7 FAQ on key ESG regulations, trends, and more

On March 21, 2022, the SEC voted to propose climate risk disclosure rules slightly more than one year after then-acting Chair Allison Herren Lee requested public input. Specifically, a domestic or foreign registrant would be required to include in registration statements and periodic reports disclosure addressing:

• How an entity’s board and management govern and manage climate-related risks
• Actual or likely material impacts of climate-related risks on the registrant’s business, strategy, and outlook
• Quantitative measures of the entity’s greenhouse gas emissions, which, for Scope 1 and 2 emissions of accelerated and large accelerated filers, would be subject to assurance
• In the notes to audited financial statements, certain climate-related financial statement metrics and disclosures, including:
  • Disaggregated information on a financial statement line-item basis about transition activities and the impact of climate-related events
  • Information about estimates and assumptions used in the financial statements
• The entity’s climate-related targets and goals, scenario analysis performed, and transition plan, if any

When the SEC published its Fall 2021 regulatory agenda, it indicated a climate rule proposal would be forthcoming, and it also included the following:

• Human capital. Disclosure requirements could address specific metrics on workforce demographics, additional workforce metrics, health and safety, skills and development training, and compensation and benefits.
• Diversity. The agenda indicates a rule proposal to enhance disclosures about the diversity of board members and nominees is forthcoming.
• Cybersecurity. The SEC also has proposed rules to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting by public companies.

Currently, many companies are hiring people who are specifically focused on and experienced in ESG compliance and disclosures. Ideally, organizations should create an integrated ESG team (which could include both employees and ESG-focused consultants) that can help:

• Determine how ESG contributes to the long-term strategy of the business
• Evaluate ESG risks and opportunities from an enterprise risk management perspective
• Actively engage with key shareholders and stakeholders
• Consider whether the board has appropriate ESG oversight structure and expertise
• Understand and revisit compliance functions and internal controls around ESG disclosure
• Consider content and scope of both voluntary and mandatory ESG-related disclosures

ESG is essential to future strategy, and if organizations are not yet being strategic about their ESG reporting, they might be behind. But keeping up with all the frameworks, standard setters, and measurement criteria in the ESG ecosystem is a big effort.

It is critical for organizations to understand how ESG is related to their unique strategy, which includes understanding all their stakeholders and what they consider material. Because what’s material to each stakeholder differs, organizations will have to make sure they focus on more than just their investors.

Organizations that have not performed a materiality analysis of ESG topics should consider doing so in the near term. Performing such an analysis should be a deliberate process in which leadership looks at the organization’s business purpose and its scope, vision, and values and considers the perspective of its stakeholders, communities, and business partners to identify the topics that matter. Organizations that have performed a materiality analysis in past years should consider further engagement with their stakeholders to confirm ESG topics. More sophisticated organizations might embrace concepts of dual materiality in their analysis.

Many organizations that produce ESG reports also publicly disclose their financial reports, so the key is consistency. Stakeholders are going to look at financial reports, ESG reports, and any other declarations, and it’s important these communications do not conflict. That’s why it’s essential to create an integrated reporting framework developed by a cross-functional team to define the organization’s position on financial reporting and sustainability.

ESG is affecting organizations in new ways, which can lead to many questions and few definitive answers. Here are a few ESG trends emerging in 2022:

• Added pressure from stakeholders. Stakeholders – including investors, regulators, customers, and employees – each have their own opinions and priorities, so a materiality analysis is essential to help prioritize ESG strategy.
• The need for a narrative. Effectively communicating the ESG story across the organization can be accomplished through the use of selective narratives.
• Expectations of data-driven, comparable, verifiable disclosures. Organizations that build ESG systems that mirror their financial systems can be better prepared for upcoming changes and ESG regulations.

There’s a lot on the horizon for ESG – which is why it’s essential for organizations to understand where they are now, determine where the future is going, and establish a plan for getting there.