BOARDS CLIMATE-GOVERNANCE FRAMEWORK

CLIMATE Governance Framework: SEC's climate-related disclosures

On March 6, 2024, the U.S. Securities and Exchange Commission (SEC) passed rules requiring public-companies to report on climate risks in a standardized format. This aims to balance investor needs for clear information with reducing the cost of implementing these rules for businesses.

The final rule sets a precedent for the SEC to use the disclosure regime "as a means for driving social change."

SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors: https://www.sec.gov/news/press-release/2024-31

SEC chair Gary Gensler said the final rule captures investor-useful information and clear reporting requirements, while staying "merit neutral."

The rule includes changes to Regulation S-K, related to annual reports, and Regulation S-X, related to financial statements.

Disclosure Highlights:

1. Disclosures required in registration statements and reports (Form 10-K, Form 20-F)
2. Focus on future impacts, with limited need for historical data (reduces transition burden)
3. Borrows from FSB Task Force on Climate-related Financial Disclosures (TCFD) framework
4. Differs from other regulations like CSRD, IFRS Sustainability Standards, CA laws
5. No "equivalency" - disclosures under other frameworks may not satisfy SEC requirements
6. SEC to monitor international climate reporting before considering future harmonization

The SEC's final rule on climate-related disclosures, issued on March 6, 2024, introduces comprehensive requirements for public companies.

The final rules dropped some proposals from the original plan, including:

• Disclosing details on a company's indirect greenhouse gas emissions (Scope 3).
• Requiring information on board members' specific climate change knowledge.

However, the final rules still require companies to identify any board committees overseeing climate risks.        

The new SEC rules require companies to be more transparent about their climate efforts.

Here's what companies will need to disclose:

• Climate mitigation activities: If a company is taking steps to reduce-climate-risks (or shouldn’t they?), they'll need to explain those efforts and how much they're spending. They also need to explain their assumptions about the impact of these actions.
• Transition plans: Companies with plans to adapt to a changing climate will need to detail those plans and how they will affect the company's finances. They'll also need to update investors on progress throughout the year.
• Climate risk analysis: If a company uses scenario analysis, carbon pricing, or sets climate targets, they'll need to disclose those details as well.
• Financial impacts: Financial reports will include specific costs associated with climate change, like extreme weather events. Companies will also need to detail the financial implications of their disclosed climate targets and transition plans.

SEC Fact Sheet

The key highlights from the "SEC Fact Sheet: The Enhancement and Standardization of Climate-Related Disclosures: Final Rules," https://www.sec.gov/files/33-11275-fact-sheet.pdf which are crucial for educating a public company Board of Directors:

• Material Climate-Related Risks: Companies must disclose material climate-related risks and activities to mitigate or adapt to these risks, including the board of directors' oversight and management’s role in managing these risks.
• Climate-Related Goals and Targets: Disclosure of any climate-related targets or goals that are material to the company's business, results of operations, or financial condition is required.
• GHG Emissions: Disclosure of Scope 1 and/or Scope 2 greenhouse gas (#GHG) emissions on a phased-in basis by certain larger registrants when these emissions are material, along with an attestation report covering the disclosure of these emissions.
• Financial Statement Effects: Companies must disclose the financial statement effects of severe weather events and other natural conditions, including costs and losses.
• Phased-In Compliance: The rule includes a phased-in compliance period, with the compliance date dependent on the registrant’s filer status and the content of the disclosure.

Protections and Streamlining

The final SEC rule offers two key benefits for companies:

• Safe harbor: Certain forward-looking statements regarding climate change are protected from liability, giving companies more flexibility in their disclosures.
• Reduced reporting burden: Companies won't have to update climate disclosures every quarter (Form 10-Q)
• Simplified weather event reporting: Companies no longer need to specifically determine if severe weather events that impact their finances are directly related to climate change. This reduces the reporting burden.

Strategic Implications for the Public Company Boards, Corporate Governance

1.???? Implications for Public Companies and the Broader Ecosystem:

• The rule aims to provide investors with more consistent, comparable, and reliable information on the financial effects of climate-related risks.
• Disclosures: Must include material climate-related financial risks, Scope 1 & 2 greenhouse gas (GHG) emissions (if material), and financial impacts of severe weather events in SEC filings (registration statements & annual reports).
• It is a continuation of the SEC’s efforts to enhance transparency in how climate-related risks affect companies' financial performance and how these risks are managed.

