Sustainability is not a new concept. Environmental, social, and corporate governance (ESG) was created as a term back in 2004 in a report called “Who Cares Wins,” which was an initiative created by the United Nations. The ESG concept has gained momentum in recent years due to increased investors’ interest in corporations’ disclosure and transparency on sustainability issues. Now, it is more important than ever because new regulations have created mandatory reporting for many organizations.

Investors care about sustainability

Sustainability has gained momentum in the past decade due to the positive impact it has had on an organization’s reputation and ever scrutinized investor demands. It is now understood that certain factors impact a company’s overall performance. By considering these factors, investors get a more holistic view of the companies they back, which advocates say can help mitigate risk while identifying opportunities.

Sustainability reduces risk and this creates value for investors and for companies. Risk management supports sustainable, long-term growth by proactively evaluating potential issues; early knowledge of potential risk provides more time to adapt and develop cost-mitigating strategies, which peaks investor interest. The 2023 Climate Change and Sustainability Services Institutional Investor survey led by EY found that companies that perform well on ESG are generally less risky, better positioned for the long term, and possibly better prepared for uncertainty. 

Furthermore, investors are increasingly choosing to invest in companies that align with their values and goals. In addition to added investor pressure, according to a 2022 global survey by the IBM Institute for Business, 44 percent of consumers are purpose-driven and choose brands that align with their values. Helping environmental and ecological causes is both beneficial to the environment, but also an organization’s reputation.

Investors are taking notice that well implemented ESG programs can save money, increase revenue, and build brand awareness. A survey conducted by the Stanford Business School & EcoVadis found the following:

• 36 percent of leading sustainable procurement professionals see increased sales revenue via consumer commitment to sustainability.
• 59 percent of leading sustainable procurement professionals said their sustainability programs foster innovation.
• 39 percent of companies say their sustainable procurement programs have helped reduce costs.
• 37 percent of companies said their sustainability programs help brand differentiation.

While all the above is vital and has encouraged organizations to heavily invest in ESG programs, why is there an uptick now? Well, California, the EU, and now the SEC, have changed the game.

New legislation

Securities and Exchange Commission

On March 6, 2024, the SEC adopted the Climate Rule which will require some of the nation's largest companies to publicly disclose their greenhouse gas emissions (the implementation of which has been voluntarily delayed until the Eighth Circuit has reviewed a challenge seeking to vacate the rule). The new rule requires ESG statements to be filed alongside financial statements, which means sustainability data and carbon accounting must be just as accurate as their corporate accounting. Although many companies already include climate-related disclosure in some form in their SEC filings and voluntary reports, this rule mandates significant new disclosure content.

The rules will require public companies to communicate details regarding:

• Climate-related risks and the material effect they have on the business
• How the company handles top-down governance and oversight of the risks
• How their risk management strategy identifies, assesses, and mitigates risk
• Any sustainability goals or targets set by the company and how they will be achieved including the cost of carbon/renewable energy credits
• Cost and losses incurred as a result of severe weather events
• Proof of internal decarbonization efforts (such as numbers used for carbon offsets)

The rules are lengthy and complex and require companies to ensure they have competent systems, professionals, and governance structures in place to implement, administer, and oversee processes to identify and accurately disclose required information and financial data.

The new rules will require enhanced accounting and financial reporting capabilities and controls, additional internal and external subject-matter experts, improved information-gathering systems and added rigor in drafting climate-related disclosures. 

Readiness will require companies to assess their climate-related risks, opportunities, and operations rigorously and consider their processes to identify, collect, monitor, and disclose material information thoughtfully, all against the backdrop of challenges to the rules, as well as potential future private litigation and agency enforcement risks.

State Legislation

In the U.S., many states are contemplating their own climate disclosure requirements, but thus far only California has passed these laws. On October 7, 2023, California enacted legislation (SB 253) that requires certain public and private US companies doing business in California to provide public disclosures regarding their climate emissions, climate risk, carbon neutral claims and use of offsets.

Unlike the SEC's new adopted rules, California’s rule goes beyond reporting the greenhouse gas emissions that they own, but also emissions of their providers. The following must be disclosed:

• •Scope 1: All direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities.
• Scope 2: All indirect greenhouse gas emissions from consumed electricity, steam, heating, or cooling purchased or acquired by a reporting entity, regardless of location.
• Scope 3: All indirect upstream and downstream greenhouse gas emissions, other than scope 2 emissions, from sources that the reporting entity does not own or directly control and may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.

California is not alone in evaluating ESG disclosures. Currently New York and Illinois have proposed rules that are akin to California’s and require disclosure of Scope 3 emissions and would apply to entities doing business in New York that meet a revenue threshold. 

California may be the pioneer in ESG legislation, with New York and Illinois potentially close behind, but many expect the SEC’s new rules will motivate many other states to follow.  

European Union

On Nov. 28, 2022, the Council and Parliament of the European Union (EU) approved the Corporate Sustainability Reporting Directive (CSRD), which was subsequently updated in October 2023. The CSRD requires different disclosure standards and staggered effective dates, depending upon the type of entity. Due to the layers of complexity, entities with revenue or operations in the EU are encouraged to evaluate the impact of the CSRD immediately.

Conclusion

Given all of this, it will be important for companies to evaluate not just how the now-final rules adopted by the SEC affect their business, but how they may be impacted by the states' and other nations' broader regimes of sustainability and climate disclosure regulations. It will also be important to evaluate how best to comply with these differing – and potentially conflicting – climate disclosure directives.