SEC Climate Rule-Making Update: Understanding the Obstacles to Finalization

“There’s something happening here, what it is ain’t exactly clear.” The band Buffalo Springfield sang these lyrics in 1967, but they still ring true today. Environmental, social, and governance, better known as ESG, has taken center stage in the world of business as companies around the globe report a variety of metrics touting their ESG performance. 

The problem is that what is being reported may or may not be accurate. While 92% of S&P 500 publicly traded companies produce some form of ESG report annually, the reported metrics are not independently audited or subject to any sort of regulation. As a result, the opportunities to inadvertently and/or purposefully disclose inaccurate data known as greenwashing are huge — and the stakes are high. According to Bloomberg Intelligence, ESG investable assets are set to grow from $35 trillion in 2022 to over $50 trillion in 2025. 

Today, there are over 600 competing ESG reporting standards and frameworks, data providers, and ratings and rankings, according to a recent article published by the Harvard Law School Forum on Corporate Governance. The differences in ESG reporting create opportunities for inaccurate ESG performance comparison and poor decision-making. As such, the US Securities and Exchange Commission (SEC) has proposed formal rules for reporting climate-related metrics and risk disclosures. 

The SEC issued its proposal in March 2022, self-assigning an October finalization deadline that has come and gone. Now, with formidable obstacles standing in the way of a final rule, nobody knows what to expect and when. Still, it’s clear that some form of the rule will ultimately pass. Investor demand for it is strong and unrelenting, given the heightened recognition of climate risk’s potential to impact financial performance. 

EY’s 2021 Global Institutional Investor Survey found that 89% of investors want mandatory reporting of environmental, social, and governance (ESG) performance measures against globally consistent standards. Deloitte suggested ESG-mandated assets will make up half of all professionally managed assets globally by 2024. Ceres’ analysis of investor and asset manager responses to the SEC proposal showed resounding support — but many issuers, regulators, and politicians remain hesitant. As companies worldwide attempt to understand what’s happening and what it means for their business, it’s helpful to understand the challenges the SEC faces.

Obstacle #1: High Volume of Comments to Process

To develop final rules, the SEC must take into account the 14,000+ comment letters it has received, including ~4,000 unique letters. This is an unprecedented volume. Bloomberg Law reported that the “volume of comments is the primary factor in the amount of time it will take to finalize the rule.”  

The sheer volume of comments isn’t surprising. This issue has been simmering during the 12 years since the SEC’s 2010 guidance on climate risk disclosures. But nothing was mandatory, and businesses proceeded as they pleased. Many embraced ESG reporting as a feel-good marketing exercise, but accuracy and verification weren’t required. The proposed rule, however, is prescriptive, putting money and credibility at stake. Companies — set in their ways, resistant to change, and hoping to make compliance as easy as possible — will naturally push the envelope.

Obstacle #2: Ongoing Schedule Delays

The SEC’s planned timeline has already been set back more than five months. Public comments were originally due May 20. On May 9, the SEC extended the comment period to June 17, citing public demand for more time to review the proposal. On October 7, they reopened the comment period, citing a “technological error” impacting comments submitted via internet form. Impacted commenters were requested to resubmit by November 1.

Obstacle #3: Legal Challenges

The SEC always knew these rulemaking efforts would face challenges in court. But the Supreme Court’s recent ruling in West Virginia v. Environmental Protection Agency opened up new avenues for challenges. The decision endorsed the “major questions doctrine,” which states that government agencies seeking to implement policies deciding issues of major national economic or political significance must be supported by clear congressional authorization. In my opinion, however, the SEC has ground to stand on because the disclosures they’re requesting are already impacting investor decision-making. The proposed rule won’t force changes to how organizations do business — only to how they disclose climate risk information that’s relevant to investors. 

Obstacle #4: Pushback on Scope 3 Inclusion

The biggest area of public complaint surrounds the inclusion of Scope 3, which many companies see as too onerous. Some regulatory experts agree. Meredith Cross, past director of the SEC’s Division of Corporate Finance, called the plan “the most extensive, comprehensive, and complicated disclosure initiative in decades,” and referred to the proposed rules as “outrageously” difficult to follow. 

To review, Scope 1 focuses on direct greenhouse gas emissions caused by company operations, and Scope 2 on indirect emissions (e.g., via energy purchases). Scope 3 addresses indirect emissions along a company’s entire value chain (e.g., a restaurant’s upstream impacts from farmers or manufacturers from which it sources products, and downstream impacts from delivery services). 

It’s unclear if or how far the SEC may back off in this area. It’s worth noting that the International Sustainability Standards Board (ISSB) confirmed Scope 3’s inclusion in their requirements (expected early 2023) while noting their intent to offer Scope 3 “relief provisions.” Given recent ESG consolidation globally, the ISSB Standards could become the baseline for businesses worldwide. 

ESG’s Expanding Global Impact 

Many smaller or private companies assume they won’t be impacted by ESG requirements. But most companies will ultimately participate, whether as issuers or as part of other companies’ Scope 3 value chains. Globally, ESG standard setting is happening on three fronts (which I’ll address in more detail in a future article): the SEC rule, focused on enhancing climate disclosures for U.S. public companies; ISSB’s Standards, which aim to create a global baseline for sustainability disclosures; and the EU’s Corporate Sustainability Reporting Directive (CSRD), which increases the scope of companies covered by EU reporting requirements four-fold — from ~11,700 to 49,000 — and includes EU subsidiaries of non-EU companies. 

Plus, ESG requirements are likely to extend beyond climate- and sustainability-related disclosures to other areas. The SEC recently pressed several companies for more information on board risk oversight and other corporate governance matters, signaling their desire for greater transparency in future proxy statements. For another example, the New York State Department of Financial Services (NYFDS) — a leading indicator of regulatory trends, given their aggressiveness in issuing requirements for Wall Street Banks — recently proposed new disclosure requirements around board cybersecurity expertise. 

Actions to Take to Get Ahead of Coming ESG Reporting Requirements

ESG reporting requirements are coming, so it’s time to assess where your organization stands and how it can improve. Get your house in order around Scope 1 and Scope 2 metrics. Make sure you understand your energy spend and sources, efforts around reducing impacts, and ESG metrics you’re already tracking or reporting. Leverage an ESG and sustainability management solution to assess reporting and identify gaps against existing ESG frameworks (e.g., SASB’s industry-specific standards), which can also be great for structuring brand-new programs. Identify data sources and assess opportunities to leverage existing (or build new) controls. AuditBoard’s Step-by-Step Guide to Building Your ESG Program and How to Audit ESG Risk and Reporting offer helpful background, resources, and best practices. 

Again, it seems clear that some version of the SEC climate rule will pass. Wherever you are on your ESG journey, it’s time to ensure you’re on the road to doing better. This will better prepare you not only to meet requirements — whatever form they take — but also to ensure the accuracy, integrity, completeness, and auditability of your ESG data.