US Companies Future-Proofing Themselves Amid an Increasing Patchwork of Climate Rules
It would seem investors should welcome mandated climate-related disclosures made by US businesses. But the increasing number of rules across jurisdictions, all with different scopes and timelines, has made this difficult terrain to navigate for both investors and companies. The last few months have only added to this challenge.
In March, the United States Securities and Exchange Commission, Wall Street’s top regulator, issued a long-awaited final rule that, for the first time, requires companies listed in the US to report material climate-related information – from greenhouse gas emissions to climate risk management.
Less than three weeks later, the SEC paused its implementation after the measures attracted a series of legal challenges, with trade groups and Republican-led states claiming the SEC had overstepped its mandate. Meanwhile, environmental groups argue the rules do not go far enough, in particular by not including supply chain – or so-called Scope 3 emissions – that account for 70-90% of total emissions for many companies. But while the rule winds itself through the legal system, many companies have already started to change their practices in anticipation of the outcome. 1
This all comes against a wider backlash against environmental, social and governance investing, particularly in the US. New research from Societe Generale suggests that rising interest rates and a more challenging environment for clean energy stocks has exposed the overly simplistic ‘index hugging’ of some fund managers -- who are now being hit by redemptions. Its clear more work is needed to assess the linkages between robust sustainability performance and financial performance.
Finding clarity amid confusion
How should companies and investors make sense of all this? Looking beyond the politization and theoretical debates, the SEC rule seeks to codify what has become table stakes beyond specific ESG strategies as part of mainstream due diligence and investment risk analysis nowadays. While numbers vary across jurisdictions, a recent MSCI analysis found that a large majority of companies are reporting on their direct emissions and a smaller but still notable group of companies on their indirect emissions.2 Beyond emissions, the voluntary reporting framework such as the one developed by the Task Force on Climate Related Financial Disclosures has enriched disclosures and shaped market expectations on governance, strategy, risk management as well as metrics and targets.
That does not mean these new rules will have no value. The reality is that despite a decade of growing voluntary disclosures, much of the publicly disclosed climate data today is still not as robust as financial data. In most cases, it is not yet comparable across sectors and geographies, nor is it auditable – essential for financial analysis and capital allocation. Mandatory disclosure requirements such as the new SEC rule bring the potential for richer, more relevant disclosure while at the same time advancing internal decision-making on climate risks and opportunities.
With all the advances voluntary disclosure frameworks and standards have brought, the divergence in scope and quality of disclosures have shown their limits in providing more accurate and material sustainability information to investors, which would allow equity markets to work more efficiently. This is where global initiatives such as the International Sustainability Standards Board can play a leading role in developing, in its own words, “a comparable common global language that is reliable, assurable and therefore decision-useful for investors, and cost-effective for preparers” by providing a sustainability disclosure blueprint to regulators across the globe.
The ISSB published its first two standards in summer 2023, with the first targeted at general sustainability-related risks and opportunities, while the second applies specifically to climate-related matters. Many smaller countries are adopting the ISSB’s standards and others, such as Canada and Japan (and soon the UK) are issuing national rules closely based on them.
As jurisdictions start adopting the ISSB’s approach, interoperability and equivalency recognition are paramount – in particular as large jurisdictions such as the US and the European Union pursue their own distinct disclosure approaches.
From telling to doing
Disclosure, though, is just one piece of the puzzle. According to EY’s 2024 CEO survey, over half of CEOs globally (54%) see sustainability issues as a higher priority than they did 12 months ago.3 Large jurisdictions such as the EU are moving ahead with requirements with specific environmental impact – e.g., the EU Due Diligence Directive and its requirements to set transition plans in line with the Paris Agreement. This is significant not just for European companies and their supply chains but because of the extraterritorial nature applicable for a large number of US corporates as well. Companies are overhauling internal processes to collect better data in order to make better decisions: to more fully integrate sustainability considerations into their financial and strategic planning. While enhanced risk assessment remains a core pillar, sustainability as a source of innovation and corporate resiliency is gaining traction.
Companies leading the way are not just trying to comply with the growing body of rules. They understand that climate risk is increasingly a reality today, and they are trying to future-proof their operations and revenues. One obvious example is the insurance sector’s need to understand and model the growing incidence of severe weather-related events and what that says about physical risk impacts. Similar for transition risks – from changing customer demands and regulatory and legal requirements to changes in technology and overall market conditions. Once data is flowing in and plans are in place, management should be able to make better real-world decisions. For example, a country’s carbon price, the robustness of its electricity grid, and the availability of renewable energy will become increasingly important factors in where to locate a new manufacturing plant.
In addition to Chief Sustainability Officers taking on more strategic roles4, more and more companies are investing in building out an enabling environment - from appointing ‘ESG controllers’ or ‘climate risk officers’ to building out cross-functional teams with budgets and mandates. While there is no one absolute approach, for companies that do this successfully, the responsibilities cut across the whole organization, involving financial planning and risk management – and are not siloed in a ‘sustainability department’.
Another key part is the role the C-suite and Board play in managing and overseeing sustainable value creation.
While sustainability disclosure requirements are on the uptick, the timeline and scope of sustainability requirements – either on specific topics such as transition planning or market mechanisms such as a price on carbon – are unclear at this stage. This leaves companies speculating what future to plan for. What companies can build on in the meantime is to advance where it makes commercial sense to transition based on the available information today as well as how to build robust assumptions that can guide financial planning and capital allocations in the future. Companies that proactively integrate climate risk into their strategic planning and daily operations tend to be in a stronger position to not only mitigate risks; they are also likely better prepared to identify opportunities, too. New, low-carbon products and services, for instance. Or the ability to segment customers and see which ones are prepared to pay more for ‘green’ products.
They will also be in a stronger position to proactively tell an authentic story to investors -- who are, of course, themselves under pressure to future-proof their portfolios.
While it may be hard to discern a premium rating for environmentally sound companies today, those leading in this area should increasingly stand out in a world where capital market products are created based on benchmarks.
Corporates, therefore, need to plan now for their future in a low-carbon world.
2https://www.msci-institute.com/insights/us-firms-fall-further-behind-global-peers-on-climate-disclosure/ - Nearly three-quarters (73%) of listed companies in developed markets outside the U.S. reported their direct (Scope 1) and indirect (Scope 2) greenhouse gas (GHG) emissions, the latest data from MSCI ESG Research shows.[1] In comparison, 45% of U.S-listed companies reported their Scope 1 and Scope 2 emissions as of the same date.
While reporting of value chain (Scope 3) emissions continues to be a topic of contention, more than half (54%) of listed companies in developed markets outside the U.S. report at least some of their Scope 3 emissions, compared with 29% of U.S.-listed firms.
3https://www.ey.com/en_gl/ceo/ceo-outlook-global-report
4https://hbr.org/2023/07/the-evolving-role-of-chief-sustainability-officers
