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Understanding SEC and ESG Reporting- Regulations, Compliance, and Challenges

SEC and ESG Reporting

Environmental, Social and Governance (ESG) initiatives are being adopted for several reasons. What started as a compliance exercise has gained new impetus because of customer and societal pressure. Stakeholders from customers, governments and investors are looking to corporations to be good citizens and care for the environment as much as they do for their bottom line. SEC and ESG Reporting is becoming increasingly important in this landscape.

SEC is a government regulator that provides oversight and is responsible for protecting investors and regulating the capital market. Therefore, the SEC’s role in ESG is centered around investor protection by ensuring that ESG disclosures are accurate and transparent.

What is SEC and ESG Reporting?- The Overview

The SEC, as a regulatory body, is tasked with safeguarding investor interests and maintaining the integrity of the capital markets. Within the realm of ESG reporting, the SEC’s focus lies in ensuring that companies provide accurate and transparent disclosures regarding their environmental, social, and governance practices.

The Role, Scope and Deadline of SEC ESG Reporting?

The role of the SEC is focused on four critical areas of ESG reporting: disclosure requirements, oversight and enforcement, investor protection, and advisory and guidance. These rules were first proposed in March 2022, and they require public companies to disclose their climate change risks. It applies to all listed companies registered in the US.

The primary goal of these regulations is for companies to communicate their long-term and short-term financial risks arising from climate change. It is meant to provide investors with a way to assess the climate change risks associated with their investments.

Understanding Scope and Emission Categories

While all the companies listed and registered in the US must comply with the regulation and report their Scope 1 & 2 emissions, larger companies with IPOs of over 700 million USD must report their Scope 3 emissions along with Scope 1 & Scope 2.

Scope 1 emissions are the ones that are caused directly by the company’s operations, facilities, and vehicles. Scope 2 emissions are the ones that are produced by the suppliers while generating the energy used by the company. Scope 3 emissions are much wider and cover emissions from suppliers and customers in the value chain. Scope 3 is also the most complex emission to calculate. Most companies use software platforms and tools to manage their Scope 3 emissions and reporting.

The timeline for compliance depends on the size of the company. Large companies with a public float of over 700 million dollars must comply with Scope 1 and 2 emissions by fiscal year 2024 and Scope 3 emissions by fiscal year 2025. Mid-sized organizations, i.e. ones with a public float of between 75 and 699 million USD, will be required to report their scope 1 & 2 emissions for the fiscal year 2024 and scope 3 emissions from the fiscal year 2025. Smaller companies with a float of less than 75 million will report their scope 1 and 2 in fiscal year 2025, and they are exempted from filing their scope 3 emissions for 2025.

SEC ESG Regulations – A comparison with EU’s regulation

Scope – SEC’s ESG regulations on climate disclosures are not as stringent as the European regulations. The scope of SEC’s regulations is limited to the financial implications. The aim is to provide financial stakeholders with reliable and clear information on the financial risks associated with climate change. EU’s CSRD, on the other hand, is broader in scope, covering financial and non-financial dimensions. They require disclosures on not only financial but also social and governance aspects of the company’s operations.

Compulsory vs Voluntary: Both SEC and CSRD are mandatory for companies operating under its jurisdiction. Non-compliance carries a range of fines and penalties. Global Reporting Initiative (GRI), another reporting framework, is voluntary.

Materiality and double materiality: SEC reporting is primarily concerned with the impact of climate change on the financial investor. Hence, it focuses only on the information that affects the financial health of the company. CSRD, on the other hand, promotes double materiality. That is the impact of climate change on the company as well as the impact of the company’s operations on the environment and society. Thus, it is more comprehensive than the SEC’s regulations.

Integration with financial systems: SEC requires climate risk disclosures to be captured in the company’s financial statements. CSRD, being of broader scope, addresses a range of stakeholders like investors, governments and consumers.

Challenges of SEC’s ESG regulations

SEC’s ESG regulations are not as stringent as the European CSRD regulations. It is simpler and makes fewer demands from corporations, yet there are some criticisms.

Cost Increases: Some corporates feel that complying with these new regulations imposes additional costs. These additional costs could make them less competitive, especially when competing with companies based in regions where ESG regulations are not mandatory.

Greenwashing: As pressure mounts on companies to become environmentally aware and responsible, they may be tempted to misrepresent or exaggerate information. This can lead to a false sense of progress and mislead investors.

One size fits all: Environmental impact varies from sector to sector and from industry to industry. While Scope 3 emissions may be essential for FMCG companies, oil and gas companies may be more concerned with Scope 1 and 2. By advocating a one-size-fits-all approach, companies may focus on being compliant rather than addressing real environmental issues.

Static nature of regulations: A final criticism of the rules is that ESG is a rapidly changing space, and regulations that don’t change fast enough to keep pace with technological and societal changes may put companies at a disadvantage.

Summary

Compliance with the SEC’s ESG regulations depends on the company’s size. However, given the complexity of the exercise, several large and mid-sized companies are already publishing their ESG reports in the public domain. While some of these disclosures include scopes 1,2, and 3, most are still grappling with the complexity of scope 3 calculations.

In addition, the SEC also expects ESG reporting to be of the same quality and rigour as financial reporting. To deal with the complexity of scope 3 calculations and manage the end-to-end reporting, many organizations are investing in dedicated ESG software platforms. Check out Lythouse’ ESG Reporting platform.

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