The rise of mandatory climate-related disclosures follows years of work by standard-setting bodies around the world to establish best practice for reporting on climate and sustainability risks and opportunities. In-House Perspective assesses how these standards are becoming part of the work of general counsel.

Mandatory climate-related disclosures are looming for companies in Europe and the US. The EU’s Corporate Sustainability Reporting Directive (CSRD) entered into force on 5 January 2023, with rules to be applied from 2024, while the US Securities and Exchange Commission’s (SEC) proposed Climate-Related Disclosure Rule could be published by October 2023. The UK, meanwhile, has already introduced mandatory climate-related financial disclosure requirements, which have been in force since 2022.

These moves follow years of work by standard-setting bodies around the world to establish best practice for reporting on climate and sustainability risks and opportunities.

A global baseline is in sight

Over recent years and months, numerous sustainability standard-setting bodies have been consolidated to harmonise their work. Two prominent organisations now stand out: the International Sustainability Standards Board (ISSB), part of the International Financial Reporting Standards (IFRS) Foundation, and the Global Reporting Initiative (GRI).

At the end of June, the ISSB published its first two standards: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures.

From 2024, the IFRS will take over the monitoring of companies’ climate-related disclosures from the Task Force on Climate-related Financial Disclosures (TCFD), the recommendations of which have been widely adopted by businesses. This marks another significant step towards the consolidation of sustainability reporting standards.

In late July, the International Organization of Securities Commissions (IOSCO) endorsed the ISSB standards and called on its 130 member jurisdictions, which regulate more than 95 per cent of global financial markets, to consider adopting them.

Eelco van der Enden, Chief Executive Officer of the GRI, sees its standards as complementing those of the ISSB. He describes a situation where ‘GRI and ISSB work closely together towards a global comprehensive baseline, whereby ISSB takes the financial part on behalf of investors into account [and] we take the impact side into account’. Van der Enden explains that the GRI standards look at the effects the business has on the environment – an ‘inside-out’ approach. Meanwhile, accounting standards tend to look at the effects of the climate crisis on the bottom line, taking an ‘outside-in’ approach. When you put the two approaches together you have what is referred to as ‘double materiality’.

Setting the regulatory scene

A recent report carried out by the IBA Capital Markets Forum and the IBA Securities Law Committee, titled ESG Survey 2022, found that ‘most countries require some type of quantitative, or at least qualitative, climate change disclosures as part of the ESG disclosure regime.’ It also highlights ‘the need for policy-makers to work towards developing more standardised and clearer ESG disclosure frameworks, which will enable better comparability and understanding of ESG risks and opportunities’.

The EU’s CSRD modernises and strengthens the bloc’s rules covering the environmental and social information companies are required to report and applies to a broader set of companies and listed small and medium-sized companies. The EU estimates that approximately 50,000 companies will fall under the CSRD’s scope. The first companies will have to apply the rules in the 2024 financial year for reports published in 2025. The CSRD makes it mandatory for companies to audit the sustainability information they report and provides for the digitalisation of that information.

Companies subject to the CSRD will have to report according to European Sustainability Reporting Standards, developed by the European Financial Reporting Advisory Group (EFRAG). These standards will be tailored to EU policies but will also aim to contribute to international standardisation efforts. At the time of writing, the European Commission was considering the responses to a public feedback period before finalising the European Sustainability Reporting Standards as delegated acts. It’s also submitting them to the European Parliament and Council for scrutiny.

In the US, in March 2022 the SEC proposed rule changes that would ‘require registrants to include certain climate-related disclosures in their registration statements and periodic reports’. These would include detailing climate-related risks that are likely to have a material impact on the business, the governance and risk management processes related to these risks and how they’ve affected or will affect strategy, business model and outlook.

Registrants would be required to disclose greenhouse gas emissions, which the SEC says are commonly used to measure exposure to climate-related risk. They would also need to include climate-related financial statements in a note to their audited financial statements. The rule would require disclosure of the impact of climate-related events – for example, extreme weather events ­– and transition activities on the organisation’s financial statements.

After a period of review and consultation, publication of the SEC’s rule is currently expected in October 2023, though this could change. If the rule were adopted, it seems most likely it would be applicable to the 2025 reporting year.

The Scope 3 debate

The Greenhouse Gas Protocol (the 'GHG Protocol'), which supplies greenhouse gas accounting standards, categorises emissions into three scopes: Scopes 1, 2 and 3. Scope 1 covers all direct emissions from sources that are owned or controlled by the company. Scope 2 covers indirect emissions from the company’s consumption of purchased electricity, steam or heat. Scope 3 covers other indirect emissions generated across the company’s entire value chain.

