New Reporting Requirements for Environmental Proposals Are on the Horizon

The gap in standardized reporting requirements

Successful fund management relies on standardized data and updated reporting. Active ESG strategies, for example, are driven by multiple sources of research and data that must be evaluated qualitatively and quantitatively for materiality.

The recognition of ESG’s materiality has outpaced the SEC’s ability to standardize ESG rating and reporting systems. The SEC is currently considering rules to enhance and standardize climate-related disclosures for investors (among new rules related to human capital management and board diversity disclosure). The proposed climate disclosure rule, introduced in March 2022, would require companies to disclose:

• Their governance of climate-related risks and their risk-management processes
• How identified climate risks could materially impact business and consolidated financial statements
• How identified climate risks may affect their strategy, business model and outlook
• Impact of climate-related events and transition activities as they are aligned with their financial statements

The proposed rule would also require disclosure of direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions (Scope 2) in addition to disclosed GHG emissions from upstream and downstream activities in its value chain (Scope 3). The proposed rules would include a buffer phase-in period with an additional phase-in period for Scope 3 disclosure and require educational material for investors at firms that have advanced disclosures (scenario analysis, developed transition plans, publicly set climate-related targets or goals).

In 2023, reporting was a hot topic, with the European Commission adopting corporate sustainability reporting standards requiring the European Sustainability Reporting Standards (ESRS) apply to companies that are subject to the EU’s Corporate Sustainability Reporting Directive (CSRD) to be phased in this year.

Additionally, this year California adopted a Climate Corporate Data Accountability Act, requiring U.S.-based companies conducting business in California to make disclosures about their emissions and climate-related financial risks. Meanwhile, institutional investors in other U.S. states await a final version of the draft rule and fill reporting gaps by introducing shareholder proposals requesting disclosure and reporting on company management of ESG risks and opportunities. In the 2022 proxy season, demands for climate-related disclosure dominated, with one out of four voted resolutions gaining majority support at 2023 annual general meetings. Following suit, 2022 witnessed a meteoric rise in voluntary ESG reporting, with 96 percent of S&P 500^® companies and 81 percent of Russell 1000 organizations publishing ESG reports.

Trends in environmental shareholder proposals and company responses

In 2023, proposals focused more on company actions beyond disclosures. This was especially the case for environmental topics. According to the Harvard Law School Forum on Corporate Governance, climate-change proposals dominated this season, with a specific focus in climate transition planning. Many of these proposals received lower support than disclosure-related proposals. However, the SEC’s new climate rule would set higher expectations for company reporting and could bolster vote support on related shareholder proposals.

The current substantial implementation rule gives companies the opportunity to assert good-enough compliance with shareholder proposals that tackle topics already subject to corporate disclosures. Therefore, shareholder proposals must strike a balance between asking for more than is provided in current disclosures, while not asking for so much that the proposal is deemed overly prescriptive. Vanguard and Blackrock explained their increased number of votes against shareholder proposals in 2023 compared to previous years as a reaction to the uptick in proposals that are too prescriptive.

Should the SEC finalize the climate rule soon, shareholder proposals in 2025 and beyond may focus on finding the gaps in reporting. Season-over-season data indicates environmental proposals are not going away any time soon, with the number of proposals submitted on environmental topics reaching new heights in 2023 over a record number in 2022. In sync with shareholder focus, a recent Honeywell survey indicates companies are preparing for this increasing shareholder demand. According to the survey, over the next year, 80 percent of companies are increasing budgets for environmental sustainability goals. Honeywell surveyed over 750 professionals responsible for the creation and implementation of environmental sustainability goals and initiatives at companies with at least 1,000 employees across multiple regions and sectors. The achievement of sustainability goals constituted the most-cited priority for executives, with 75 percent of organizations listing it as one of their top five near-term initiatives, up from 65 percent in the previous year.

Investors interested in climate risk will welcome SEC guidance

Climate remains a top ESG risk for many investors and detailed data has been scarce. The SEC’s long-awaited climate rule is likely to make waves in 2024.