Published Date:
Apr 16, 2024
Updated Date:
April 18, 2024
Transition Plans
Learn more about the required disclosures for climate-related transition plans.
Introduction
On March 6, 2024, the SEC issued a final rule that requires registrants to include certain climate-related disclosures in their registration statements and periodic reports. This ruling is based on the SEC’s March 2022 proposal. Under the new ruling, companies will need to disclose information to help investors understand their climate-related transition plans, which will “help investors evaluate whether a registrant has an effective strategy to achieve its short-, medium-, or long-term climate-related targets or goals.” Disclosures will be required in annual reports for the fiscal year ending December 31, 2025, for calendar-year-end large accelerated filers. The purpose of this article is to help inform what a transition plan entails, the principles underlying an effective transition plan, and what companies are doing now to implement transition plans.
Transition Plans and Their Potential Requirements
A climate transition plan outlines how an organization will pivot its existing assets, operations, and entire business model toward alignment with the latest climate science recommendations. Due to an increased desire for transparency and a better climate, these transition plans are applicable to any company looking to stay relevant in a net zero economy. Carbon Disclosure Project (CDP), a nonprofit organization that helps companies manage and report their environmental impact, says that these plans “demonstrate to investors, and other stakeholders, that an organization is aligning with ambitious long-term climate goals, and that its business model will transition, in order to be relevant (i.e., profitable) in a net-zero carbon economy.”
CDP is regarded as one of the world’s leaders in environmental impact reporting and is fully aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). CDP’s framework indicates that a credible climate transition plan’s overall purpose is to support a company’s strategy in making the change towards a more environmentally friendly business model. The company’s strategy should include key performance indicators that are both verifiable and measurable. Additionally, it should easily integrate into a company's existing filings.
The process of making a climate transition plan should be guided by these principles:
- Accountability
- Internal Coherence
- Time-Boundedness and Quantifiability
- Flexibility and Responsiveness
- Completeness
- Forward-looking
By keeping these principles in mind, an organization can properly incorporate the key elements of a transition plan which are provided in the following table below. Each of these elements is divided into its appropriate TCFD pillar: governance, strategy, risk management, or metrics and targets.
Governance
The first key element of a climate transition plan is governance. Governance involves having board-level oversight and management structure in place to oversee the implementation of the climate transition plan. Disclosure of company policies, standards, internal controls, auditing, procedures for handling compliance matters, etc., is crucial to a credible transition plan. Good governance exists when there is a responsive tone at the top that holds everyone accountable and encourages participation, transparency, and inclusiveness while at the same time being effective and efficient. Ensuring good governance and board-level oversight over a climate transition plan furthers an organization’s progress toward meeting its targets.
Strategy
The SEC rule outlines that a transition plan is “a registrant’s strategy and implementation plan to reduce climate-related risks.” Strategy is how the company will accomplish the goals outlined in its transition plan and minimize risks associated with the transition by pivoting its existing assets, operations, and entire business model to be more environmentally minded. Some key elements to include in the strategy section of a transition plan are scenario analysis, financial planning, value chain engagement, low-carbon initiatives, and policy engagement.
Risk Management
The SEC’s rule requires companies that have adopted transition plans to disclose how they plan to mitigate or adapt to any physical or transitional risks they identify. Management should disclose any significant climate-related risks to the company and then outline a specific, realistic plan for each risk. The plans to mitigate these risks will vary based on the nature of the company and the risks associated with certain industries or locations. These plans should not include standardized language or processes but should rather be written and tailored to the risks and needs of the business.
Organizations should consider a wide variety of physical risks, such as exposure to sea level rise, extreme weather events, wildfires, drought, and severe heat. The transition plan should outline the company's specific steps to mitigate or adapt to any relevant physical risks. For example, if severe storms are a large risk to a company, the transition plan may outline how management plans to reinforce its buildings or equipment to reduce the damage that could be costly or how it intends to relocate to a safer area. Agricultural producers may discuss plans to adjust business strategies in case of a drought, such as switching to a different type of crop, developing technologies to optimize water use, or acquiring land in a different area.
Under the SEC rule, firms are required to consider and disclose any transition risks pertinent to the business. Fighting climate change will cause many adjustments to government policies, technology, and market conditions. These changes could greatly alter a company’s operations, creating significant risks it must consider and plan for. The SEC rule requires a company to discuss how they plan to mitigate or adapt to any relevant transition risks, such as:
- Laws, regulations, or policies that:
- Restrict greenhouse gas (GHG) emissions or products with high GHG footprints, including emissions caps; or
- Require the protection of high conservation value land or natural assets;
- Imposition of a carbon price; and
- Changing demands or preferences of consumers, investors, employees, and business counterparties.
By requiring disclosure of risk management plans, the SEC intends to give investors insight into how companies intend to address risks that significantly impact the firm’s business.
Metrics and Targets
For a company to develop a successful climate-based transition plan, clear and measurable targets must be outlined. These targets allow shareholders to evaluate management performance in achieving climate-related goals. Two defining characteristics of climate-based transition targets include time boundedness and alignment with current scientific principles.
Although many sources outline the timing requirements and disclosures for ESG plans, the CDP guidance is comprehensive. The time frames for each of the goals need to meet specific criteria. Each metric must have a base year for when the goal was first created and implemented. Following the base year, there must be a series of target years, not to exceed 5-year multiples. The target years will serve as benchmarks to measure goal progression. Finally, a progress-to-date is needed. This is the date when the goal will be completed by. It is recommended that companies do not have progress-to-dates beyond the year 2050 (if scientifically possible). This framework gives an understandable timeline to investors and management to carry out their climate-based transition plans.
After creating a timeline, the SEC rule requires that companies disclose the actions taken during the year to achieve the plan’s targets or goals. Doing so will provide investors with information that can help them better understand the company’s effectiveness in implementing any transition plan and the potential risks and costs associated with what it still needs to accomplish. This would require companies to be accountable to shareholders and actively work towards reaching their goals.
One tool that companies use to set their climate-related goals is SBTi. The SBTi, Science-Based Target initiative, provides guidance into how companies should set ESG goals that are in line with what is realistic in the scientific community. This tool can provide an understanding of how science plays a role in goal setting for ESG. The main objective of the SBTi is to help companies create goals that are good for the world and communities through implementing modern-day scientific principles.
Conclusion
Climate-based transition plans will become increasingly important in a world pushing towards being more environmentally conscious. These plans allow companies to disclose strategies for how to pivot existing business structures toward being more environmentally minded. Climate-based transition plans will lead to greater accountability through well-defined objectives and science-based metrics.
RESOURCES CONSULTED
https://www.sec.gov/files/rules/final/2024/33-11275.pdf
https://www.centrica.com/media/5591/climate-transition-plan-2021.pdf
https://www.sec.gov/ix?doc=/Archives/edgar/data/789019/000095017023035122/msft-20230630.htm
https://blogs.microsoft.com/blog/2020/01/16/microsoft-will-be-carbon-negative-by-2030/
https://www.fsb.org/wp-content/uploads/P291020-2.pdf
https://about.att.com/ecms/dam/csr/2023/Environment/ClimateStrategyTransitionPlan.pdf
https://sciencebasedtargets.org/
https://uclg-aspac.org/good-governance-definition-and-characteristics/
Footnotes
Apr 16, 2024