This March, the U.S. Securities and Exchange Commission (SEC) proposed a landmark set of proposals that promises to have a significant impact on publicly owned enterprises in the United States. Its Rules on Enhancement and Standardization of Climate-Related Disclosures for Investors cover three key areas: climate-related risks that would likely have a material effect on the business; greenhouse gas (GHG) emissions; and climate-related finance metrics.

With the public comment period extended until June 17, 2022 and experts expecting any timeframe to be further delayed by a lawsuit, many companies may be tempted to take a “wait and see” approach. However, as former SEC Commissioner Allison Herren Lee highlighted, citing climate risk as “one of the most momentous risks to face capital markets since the inception of this agency,” the issue is not going to go away.

Companies that proactively take action on their climate strategy now are not only placing themselves in a better position for a finalized rule—they are also gaining a competitive edge by becoming more agile in identifying and executing on opportunities, as well as mitigating risk.

From scenario analysis to climate strategy

One way companies can get a head start is by assessing their capabilities against the Task Force on Climate-Related Financial Disclosures (TCFD) framework, which is structured around four categories: governance, strategy, risk management, and metrics & targets. These are the same categories that underpin the SEC’s proposed rules, making the framework a useful guide for pre-empting compliance requirements.

ERM worked with the TCFD on the technical supplement to its framework on the use of scenario analysis in relation to climate-related financial risks and opportunities, with the aim of helping companies determine strategic response options. This type of analysis can unlock critical insights as companies evaluate broader climate scenarios against sector and company-specific considerations. Climate Strategy Assessments for the U.S. Electric Power Industry, compiled by ERM and Ceres in 2019, illustrates a sector-specific application of climate-related scenario analysis.

Often, after companies are led through an initial exercise, many choose to repeat it, building deeper insights to both risk and opportunities with each iteration. This work frequently becomes the basis for their climate strategy and related commitments, and helps them ensure alignment and confidence in taking these commitments on. One company ERM has worked with is now on their third generation climate strategy corresponding with changing market dynamics, their evolving business model, and the level of ambition they associate with climate-related opportunities.

Aligning helps ensure good governance 

From a cost perspective, the SEC’s proposed rules align closely with corporate issuers’ current average spend on climate-related disclosure activities. The SEC forecasts that the first-year cost of meeting its disclosure requirements will be $530,000 per corporate issuer. Recent research by the SustainAbility Institute by ERM for Ceres and Persefoni found that organizations already spend $533,000 annually on climate-related disclosures.

By aligning disclosure activities with the TCFD framework, organizations can ensure their investment is going to the right areas. The framework is in essence a blueprint for good governance. It helps organizations address their governance structure, assess how they integrate climate risks into their overall risk management model, and understand how to test their strategy in the context of the transition to a low-carbon economy.

The TCFD framework also helps CFOs and other business leaders understand both the risks and opportunities of decarbonization and feed this information into how they manage their company, supported by robust key performance indicators (KPIs) that keep progress on track and provide transparency to stakeholders.

Riding a global wave of regulation

The SEC’s proposals are part of a broader global trend towards regulating for climate-related disclosures. In Europe, for example, the European Financial Reporting Advisory Group (EFRAG) is working on recommendations for European reporting standards – the EU Corporate Sustainability Reporting Directive. Meanwhile, the International Sustainability Standards Body (ISSB) is in the process of establishing a comprehensive global baseline of sustainability disclosures for the capital markets.

For organizations that have not yet put in place climate risk reporting or analysis aligned to the TCFD framework, doing so should be viewed as a matter of urgency. Even if the SEC’s proposals are significantly altered, TCFD is gaining momentum. As SEC notes in its proposal, investors and issuers are converging around TCFD as a useful framework for communicating information about climate-related risks. Delaying investment in climate-related disclosures systems and processes will leave companies in a weaker position than their peers when responding to investors or when new rules do emerge.

Another good reason to start now is that by proactively responding to climate-related risks and opportunities, CFOs have an opportunity to gain competitive advantage, ensure their company’s response is understood by capital markets and lenders, and capitalize on a broad range of new sustainable finance instruments. As highlighted in our previous research on the evolving relationship between ESG, capital markets, and corporate finance, sustainability-linked bonds and sustainability-linked loans have experienced exponential growth in recent years, and their uptake is expected to continue to expand at a rapid pace.

Next steps in aligning with the TCFD framework

For companies looking to align with the framework, we recommend two initial actions to ensure the process gets off to the best start possible:

• Conduct a gap analysis. Carry out an objective assessment of current processes and compare to the requirements of the current draft of the SEC’s proposals along with the TCFD framework to identify capability gaps. This can be done internally or with the help of an independent third party. To note: the SEC’s proposals include both mandatory reporting on specific areas, such as GHG emissions, and reporting on commitments that companies have made of their own volition (for example, if an organization has taken on a climate target it needs to be able to report widely on that target). The gap analysis needs to cover both requirements in detail.

• Convene an interdisciplinary team. SEC’s rule will further drive a trend whereby climate disclosures are no longer only of interest to sustainability teams. The whole area is now of relevance to other key business functions, particularly the department of the CFO. Climate-related disclosures is an enterprise-wide issue and associated systems and processes need to reflect that fact. If it’s not already on the agenda, start an ongoing SEC/ISSB/EFRAG/climate disclosure discussion at the executive team and Board level.

While the details of the rules may or may not change before being finalized, the direction of travel is clear enough for businesses to act now. Those that do by putting in place the systems needed for timely, accurate, and detailed disclosures will be better placed to manage risk, build trust with customers and investors, and meet the regulatory challenge head on.