have confidence that a business is paying attention and taking responsibility for climate-related financial risks.
SEC’s Climate Proposal Overview
The SEC's climate disclosure proposal, released on March 21, 2022, would require companies to inform their investors and shareholders of their climate-related financial risks. The proposal would improve the quality and consistency of climate-related disclosures, thereby providing investors with the information they need to make informed investment decisions.
The proposal would apply to public companies, including foreign private issuers, that are required to file periodic reports with the SEC under the Securities Exchange Act of 1934. It would require disclosures related to the company’s climate-related financial risks in registration statements filed to register securities offerings or securities, and in annual reports filed on Form 10-K or Form 20-F.
The proposal would require climate-related disclosures, that include the following:
- Scopes 1 and 2 GHG emissions;
- Scope 3 GHG emissions for larger companies, if scope 3 emissions are material, or if the companies have made GHG reduction commitments that include scope 3 emissions.
- Financial impacts of climate-related risks on the company's business and operations, including physical risks (e.g., sea-level rise, hurricanes), and transition risks (e.g., the financial impacts of changes in regulations or markets due to the transition to a lower carbon economy).
- Description of the company's climate-related governance.
- Description of the company’s processes for identifying climate-related financial risks.
- Description of the company’s risk management processes for addressing climate-related financial risks.
- Targets or objectives the company has established related to material climate-related risks and opportunities, and how progress towards those targets or objectives is measured and assessed.
The Proposal closely aligns with the Greenhouse Gas Protocol and recommendations put forth in the TCFD framework, which comprises four areas of disclosure:
- Governance: Disclosure of the company's governance around climate-related risks and opportunities by the registrant’s board and management.
- Strategy: Disclosure of the actual and potential impact of climate-related risks and opportunities on the organization’s strategy and financial planning.
- Risk Management: Disclosure of how the organization identifies, assesses, and manages climate-related risks.
- Metrics and Targets: Disclosure of the metrics and targets used to assess and manage relevant climate-related risks and opportunities.
How Does the SEC’s Proposal Address Governance Disclosure?
The SEC (Securities and Exchange Commission) recommends that companies disclose their climate-governance structures under two parts in their public filings:
- Describe the board of directors’ oversight of climate-related risks. The SEC proposal would require companies to disclose information about the board’s oversight of climate-related risks. This disclosure would include whether any board members has expertise in climate-related risks, how frequently the board discusses climate-related risks, how it is informed of such risks, whether and how the board considers climate as part of its business strategy, risk management, and financial oversight, and whether and how the board sets climate-related targets or goals.
- Describe management’s role in assessing and managing climate-related risks. The proposal would require companies to disclose information about the role of management in assessing and managing climate-related risks. This includes disclosure of whether certain management positions or committees are responsible for assessing and managing climate-related risks, their expertise, the processes by which they monitor climate-related risks, and the cadence and framework for internal communication around such risks and strategies.
The SEC recommends that companies provide clear and comprehensive disclosures about their climate governance structures to enable investors to make informed decisions about their investments.
How Boards Can Prepare for the SEC’s Proposed Rule and Governance Disclosures
The role of a board director in carbon accounting is to provide oversight and advice to corporate management on behalf of shareholders. Board directors should be familiar with the steps management should take to develop and report their carbon footprint and how to provide oversight of those activities:
- Risk Assessment: Conducting a comprehensive assessment of climate risks and their potential impacts on the organization, its operations, and its stakeholders.
- Strategy Development: Developing a clear and comprehensive strategy for managing climate risks, including setting targets, prioritizing actions, and allocating resources.
- Integration: Integrating climate risk management into the organization's overall risk management framework, including governance structures, processes, and reporting.
- Stakeholder Engagement: Engaging with stakeholders, including investors, customers, employees, and communities, to understand their perspectives and concerns regarding climate risks and to communicate the organization's approach to managing these risks.
- Reporting and Disclosure: Disclosing information about the organization's climate risks, including the potential financial impacts, to investors, regulators, and other stakeholders.
Source: Persefoni + NACD Joint Publication - A Director's Guide to Carbon Accounting
Boards should consider the following questions when preparing for the SEC’s proposed climate rule:
- What structures do we currently have in place to manage climate-related risk?
- Who oversees the process (full board or management), and what processes and/or frameworks do both the management and board rely on?
- Does the board or any members of management have the necessary climate-related expertise under the Proposed Rules?
- How does management's risk identification and evaluation process address climate-related risks? Are the reporting mechanisms comprehensive and frequent enough to allow the board to know how climate-related risks impact business strategy, risk management, and financial oversight?
- How much information have we publicly disclosed regarding our assessment, planning, and goals related to climate-related risks, and our framework or processes for governing them?
- Are there gaps between current disclosure capabilities and the requirements of the proposed rule? What additional disclosure requirements should we consider?
- What is the company's plan to ensure it has the necessary resources (people, processes, technology) to meet the reporting requirements and timeline?
Examples of Governance of Climate-Related Risks and Opportunities
Many companies have built climate governance systems that can serve as inspiration for other organizations. A few examples that demonstrate different approaches include:
- Shell’s Annual Report 2021 provides detail on the three board committees tackling sustainability at-large. It features an organizational chart, the chief responsibilities of key parties, and the communication framework they follow to stay united and informed.
- Peloton’s 2021 ESG Report articulates the code of conduct of their internal governing team and the expectations of leaders that will help them drive toward climate action.
- Goldman Sachs’ 2019 TCFD Report divides the leadership team into functions and cross divisions, giving each team a set of responsibilities and illustrating how they must collaborate to reach their climate targets.
- Legal and General 2020 TCFD report shows a full organizational chart for their climate governance team, including where it falls within the larger leadership team and the responsibilities of various climate subcommittees. Their report maps all their climate initiatives to the TCFD framework.
Just Get Started
Effective climate risk governance is essential for organizations to mitigate and adapt to the potential impacts of climate change and to ensure long-term sustainability. It requires leadership and commitment from senior management, engagement with stakeholders, and a willingness to invest in risk management strategies and solutions. Reach out today to learn how Persefoni can support your business to embed resilient climate governance within your organization.