The question of whether to include Scope 3 emissions in mandatory climate-related disclosure requirements is hotly debated. Including Scope 3 emissions will vastly increase the volume of disclosure an organisation is required to make, and the related data it will need to collect.

Although Scope 3 emissions are often outside a company’s direct control, they can account for a significant proportion of its overall emissions. It’s important, therefore, for companies to have an understanding of their Scope 3 emissions so they can develop meaningful strategies to reduce their overall emissions. Applying a materiality lens to Scope 3 emissions can help to make them feel more manageable.

The EU’s CSRD requires disclosure of Scope 3 emissions, which is covered in detail in the draft ESRS E1 Climate Change standard, referring to the relevant GHG Protocol standard and the 15 Scope 3 categories it identifies.

The SEC’s Climate-Related Disclosure Rule would include Scope 1 and 2 emissions and Scope 3 ‘if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions’. Smaller reporting companies would be exempt from Scope 3 disclosure requirements. Accelerated filers and large accelerated files would need to include an attestation report from a third party covering Scope 1 and 2 emissions, which the SEC says would promote reliable disclosure of greenhouse gas emissions for investors.

According to Susan H Mac Cormac, co-chair of the Environmental, Social, and Governance (ESG), Social Enterprise + Impact Investing and Energy practices at Morrison Foerster in San Francisco, the CSRD will be important in the US as well as in Europe because a significant number of US companies will fall under its remit, either because of their size, revenues or assets, or because the inclusion of Scope 3 emissions makes it likely that most companies will be included as part of another organisation’s supply chain emissions.

The CSRD rules are significantly more comprehensive and detailed than those the SEC is proposing. Therefore, while the SEC proposals are significant in the US, it would be sensible for US companies to prepare for the CSRD’s extensive requirements in anticipation of falling within their remit.

Ready, set…

Most companies, especially larger organisations, are already disclosing some climate-related information on a voluntary basis. This work leaves them well placed to report in line with new mandatory requirements. However, the comprehensive nature of the CSRD in particular means many companies still have much work to do over a short period of time.

Mac Cormac says organisations are using the new ISSB S1 and S2 standards as a roadmap to help prepare for the mandatory disclosure required under the CSRD. In her view it would be best if standards and regulation overlapped completely to provide greater harmonisation. She argues it makes sense for regulators to use the work already done by standard setters in this area, which sets it apart from other areas needing regulation, such as artificial intelligence (AI) or cryptocurrencies.

Perhaps the greatest concern is in regards to the accuracy of climate-related information once it’s subject to legal liability and external audit. Larger organisations will find most of their work relates to this issue. Their management teams will need to spend more time thinking about how the relevant data is collected, compiled and disclosed.

Wilhelm Bergthaler, Co-Chair of the IBA Environment, Health and Safety Law Committee and a partner at Haslinger/Nagele Rechtsanwälte in Vienna, believes that, to be prepared in time, companies will need help from consultancies. ‘Companies have massive data but so far they have not structured these data according to the needs of all the reports that are coming up’, he says. He suggests AI could be used to help categorise the sheer mass of data. 

Bergthaler also describes an interesting trend whereby technology startups are inventing new tools to help companies extract data from their systems and generate reports for making climate-related disclosures. Individuals or organisations such as this are now being hired by companies that understand the importance of getting ahead and the competitive edge it gives them. Bergthaler observes that once a company understands this benefit from taking action to address the climate crisis, it’ll put its best people on the issue – with impressive results.

Under pressure

Regulation will standardise the voluntary disclosure already being made. This will help to benchmark companies, allowing peers to be compared and creating a better understanding of best practice. It’ll also enable stakeholders to assess the progress organisations are making towards achieving their climate-related targets. The requirement for external assurance means the methodology for reporting is likely to be standardised as well. ‘There was […] a lot of disclosure […] long before regulation’, says Mac Cormac. ‘What regulation is really doing is helping standardise, set the methodology, set a benchmark for governance and allow for this benchmarking’.

Credible, comparable disclosure should also help mitigate greenwashing risk and create a more comfortable environment for companies to operate in.