2.???? Understanding for Board Members:

• Board members need to grasp the comprehensive nature of these disclosures, including the direct and potential impacts of climate-related risks on the company’s strategy, business model, and financial outlook.
• Oversight and management roles in assessing and managing climate-related risks are critical.

3.???? Compliance Timeline:

• Large Accelerated Filers (accelerated filers with over $750 million public float): December 31, 2025 fiscal year.
• Accelerated Filers (except Large Accelerated Filers): December 31, 2026 fiscal year.
• Smaller Reporting Companies & Emerging Growth Companies: December 31, 2027 fiscal year (exempt from GHG emissions reporting).

4.???? Impact on Investors:

• Access to comparable and reliable information on climate risks
• Better assessment of long-term investment opportunities
• Ability to hold companies accountable for climate performance

5.???? Impact on Boards:

• Enhanced oversight of climate-related risks and opportunities
• Ensuring management has adequate processes for identifying and managing climate risks
• Understanding the potential financial implications of climate change

6.???? For the Sustainability Ecosystem:

• ?The rule represents a significant step towards standardized climate-related reporting, potentially influencing global regulatory developments and promoting a more sustainable business environment.
• Increased transparency on climate-related issues fosters market efficiency and promotes sustainable business practices.

?7.???? Impact on Corporate Reporting: Enhanced reporting requirements will necessitate rigorous data collection, analysis, and verification processes.

8.???? Implications for Finance and Audit Functions: There will be significant implications for internal controls, auditing standards, and financial reporting, requiring adjustments to policies and procedures.

9.???? Global Regulatory Developments: The rule aligns with global trends towards increased transparency on climate risks and sustainability reporting.

10.? Preparation for the Final Rule: Boards and executives must ensure robust governance frameworks are in place to manage and report climate-related information accurately.

Climate Governance Framework: Strategic Recommendations

1. Understand the Requirements: Board members should familiarize themselves with the specifics of the new rule, focusing on the implications for their organizations. The whole board should be involved in these discussions because responsibility for the disclosures will cut across committees.
2. Assess Material Climate-Related Risks: Conduct a thorough assessment of how climate-related risks impact the company's strategy, operations, and financial condition.
3. Enhance Oversight Structures: Ensure that the board's oversight of climate-related risks is robust, involving regular updates and strategic discussions on climate risk management.
4. Integrate Climate Considerations into Risk Management: Climate-related risks should be integrated into the company's overall risk management processes, with clear roles and responsibilities for managing these risks.
5. Prepare for Disclosure Requirements: Develop and implement processes for collecting and reporting the required information, including Scope 1 and Scope 2 GHG emissions, and the financial impacts of severe weather events.
6. Update Accounting Policies: to ensure consistent climate-related financial reporting.
7. Engage with Auditors and Assurance Providers: Work with auditors to understand the assurance requirements for GHG emissions disclosures and ensure that the company is prepared to meet these requirements. The audit committee will have a larger role to play than before. Consider engaging external auditors as well with expertise in climate reporting. Importantly, Contact/ Select an Assurance Provider if your company does not have one yet.
8. Perform a Gap Assessment: Conduct a detailed gap assessment to identify any areas where the company's current practices do not meet the new requirements, and develop a roadmap for addressing these gaps.
9. Monitor Global Regulatory Developments: Stay informed about other regulatory developments globally to understand how the SEC's rule intersects with other requirements and ensure compliance. Develop a “Compliance Roadmap”.
10. Educate and Train Relevant Personnel: Ensure that board members, management, and relevant staff are educated about the new rule and trained on the processes and controls necessary for compliance.
11. Communicate with Stakeholders: Proactively communicate with investors and other stakeholders about the company's approach to managing climate-related risks and its efforts to comply with the new disclosure requirements.
12. Implement Robust Data Management Systems: Invest in systems for accurate data collection, analysis, and reporting of climate-related information.

Artificial Intelligence (AI)

Artificial Intelligence (AI) can significantly aid in implementing the SEC's Final Rules on Climate-Related Disclosures across various aspects of the Strategic Governance Framework. Here's how #AI can be leveraged in specific areas:

Data Management Systems

1. Automated Data Collection and Analysis: AI can streamline the collection and analysis of vast amounts of environmental, social, and governance (ESG) data required for climate-related disclosures. This includes automating the tracking and reporting of Scope 1 and Scope 2 greenhouse gas (GHG) emissions, as well as identifying and quantifying material climate-related risks and opportunities.
2. Enhanced Accuracy and Efficiency: By employing machine learning algorithms, companies can improve the accuracy of their data analysis, reducing the risk of errors in climate-related disclosures. AI can also significantly speed up the data processing time, making it easier to meet disclosure deadlines.
3. Predictive Analytics: AI can use historical data to predict future climate-related risks and their potential impact on the company's financial performance. This can help companies in planning and implementing more effective mitigation and adaptation strategies

AI can be a valuable tool for public companies implementing the SEC's final climate disclosure rule and fulfilling the recommendations within the Strategic Governance Framework.

