Is ‘Voluntary' ESG Reporting Still Optional?

Sustainability disclosures, or the disclosure of environmental, social and corporate governance (ESG) metrics, by corporations to investors and the general public, has been a somewhat commonplace practice by large public companies for the past few years. The general idea behind these disclosures is that investors want to see that their money is going toward companies that share their values and are more likely to withstand climate changes, the transition to a greener energy grid, and the increasingly limited availability of finite resources. It would be hard to find investors willing to put their money into a fishing company located in a lake that is rapidly drying out, as there is a low likelihood that the fishing company will be viable in the future. Thus, the past few years have seen a rise of sustainable finance, spurring the voluntary disclosures of various ESG metrics.

Within the United States, no legal or regulatory schemes require any company, public or private, to make annual, public ESG disclosures.  In 2022, the SEC released two proposed rule changes which would require foreign and domestic registrants to formally include certain climate-related information, and the adoption of ESG factors, into annual reports mandated by the Exchange Act, such as 10-K Forms. For a time, it seemed as if mandatory ESG disclosures were imminent. Nevertheless, these proposals drew a somewhat partisan response, with many investor-led groups applauding the proposals and others criticizing the lack of clarity of the plans or objecting to the idea that the SEC has the authority to require such disclosures. Original factsheets published by the SEC assumed these rules would be implemented in December 2022. As that date has come and gone, it is currently unclear if and when the SEC will continue pushing for such disclosures to be mandated.

However, the lack of federal regulations does not mean American companies should ignore the advancement of ESG disclosure requirements worldwide. Currently, the majority of companies which make annual disclosures are large, public corporations which do so voluntarily or under the strong encouragement of shareholders, sometimes via a proxy vote. However, between international regulations, individual market rules and investor demands, it is increasingly important that all US companies be aware that these "optional ESG reports" may not be optional for much longer.

European Union's CSRD

On January 5, 2023, the European Union's Corporate Sustainability Reporting Directive (CSRD) took effect (EU 2022/2464). Under the CSRD, certain public companies will be required to annually complete and submit a report that complies with the European Sustainability Reporting Standards (ESRS). Under the current directive, the CSRD applies to companies with the following:

• Over 250 employees
• More than 40€ million in annual revenue
• More than 20€ million in total assets
• Publicly listed equities and have more than ten employees or 20€ million revenue.
• International and non-EU companies with more than 150€ million annual revenue within the EU and which have at least one subsidiary or branch in the EU

By the EU's estimates, 50,000 companies based in an EU member state or who do significant business within the EU will now be required to disclose ESG metrics annually. This is the most extensive enacted rule requiring ESG disclosures, affecting the largest volume of companies worldwide.

Rules in Development

Beyond the United States, several other countries are seriously considering implementing similar ESG disclosure regulations to the EU's CSRD. The United Kingdom's Financial Conduct Authority (FCA) intends to finalize and publish rules mandating sustainable finance disclosures and anti-greenwashing rules this year.

Under the National Greenhouse and Energy Reporting Act (NGER), Australia's top 500 corporate entities have been required to report their annual GHG emissions since 2007. Australia's mandatory GHG reporting scheme is one of the oldest in the world. However, in December 2022, the Australian Treasury published an updated plan to expand and reform requirements to better align with reporting requirements developing around the world. The Australian Government will accept formal comments to this published plan until February 17, 2023. Additional countries actively drafting disclosure rules include Canada, Japan and South Africa.

Regulations Set by Markets

It's worth noting that outside of government entities, markets themselves appear to be driving ESG reporting. The Sustainable Stock Exchanges Initiative (SSE), a United Nations Partnership Program developed to encourage sustainable investment, identified 34 global stock exchanges which independently require ESG disclosures as a prerequisite for listing regardless of their respective national rules. Collectively, nearly 20,000 companies are registered between these exchanges.

Impacts on Private Suppliers

All American public companies need to be familiar with ongoing regulatory developments and begin developing a plan to calculate various ESG metrics if they do not do so already, as there is a likelihood that they will be compelled to disclose these metrics in the future. However, private companies may be surprised to find that they also need to have ESG metrics calculated and prepared. Within ESG metrics is a category of disclosure called Scope 3 Greenhouse Gas (GHG) Emissions. Scope 3 GHG Emissions can be thought of as the emissions generated in the supply chain of the entity or corporation making the disclosure. If you are calculating your Scope 3 GHG Emissions, you need to know the carbon footprint of your suppliers and what happens to your product when it hits the market (i.e., cradle-to-grave assessment). If public corporations are compelled to calculate and disclose their Scope 3 GHG Emissions, they will need to ask their suppliers for specific data, even if those suppliers are private companies. Some corporations have even begun auditing their suppliers to confirm the accuracy of what is reported to them. While it is true that private corporations may not be required to disclose their ESG metrics to the public, they may need to calculate their ESG metrics at the request of their consumers.

Summary

Despite the lack of a codified federal rule which requires ESG disclosures by American companies, it is evident that all companies, big or small, public or private, are aware of how they will be impacted by rules that are developing around the world. It is vital that all companies understand their supply chain, both upstream and downstream, and begin assembling a list of who could start requesting data to satisfy their disclosures. It is also important to remember that shareholders are the ones pushing for the adoption of these regulations. Regulations would streamline how ESG metrics are disclosed between corporations, yet the prevalence of disclosures will increase even without SEC mandates.