A range of stakeholders are placing increased pressure on companies to make meaningful progress towards achieving pledges they have made on climate issues, for example plans to achieve net zero by a certain date. Stakeholders such as investors or non-governmental organisations are willing to hold organisations to account by taking legal action, divesting or using activist shareholder tactics when they feel progress hasn’t been made towards climate targets, or if they believe a company’s climate-related commitments have been abandoned altogether. According to David Lynn, Chair of the Public Company Advisory & Governance practice at Morrison Foerster in Washington, DC, companies can get caught in the middle of the competing viewpoints of different stakeholders. ‘They’re trying to address the concerns of their shareholders and other stakeholders and shareholders don’t always agree on what the right path is’, he says. 

Richard Barker, a board member of the ISSB, says his organisation’s standards aim to facilitate communication between companies and their investors. He says the appropriate disclosure for a company without a net zero target would be to tell its investors and explain why. If a company does have a net zero target, tell investors what it is and how the company plans to reach it, outlining the associated governance process, strategy and important milestones. ‘[The ISSB standard] focusses on information that is material to your investors’, he says. ‘If it’s material to your investors, then it’s part of the way you’re running your business’. Disclosure therefore means providing transparent, consistent and assured data on activities that are already being carried out.

Crucial information, crucial roles

Robert Eccles, Visiting Professor of Management Practice at the Saïd Business School at the University of Oxford, says general counsel and their legal teams ‘need to be completely on top of what the SEC is doing, what the ISSB is doing, and what EFRAG is doing and know whether this is going to have implications for their company’. Van der Enden highlights that even if a company falls outside the remit of the CSRD or the proposed SEC rules, it could be forced by its investors to use the GRI or ISSB standards. For him it’s important to understand the entire landscape to be prepared for all eventualities.

Lynn says it could be useful for in-house legal to carry out a mapping exercise, looking at the disclosures they’re making now and how those compare to what they will have to say when the CSRD comes into force, or when the SEC rules are adopted. Following this exercise, legal counsel will need to analyse the controls that will be required, the veracity of the data and the use of outside parties for attestation. This element is more complex and therefore should be prioritised to allow sufficient time to address it before any mandatory disclosure is required.

It’s likely the management team will be required to sign off on the accuracy of the numbers involved, which will mean the chief financial officer (CFO) and compliance teams are more involved. In-house legal will need to monitor on an ongoing basis published information, how results compare to targets and how the markets and others are reacting.

Eccles says that, in light of the requirement for external assurance of disclosed data, ‘major upgrades are going to need to be made to the internal controls and measurement system’ to ensure it’s as rigorous as the system used for financial disclosures. This will require general counsel to be much more engaged with sustainability reporting than they may have been in the past. He adds that ‘grounding all the disclosures in materiality is really the fundamental point […] what are those material issues that matter to value creation?’ These will vary across industries and each will have to address the climate crisis in different ways.

In-house legal shouldn’t be tempted by so-called ‘green hushing’, which refers to the practice of not disclosing or publicising environmental targets or other climate-related information as a tactic for mitigating greenwashing risk. While disclosing as little as possible may seem like the safest option, Eccles says ‘there’s more risk in under reporting than over reporting as long as you make sure all the numbers are right’. He says in-house legal should facilitate as much transparency as possible and believes doing anything else could be counterproductive. 

Van der Enden says it’s important that sustainability reporting is not seen as a marketing gimmick. ‘Looking from a liability point of view it’s pretty crucial information to investors’, he says. ‘If you on purpose do not put your best effort in publicly available information, you’re misleading markets’. Sustainability reporting should be considered on a par with financial reporting with the same level of rigour applied to it. For Van der Enden, it’s a matter of responsible long-term risk management.

Sustainability and climate information will become part of the main annual report. To get reporting right, therefore, sustainability teams will need to work more closely with other teams: financial accounting, corporate reporting and investor relations, as well as in-house legal, for example. According to Barker, ‘in order to do sustainability reporting well, those functions have got to work together’.

In-house legal may find they’re most closely involved with monitoring the risks associated with climate disclosure, such as greenwashing and green hushing, and any associated reputational risk. Marketing material promoting newer initiatives in this space might warrant closer inspection, for example, to screen for risks unique to this area. The wording of the sustainability elements of the annual report might also need to be reviewed in the context of the listing rules of the relevant jurisdiction.

Eccles suggests the first thing general counsel should do is call a meeting with the CFO and the chief sustainability officer to talk about how prepared the three of them believe the organisation is to face the challenge of climate reporting. For many, he says, the conversation will be very illuminating.