Here's more on how AI can assist in various aspects:

1.???? Data Collection and Analysis:

• Streamlining Data Collection: AI can automate data collection from various sources (e.g., energy meters, production logs, supply chain data) for Scope 1 & 2 GHG emissions calculations. This reduces manual effort and improves data accuracy.
• Identifying Trends and Risks: AI can analyze large datasets to identify trends in energy consumption, resource use, and potential climate-related risks to the business. This helps companies proactively manage their environmental footprint.

2.???? Scenario Analysis and Reporting:

• Modeling Climate Impacts: AI can be used to run simulations and model the potential financial impacts of different climate change scenarios on the company's operations. This helps with strategic planning and risk mitigation.
• Generating Draft Disclosures: AI-powered tools can generate draft climate-related disclosures based on the collected data and scenario analysis results. This saves time and ensures consistency in reporting.

3.???? Internal Controls and Assurance:

• Data Quality Monitoring: AI can continuously monitor data quality for inconsistencies or errors, ensuring the reliability of reported information. The effectiveness of AI relies on high-quality data. Invest in data governance to ensure data accuracy and completeness.
• Identifying Anomalies: AI can detect unusual patterns in climate-related data, potentially indicating areas requiring further investigation or control improvements.

4.???? Update Accounting Policies:

• Data Integration: AI can automate data collection and integration from various sources to streamline the process of updating accounting policies for climate-related impacts.
• Trend Identification: AI can analyze historical data to identify trends in climate-related costs and expenses, informing policy updates.

5.???? Integrate Climate Considerations:

• Risk Management: AI can be used to develop risk management models that factor in climate-related risks, aiding strategic decision-making.
• Supply Chain Analysis: AI can analyze supply chain data to identify climate-related risks and opportunities within the company's ecosystem.

6.???? Aligning with Strategic Governance Framework:

AI can directly support the recommendations within the framework:

• Gap Assessment: AI can analyze existing data collection and reporting practices to identify gaps compared to the new rule's requirements.

• Compliance Roadmap: AI-powered tools can be used to track progress towards compliance deadlines and adjust the roadmap as needed. Scenario Planning: AI can be used to simulate different climate change scenarios and their potential financial implications, informing the compliance roadmap.

Benchmarking: AI can analyze how industry peers are approaching climate disclosures, helping the company develop a competitive compliance strategy.

7.???? Additional Considerations:

• Transparency and Explainability: When using AI for disclosures, understand its limitations and ensure the underlying logic and data sources are transparent for auditors and stakeholders.
• Human Oversight: AI should be used as a tool to enhance human expertise, not replace it. Boards and management teams should maintain ultimate oversight of climate disclosures.
• Data Security: When using AI, ensure proper internal controls are in place to maintain data integrity and mitigate security risks.

By leveraging AI effectively, companies can streamline the implementation process, improve the accuracy and efficiency of disclosures, and gain valuable insights to manage climate-related risks and opportunities.

Overall, AI can significantly enhance the Strategic Governance Framework by automating tasks, improving data analysis, and providing valuable insights. However, it should be used as a complementary tool alongside human expertise and sound governance practices.

Note: This rule only requires disclosure of material climate risks. Companies should conduct a thorough analysis to “determine which risks are material”.

By proactively addressing these considerations, Boards can ensure their companies are well-positioned to comply with the SEC's final climate disclosure rule and enhance their long-term sustainability as-well-as transparency with investors and stakeholders.

Some 70% of 300 executives surveyed by 普华永道 and Workiva last year said they have already started to gather and disclose data in alignment with the SEC's proposed rule and plan to proceed with such efforts regardless of when the final rule was published. However, 39% said they were not fully prepared to meet the requirements as listed in the proposed rule.

Remember: Early preparation is key for a smooth transition to comply with the SEC's final climate disclosure rule.

Seeking guidance from experts and relevant resources is advisable: for your strategic governance needs, reach out to me "Bo" Subodh Dalvi (Board Director | Executive Advisor | Corporate Governance | Entrepreneur & Impact Investor) for a valued governance advise.

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