By: Stephanie Selva
The exigency of the climate crisis is underscored by a staggering statistic: a recent study suggests that corporate entities contribute to over 70% of global greenhouse gas emissions. Amidst the growth of environmental, social, and governance (ESG) investing and investor demands for transparency, governments have begun to take initiatives to hold corporations accountable for their contribution to the climate crisis. Both the United States Securities & Exchange Commission (SEC) and the European Union (EU) have recently imposed climate-related disclosures that represent notable steps toward integrating sustainability into corporate reporting. Both frameworks aim to provide stakeholders with meaningful insights into companies’ environmental impacts; however, they approach this goal from different regulatory and geographic perspectives, which, unfortunately, leads to inconsistencies and potentially dilutes their effectiveness. This concern is underscored by the fact that multinational companies, “such as BP, Coca-Cola and Walmart are responsible for nearly a fifth of climate-changing carbon dioxide emissions . . . .”
As part of the European Green Deal, the EU Corporate Sustainability Reporting Directive (CSRD) went into effect earlier this year. The directive aims to enhance the consistency and comparability of sustainability reporting to guarantee that investors and other stakeholders are equipped with the necessary information to evaluate risks and opportunities that may arise due to climate change and other sustainability concerns.
By setting remarkably low thresholds, the CSRD applies to all companies listed on an EU-regulated market and “large” private companies. A company will be considered “large” if it surpasses certain asset, revenue, and workforce size thresholds. However, the directive also extends to non-EU companies by requiring EU-based branches or subsidiaries to report at the level of their ultimate holding company, regardless of where that holding company may be headquartered or listed, so long as the group generates significant revenue in the EU soil.
This significant, broad expansion of a prior initiative (the Non-Financial Reporting Directive (NFRD)) is anticipated to reach 50,000 EU companies and over 10,000 non-EU companies, 31% of which are American.
The CSRD adopts a comprehensive “double materiality” framework, requiring that companies provide detailed reports on two fronts: the impact of external issues on their operations and, conversely, the influence their operations have on these issues. Consequently, the CSRD mandates that corporations disclose information on substantiality-related matters, such as their strategies for managing pollution, their effects on communities, and their treatment of employees.
Further, the directive explicitly prioritizes the mitigation of climate change, compelling corporations to clearly articulate their initiatives to reduce their carbon footprint. This requirement extends to explaining how the increasing frequency of severe weather events and the global transition to a lower-carbon economy could potentially impact their bottom line, in addition to reporting on their greenhouse gas emissions.
Important in this context is the internationally recognized classification of greenhouse gas emissions into scopes 1, 2, and 3. Scope 1 emissions are those directly produced by a company’s own operations, such as fuel combustion in company vehicles, while Scope 2 emissions are indirect emissions from the production of purchased energy, like electricity used in buildings. Scope 3 emissions extend beyond direct and energy-related activities to include all other indirect emissions throughout a company’s value chain, such as those related to the companies’ supply chains and consumers.
While the CSRD’s disclosure requirements extend to Scope 3 emissions, the SEC’s final rules fell short–only mandating disclosure of Scope 1 and Scope 2 emissions.
The SEC released its first climate-related disclosure requirements on March 6, 2024. This move by the SEC is part of a longstanding effort to adapt disclosure requirements to the evolving needs of investors for reliable and standardized climate-related information. In short, the requirements are designed to provide investors with a clearer understanding of how climate risks affect US companies and foreign issuers. They focus on the financial implications of climate change, including direct impacts and regulatory risks. This approach is more focused on material risks to companies’ financial condition or operating performance, unlike the CSRD’s “double materiality” standard.
Particularly, the SEC will now require companies to include in their filings a broad array of details regarding the influence of climate-related risks on their operational, strategic, and financial aspects. This includes the impacts of these risks, risk mitigation or adaptation efforts, and associated costs and their effects on financial projections and assumptions. The rules also cover corporate governance aspects, detailing the involvement of the board and management in climate risk oversight and its incorporation into the entity’s overarching risk management framework. Moreover, companies will be required to disclose information about their climate-related objectives and the economic repercussions of pursuing these goals, as well as provide specific data on emissions, complete with verification reports. Lastly, disclosures must also address the economic consequences of severe weather events and the role of carbon offsets or renewable energy certificates in achieving climate goals, alongside a qualitative analysis of how these elements affect the assumptions and estimates in financial statements.
Multinational businesses face several challenges in complying with the SEC’s reporting rules and the more comprehensive reporting obligations under the CSRD. Adapting reporting processes to meet both requirements can be a resource-intensive and costly task, with even greater financial consequences for non-compliance.
To add to these challenges, these efforts to address environmental, social, and corporate governance (ESG) investing demands have faced repercussions. In the US, several Republican-led states have brought suit against financial firms for their ESG commitments and against the SEC as a result of their climate-related disclosures. This backlash has prompted significant US financial firms like BlackRock and Vanguard to retract from climate-related initiatives. This has caused a noticeable decrease in support for ESG-related proxy voting and a shift away from ESG branding in investment funds, evidenced by a significant withdrawal of investments from sustainable funds. On the other hand, environmental organizations like the Sierra Club considered challenging the SEC’s decision to remove more Scope 3 disclosure requirements from the final rule on climate-related disclosures.
And this divide is not limited to the US. The EU, while at the forefront of ESG regulation, is experiencing similar reactions–with widespread protests against sustainability measures and a decrease in new sustainable fund launches. In response to changing political landscapes and investor sentiment, the EU has considered softening and reevaluating its sustainability reporting regulations amidst concerns over the potential economic impact of stringent climate regulations.
Thus, despite the noble intentions and potential of the EU’s CSRD and the SEC’s new climate-related disclosure initiatives to foster transparency, promote sustainability, and encourage corporate responsibility, their impact is muddied by inconsistencies, challenges in implementation, and varying levels of scope and materiality considerations.
This juxtaposition highlights the international urgency and complexity of addressing corporate contributions to climate change. The divergence in regulatory approaches, the significant resource demands placed on multinational corporations to comply with disparate frameworks, and the political and societal backlash against ESG initiatives pose formidable challenges. These issues not only complicate compliance for corporations but also risk diluting the effectiveness of such disclosure mandates in driving meaningful action against climate change.
As the world grapples with the escalating climate crisis and its consequences, it becomes increasingly clear that isolated efforts, however well-intentioned, may not suffice. The need for a harmonized, international framework for climate disclosures that bridges regulatory disparities and fosters collective action has never been more critical. Such a unified approach would not only streamline compliance for multinational corporations but also reinforce the global commitment to mitigating climate change. As companies begin to adapt and come under these compliance requirements, the lessons learned from the implementation of the CSRD and SEC’s disclosure requirements should serve as a catalyst for international collaboration, driving toward a future where corporate transparency and accountability in environmental stewardship are not just encouraged but mandated as a cornerstone of global business practice.
