Monday, June 24, 2024

U.S. companies scramble ahead of EU climate disclosure rules

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Major U.S. companies are getting ready to meet sweeping climate disclosure requirements from the European Union — even as the U.S. Securities and Exchange Commission struggles to finalize its own disclosure rule.

Starting as soon as January, the largest U.S. companies that raise money on European stock exchanges will be forced to begin compiling information about their climate risks, strategies and emissions. But those limited number of companies — estimates of which remain difficult to pin down — are expected to increase to more than 3,000 U.S.-based companies by 2025, when more expansive European rules take effect.

They include any U.S.-based business that has an E.U. branch with more than 250 employees, more than $42 million in local revenue or a balance sheet above $21 million.

Six experts who work closely with U.S. companies on corporate climate disclosure said the E.U.’s looming compliance dates mean their clients can no longer afford to wait and see what U.S. regulators will do, and they have started preparing for mandated climate disclosure in earnest.

That’s the case in large part because complying with the E.U. rules will mean tackling thorny financial and legal questions that could take months — if not years — to get right. Among them: which parts of their business are subject to the rules, and how they should go about compiling the data.

The Securities and Exchange Commission, meanwhile, proposed a narrower climate disclosure rule more than a year ago. The agency has yet to finalize the proposal, in part due to fierce pushback from Republican lawmakers and industry groups, as well as internal debate over its most controversial provisions.

The SEC has not indicated when it will finalize the rule, but observers expect the agency will work to do so well in advance of the 2024 elections.

“We had a lot of companies say, well, the SEC rule has been put on hold, so we’re just going to wait and see what happens,” said Maura Hodge, KPMG’s environmental, social, and governance audit leader.

But with the recent passage of climate disclosure legislationin California and looming compliance deadlines in Europe, Hodge added, “there’s been a clear uptick in interest and focus on the need to move forward.”

‘Caught flat-footed’

The European Commission in 2022 adopted new standards meant to increase the amount of sustainability-related information that companies are required to disclose — as well as how many companies are required to disclose it.

The framework, known as the Corporate Sustainability Reporting Directive, builds on a prior set of rules that required only the largest companies to report information including how they handle the treatment of employees, human rights, environmental matters and board diversity.

The so-called CSRD is far more sweeping — and eventually will apply to a whopping 50,000 companies, as opposed to just 11,700 previously, according to the E.U.

The standard requires companies to disclose information related to everything from the company’s approach to issues including biodiversity, pollution, and the company’s impact on communities and workers.

The standards also focus on climate change specifically, and make clear companies should report their plans to reduce their climate footprint, how intensifying extreme weather events and the global transition away from a low-carbon economy will impact their bottom line, as well as their greenhouse gas emissions. That includes emissions associated with their supply chains and customers, known as Scope 3.

They also require companies to assess and disclose not only the ways climate change and other sustainability issues could impact profits, but also how their business impacts society.

“That’s where most angst is for the U.S. companies,” said Farzad Damania, a partner at Katten Muchin Rosenman who represents companies on securities law compliance issues. “Most U.S. companies don’t know how to do that, so that’s where the stress point is.”

Damania highlighted several major differences between the approach of the E.U. compared with the SEC. One notable divergence is that the SEC focuses on climate risks to companies but sidesteps broader sustainability issues as well as companies’ impacts on society.

Also important is that the SEC’s proposal, like the E.U.’s, does say some companies would be required to report their Scope 3 emissions. But Chair Gary Gensler has repeatedly signaled that the highly controversial provision could be watered down or removed from the final rule amid industry opposition.

Under the E.U. rules, the largest companies — those that have already been disclosing sustainability-related information and are listed on European stock exchanges — will begin collecting relevant information in 2024 and submit their disclosures in 2025.

But starting in 2025, any company with subsidiaries in the E.U. that meet certain criteria — such as having an E.U. branch with more than 250 employees — will be required to do the same.

Most large U.S. companies will fall into the second bucket, said Emily Pierce, a former assistant director of international affairs at the SEC, where she worked on sustainability standards and requirements.

“That’s where I think we’re seeing a lot of U.S. corporates wrestle with these obligations, because they have subsidiaries or groups of subsidiaries that are registered as companies in Europe that trigger that large threshold,” said Pierce, who now serves as chief global policy officer at Persefoni, a carbon accounting software company.

As she sees it, that means “2024 is really a crucial year to get ready.”

Adam Fishman, an associate director at Business for Social Responsibility, a business network and consulting group that works with companies on sustainability issues, echoed that point.

“The preparations for compliance is a multiyear exercise,” Fishman said. “If this hit tomorrow, I think there would be a lot of companies that would be caught flat-footed based on where they’re currently at.”

Crunching the numbers

U.S.-based companies now are digging into several major questions they will need to answer to better understand the European rules — and what it will take to meet them.

“The SEC rule got delayed, but then also at the same time the CSRD rule was finalized, and now it’s up to the different countries to” adopt it, said Elodie Timmermans, a nonfinancial reporting assurance and advisory leader at Ernst & Young.

“We’ve seen the U.S.-based companies really starting to pivot … to understand what CSRD means for them,” she added.

A key step entails determining which parts of their business will get caught up in the requirements — and how they want to go about reporting the data.

Take, for instance, a company headquartered in the United States with a handful of subsidiaries in Europe.

The company would need to figure out which of those subsidiaries meet the regulations’ thresholds. Then, it would need to decide whether it’s best to report on each subsidiary separately, consolidate all of the subsidiaries into one report, or disclose information relevant to the entire parent company.

“The entity structures of organizations can be so complex that they have to really go deep into understanding how [their] entities are set up,” Timmermans said.

Then comes a “double materiality analysis.” The CSRD requires companies to identify and disclose social and environmental information that is financially material to the business — as well as the ways the companies have a material impact on society and the environment.

Once that’s settled, companies will need to compare the voluntary disclosures they currently provide with what Europe is requiring to determine what data they lack. Just one of those steps, experts said, can take months.

“While 2025 might sound like a long way away, it’s really not,” said Kristen Sullivan, a partner at Deloitte who leads sustainability and ESG services. “2024 is going to be the activation year.”

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