Implementation for Small Businesses

Introduction

With rising consumer interest in sustainability and the emergence of the SEC’s climate proposal, ESG reporting is no longer just a large company concern. Smaller reporting companies must plan ahead and be prepared to fulfill future SEC requirements as they continue to grow. Putting off ESG reporting until it is required creates more work in the long run and can put small business behind. This article discusses SEC requirements for small businesses and what steps each business should take 24 months before, 18 months before, 9 months before, and right after initial ESG reporting is complete.

Proposed Requirements

The SEC’s current proposal would require small companies to adopt all new reporting requirements by their 2025 annual report. The smaller reporting companies would be required to include a new footnote in their annual reports or registration statement discussing climate disclosures and metrics. Companies would also be required to include a climate section (separately or in another section) which would disclose material climate-related risks and Scope 1 and Scope 2 greenhouse gas (GHG) emissions. In the interim reports, the companies would have to disclose any material changes. The financial statement footnote would be audited and subject to internal control over financial reporting (ICFR). However, Scope 3 GHG emissions would not be required to be reported. Neither would an audit report on ICFR or an assurance report on GHG emissions.

In accordance with the SEC’s proposal, the disclosures would include information about (1) the registrant’s governance of climate-related risks and relevant risk management processes, (2) how any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, (3) how any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook, and (4) the impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.

The following table summarizes requirements for small reporting companies:

Timeline Requirements

There are many activities that a company should perform before filing the initial report subject to the SECs requirements. This section discusses what small companies should do leading up to the initial report and after the initial report in order to pave the path to accurate, reliable, and timely climate reporting.

Starting 24 months before initial reporting

2 years before the initial reporting, smaller reporting companies will want to do the following suggested activities to be prepared for future requirements. These include (in no order):

• Conduct an “ESG Readiness Assessment” to determine areas for improvement. A variety of accounting and other financial service firms have created ESG Readiness Assessments that companies can use, such as this one by PricewaterhouseCoopers.
• Become familiar with the disclosure requirements proposed by the SEC. Our article on proposed disclosures gives an overview of the SEC’s proposal and highlights important areas. A summary fact sheet and the full text of the proposed rule can be found on the SEC’s website. After looking through the proposed disclosures, companies may want to modify their ESG goals to address the disclosure requirements.
• Identify and assess climate risks and impacts (including physical and transition factors) on business and financial statements. One way to do this is through climate-related scenario analysis. Our article[1]  on this topic explains the current recommended processes for implementing climate-related scenario analysis and how companies are reporting data on climate risks to their business and in financial statements.
• Identify sources and types of GHG emissions (Scope 1, 2, and 3). It is especially important for small businesses to identify Scope 1 and 2 emissions, as the SEC will require that the climate section discusses these emissions in FY 2025. Our article[2]  on GHG emissions provides an overview of the three different scopes, and how companies are currently reporting this information.
• Identify data owners, sources and existing processes and systems. Knowing where to gather the data required to comply with the proposed disclosures will likely be a hurdle for many companies. By identifying sources of data early on, your company will be in a strong position to prepare the required disclosures in a timely manner.
• Align required disclosures with ESG goals. Aligning required disclosures with the company’s overall ESG goals is important for uniformity across all divisions of the company.
• Develop ESG recommendations, project plan, workstreams, timelines and cost estimates. Having a plan and a timeline will ensure that all necessary steps are taken to enable the company to be compliant when required.

Starting 18 months before initial reporting

After beginning the process of implementation, small businesses should take more concrete steps to comply with the proposed standards. The following activities should be performed 18 months before initial reporting:

• Process and system implementation. Small businesses need to begin implementing a system by which climate-related metrics will be recorded and establish the process by which those metrics will be disclosed in the financial statements.
• Identify and procure relevant resources (people, systems) for the implementation. Some of the proposed disclosures are quantitative, while others are qualitative. Understanding which individuals or systems will be able to provide different types of data will ensure the accumulation and testing of data goes smoothly.
• Establish or remediate data feeds and integrate into relevant systems. Identifying, understanding, and integrating systems that can retrieve the necessary climate related data is crucial for initial reporting. Beginning this now will save hassle when initial reporting is required.
• Establish, document, and stress-test processes and controls around GHG emissions data (Scope 1-2) and financial statement impacts. Due to the number of disclosures surrounding GHG emissions, it is crucial that the sources of GHG information are tested and prepared for implementation.
• Develop policies, assumptions, and estimates for financial statement purposes. It is possible the data required for all the proposed disclosures may not be currently available. Creating new policies that outline strategies and procedures for creating ESG related estimates will benefit your company in the long term. Estimates should be reasonable and the assumptions behind them should be documented for review.
• Engage auditors for ESG data testing (including SOX controls testing if practical).  Strong controls are critical for making sure that ESG data is reliable. Management should identify areas of risk and implement controls. Auditors should determine how data should be tested.
• Accumulate and internally report interim period data. An interim report can be seen as a dry run before the required initial report. Issues can be identified, and steps can be taken to rectify them.

Starting 9 months before initial reporting

The following activities should be performed 9 months before initial reporting:

• Consider reporting experiences by public company peers. Public companies will already be required to disclose this information in their financial statements. Benchmarking and looking at peer companies that already have the required and audited disclosures is a great way to see how the SEC wants these to appear in the financials.
• Assess findings and report to the Board on ESG readiness. Any concerns with the process thus far should be addressed, and material findings should be discussed.
• Conduct the final remediation of errors and gaps. Errors and gaps identified during the interim report should be addressed and those uncovered by auditors should be fixed. This will likely be a continuous process in conjunction with the refinement of processes and controls surrounding the required information.
• Accumulate, test, and prepare year-end data for the annual report. Doing this several months before the initial report will ensure that all necessary data is collected and any errors are corrected in a timely manner.
• Facilitate audits of reported data (including testing of SOX controls as relevant) as well as auditor review of other ESG information. Working to ensure that all data is protected by strong controls will ensure that information presented is reliable and useful to investors.

Next steps after the initial reporting is complete

Once the initial report has been filed and all the SEC requirements have been met, management should have a debrief on the initial reporting experience. This includes comparing reports to similar companies and refining policies, processes, controls, assumptions, and other inputs and outputs as relevant. The company would continue to maintain ongoing GHG data aggregation, accounting, and reporting as they seek to add and improve controls to get the most accurate GHG emission metrics.

Conclusion

While the climate-related requirements might seem overwhelming for small companies, getting a jump start on ESG reporting can better prepare companies and lighten the workload when filing day arrives. Learning about climate-related disclosure requirements now and conducting an ESG readiness assessment can be extremely beneficial for companies' ESG reporting in the long run. Following the above timeline and performing the associated activities will prepare companies for the SEC’s proposal and any other ESG-related standards that come in the future.

Sources

https://www.sec.gov/news/press-release/2022-46

Conner Group