California recently passed legislation requiring large companies to file sustainability disclosures by 2026. Governor Gavin Newsom confirmed he will sign the bill, making California the first state to impose a disclosure mandate.
The rise of sustainability disclosure requirements is being pushed by the priorities of the Paris Climate Change Agreement, also known as the Paris Agreement or Paris Accords, and by the United Nations through various environmental initiatives like the annual UN Climate Change Conference, with the next being COP28, and the UN Principles for Responsible Investing.
The European Union was the first to create a comprehensive reporting program. On July 31, the European Commission adopted the European Sustainability Reporting Standards. The ESRS will standardize how companies within the European Union report climate change and other environmental, social, and governance related actions. They are set to go into effect on January 1, 2024.
For climate disclosures, the ESRS will use International Financial Reporting Standards Foundation’s Sustainability Disclosure Standards adopted by the International Sustainability Standards Board. The ISSB drafted the IFRS Standards as the global standard for sustainability and climate change reporting. IFRS is not used in the United States, but is used in 132 jurisdictions including European Union member states.
The US uses Generally Accepted Accounting Principles adopted by the US Securities and Exchange Commission, which is in the final drafting stage for sustainable reporting standards for publicly traded companies. The SEC is expected to follow the template established by the ISSB and EU. The proposed rule would require three levels of reporting from publicly traded companies. Scope 1 addresses direct greenhouse gas emissions of the company. Scope 2 addresses indirect GHG emissions from purchased energy. Scope 3, the most controversial, addresses GHG emissions from suppliers and end users of the product.
However, the announcement of the SEC rule has been delayed as conservatives and business leaders push back on the plan. In an effort to appease critics, it is believed that the final SEC rule will not include Scope 3. The final rule is expected to be announced in October.
However, even with the concession, there are serious questions as to if the SEC has the authority to enact such a rule and how the current Supreme Court of the United States will interpret their authority. If the inevitable legal challenges do result in SCOTUS overturning the rule, it will be in the hands of Congress to properly delegate the authority. The Republican controlled House passed legislation overturning the Department of Labor ERISA rule on ESG, resulting in President Biden’s first veto.
California offers an alternative approach to sustainability reporting by utilizing the regulatory authority of the states. The Climate Accountability Package is a pair of bills passed by the California Legislature to require climate reporting from companies that meet certain requirements.
Senate Bill 253 requires companies who do business in California and have an excess of $1 billion in revenue, defined as “reporting entities”, to submit an annual report for Scope 1 and Scope 2 starting in 2026. Scope 3 reporting will begin in 2027. The State Air Resources Board must create the details of the reporting requirement by January 1, 2025.
Senate Bill 261 requires companies who do business in California and an excess of $500 million in revenue, defined as “covered entities”, to submit a biennial climate-related financial risk report. The report is based on the work of the Task Force on Climate-Related Financial Disclosures, established by the Financial Stability Board.
While the implementation of California’s climate disclosure regulation will take years, it is an example for Democrat controlled states wishing to buck the anti-ESG actions of Republican controlled states like Florida and Texas. However, as with any state legislation that has a long enactment period, it is also subject to the whims of the legislature. Reporting requirements may be modified or the enactment date may be postponed if they find it creates too much of a burden on business. I also expect legal challenges as to the reach of the reporting entities and covered entities under the standards.