April 25, 2023
April 25, 2023
As the US Securities and Exchange Commission (SEC) works to finalize its rules around climate-related disclosures, one might think the latest political pushback on all things related to environmental, social, and governance (ESG) issues would deter organizations from moving forward on their own ESG journeys. But upon closer examination, it’s clear that while certain political rhetoric grabs headlines, the US government is continuing to steadily advance the country’s energy transition—and that will create significant new opportunities for those companies who are prepared to capitalize on them.
The passage of the Inflation Reduction Act in August 2022 is considered to be the largest investment in combating climate change in US history. This was followed by an announcement by the Federal Reserve Board that the six largest banks in the United States would conduct a pilot climate scenario analysis in 2023. And in recent weeks, SEC Chair Gary Gensler has promised that the SEC’s final rule on climate-related disclosures will be announced this spring.
This momentum, coupled with ongoing stakeholder pressure, has prompted many publicly listed organizations to align with existing climate reporting guidelines. These guidelines help companies focus on identifying and disclosing relevant and material risks in their businesses. Once the SEC’s final rule is disclosed, certain guidelines may become requirements. For example, the SEC has proposed a requirement for companies to outline their boards’ expertise in climate risk. This shines a spotlight on the board’s responsibility to understand and provide strategic guidance on a company’s climate-risk analysis and management. It also makes climate training for directors a greater priority than ever before, ensuring that they are better equipped and motivated to act on climate change and to help the companies they serve seize new opportunities created by the energy transition.
There are a number of organizations that provide reporting guidelines including the Sustainability Accounting Standards Board, the Global Reporting Initiative, and the International Sustainability Standards Board, but the Task Force on Climate-related Financial Disclosures (TCFD) is a globally recognized framework for climate disclosures. The number of companies that have aligned to TCFD’s climate reporting guidelines has increased significantly in recent years as has the amount of information individual companies are disclosing. TCFD’s 2022 Status Report showed a 14 percent increase in alignment by companies over the past two years across all 11 TCFD recommended disclosure categories, including the disclosure of climate-related risks and opportunities. According to the report, preparers and issuers of disclosures increasingly view climate-related issues as mainstream business and investment opportunities.
Even though there is strong alignment between the TCFD and the SEC’s proposals around governance, the SEC’s proposals are much more specific in certain areas. Organizations already following TCFD guidelines will likely need to take additional actions to comply with the eventual SEC rule, such as specifically outlining their boards’ expertise in understanding and managing climate risk.
Climate training is a journey that is dependent on the level of maturity of each company. While the SEC’s proposed rules are still being finalized, now is the time for boards to upskill and get ahead of the rules. Board members need to be aware of why ESG is so important to stakeholders, especially in today’s environment, and understand the risks their companies face due to climate change.
But it’s not all about managing risk. It’s also about recognizing opportunities that exist in relation to mitigating or adapting to climate change. Identifying and taking full advantage of these opportunities will enable an organization to take meaningful steps toward offsetting climate risk and future-proofing the business. For companies that elect to make net-zero commitments or to define ambitious decarbonization strategies, the board of directors must understand the implications of declaring such commitments and the reputational risk of not meeting them.
Board alignment with the company’s overall climate roadmap is extremely important. Helping management navigate the complexities of ESG while also integrating execution into the business strategy requires a deep understanding of the issues and the opportunities. If management decides to add a new capability or new strategy to its climate agenda, the board of directors should have proper training to understand those capabilities and how the strategy will be embedded into the company’s normal course of business.
Companies at the beginning of their climate and environmental journey should be focused more broadly on understanding the overall ESG landscape, as well as the basics of ESG risk. Organizations must be able to answer the following questions: Why do we care about ESG issues? How do ESG issues potentially impact our company’s business strategy? What is our level of ambition around ESG? What are our key priorities and focus areas related to the climate agenda?
The answers to these questions will provide organizations with a clear understanding of their priorities and help define the type of training board members will need. It’s important for the board to have a solid understanding of what climate change is, how it impacts the company’s industry, and the overall climate change landscape.
Training should be actionable and clearly break down how executives can protect the business and, by extension, their shareholders’ investment from climate risk. This can be accomplished by updating the existing operating model to embed climate considerations into different business functions, such as risk management frameworks and data processes. Developing a strong operating model that factors in climate risk is a critical step boards can initiate to ensure their organizations have the right systems and processes in place for strong governance and accountability. For instance, under the SEC’s proposed rules, board-level leaders would be required to have oversight of the company’s interim climate-related targets. This helps to ensure the organization is on the right track to meet its longer-term climate goals. Linking executive bonuses to the company’s climate-related targets also provides a monetary incentive to promote progress and drive change while protecting the business from greenwashing.
Implementing certain components of the proposed SEC rules might require more foundational work and training for companies that are not as prepared as others, but the value goes far beyond compliance. The SEC’s proposed rule offers a roadmap for companies to reduce risk, identify new opportunities on the path to net zero, and ultimately protect the planet in the process. Boards should be trained on climate and sustainability on an ongoing basis as their organizations’ strategies shift to meet new goals and capabilities. While hiring someone with expertise in ESG may be one piece of the compliance puzzle, ensuring that the board has proper training will benefit the organization as a whole, especially at smaller companies that may be less advanced in their ESG journeys.
Hortense Viard-Guerin is a director at Baringa.
NACD: Tools and resources to help guide you in unpredictable times.
Thank you for this well-written summary, Hortense Viard-Guerin.