ESG Regulation Review

April 26, 2023
5 min

Over the last few years, we’ve seen growing discontent among the investment community, corporate managers, and climate activists with the state of corporate ESG reporting. The major criticisms have centered on the (lack of) decision-usefulness of current reporting and rating practices. 

In 2022, we saw unprecedented activity among two of the most important regulatory bodies in the global finance — the Securities and Exchange Commission (SEC) and the European Financial Reporting Advisory Group (EFRAG) — who heeded the call of the International Organization of Securities Commissions (IOSCO) to promulgate regulatory standards for ESG, with the goal of protecting investors, while encouraging greater capital flows to corporations creating true long-term value through their ESG platforms.

In practical terms, what we’re seeing is what Alex Edmans has called the de-specialization of ESG, beginning with government regulation and the push for complete, consistent, comparable, reliable, and auditable environmental, social, and governance data.

Below, we’ll review – in broad strokes – what has been proposed, and what it may mean for you and your organization. 

The Proposals

In the US…

In March 2022, the SEC released the first draft of the organization’s first rule on climate disclosure, mandating that publicly-traded companies of a certain size disclose climate-related risks understood to be (financially) material to their performance. The rule will be rolled out in phases, the first of which will cover companies with more than $700 million in free float (who would be required to report relevant data to the SEC covering the fiscal year 2023). 

A final draft is expected to be finalized this spring and is expected to require companies to provide investors with information, including (1) financial statement footnote disclosures, explaining any physical and transitional climate-related impacts; (2) GHG emissions disclosures — Scopes 1, 2, and 3, both absolute and relative to intensity; (3) qualitative disclosures, including how consideration of climate-related risks have been integrated into strategy, business model, and outlook; (4) governance disclosures — the role the board of directors and management play in managing climate-related risks.

In Europe…

In parallel, in May 2022 the European Financial Reporting Advisory Group (EFRAG), with the support of the EU Commission, as a part of their proposed Corporate Sustainability Reporting Directive (CSRD) regulation, released a first draft of the European Union Sustainability Reporting Standard (ESRS). Similar in purpose to the SEC proposal, the CSRD aims to engender increased trust in ESG reporting by providing transparent, standardized requirements for the preparation and disclosure of ESG data. 

Unlike the SEC’s alignment with “single materiality”,  the CSRD is guided by the principle of double materiality, which incorporates consideration of externalities — not only how climate-related risks and opportunities stand to impact a firm’s financial performance, but how a firm’s operations impact its surroundings. Importantly, the ESRS is far broader in scope than the SEC’s proposed rule – which focuses exclusively on climate-related risks – consisting of 13 standards covering a variety of social, environmental, and governance topics.

Although it is still in draft form, we know that the CSRD is forthcoming, as it was passed, almost unanimously, by the European Parliament in November 2022, and that it will be mandatory for all large companies (public and private) operating in the European Union that meet two of the three following conditions:

  • 40 million Euros in net annual turnover
  • 20 million Euros in assets
  • 250+ employees


Both the SEC and EFRAG have proposed phased rollouts, which are laid out in the table below:


Our Takeaways

It’s time to focus on TCFD: In practical terms, the two proposed rules may significantly impact the reporting activities of large companies in both the EU and US, depending on their current ESG reporting practices. Both proposed rules rely heavily on the framework laid out by the Task Force on Climate-related Disclosures (TCFD), which requires companies to focus on 4 core themes deemed most central to core operations: Governance, Strategy, Risk Management, and Metrics & Targets. Companies who have yet to incorporate TCFD reporting into their annual practices, should. Given the work likely involved — scenario analysis, GHG inventories, assessment of financial impact — those companies who do not currently use the TCFD framework should begin their work soon.

More Scope 3 emissions: Indirect/Value Chain emissions, known as Scope 3 emissions, comprise the largest share of many companies’ carbon footprint. By definition, Scope 3 emissions are those outside the operational or financial control of the reporting company; as a consequence, the data collection, management, and verification process for Scope 3 emissions often require substantially more time and resources than Scopes 1 and 2. Companies with large and complex value chains, many of whom will be expected to report in the fiscal year 2023, should undertake this work as soon as feasible.

Watch what you say in your reports: ESG funds will no longer be the only targets for potential litigation resulting from misleading claims or so called “greenwashing.” The SEC’s newly-formed (2021) Climate and ESG Task Force has committed to investigating and pursuing ESG-related misconduct more aggressively and with greater levels of sophistication. It’s not been uncommon for companies to play it fast and loose with sustainability or green claims in reports or marketing materials. Both the SEC and EFRAG have made it clear that investor-facing sustainability disclosures, across a variety of mediums, will be scrutinized and subject to policing and enforcement. 

Assurance will be necessary: Presently, there is no formal requirement for reporting entities to undertake any level of third-party assurance of their ESG data, and substantially less than half of corporate entities that report pursuing such assurance. All companies need to be prepared for additional scrutiny; it’s time to invest in credible, auditable ESG data practices.

What we still don’t know

Interoperability: In recent years, there has been a growing push for a coherent global standard for ESG data that allows for comparison not just within, but across jurisdictions (and is less onerous for companies operating multi-nationally). Although the SEC rule and the CSRD share a focus on TCFD climate-related reporting, they differ substantially in principle, scope, and prescriptiveness. It remains to be seen if and how the EFRAG and the SEC will seek to align with each other (and the ISSB) to maximize their interoperability/complementarity.

Scope 3 emissions ruling: There has been substantial pushback from many companies on the Scope 3 emissions reporting requirement, out of concern for the added complexity, issues with data quality, and confidential information. In our opinion, for most companies, a credible assessment of climate-related risk must include Scope 3 emissions, but it remains to be seen if those reporting requirements remain, as well as the shape that any safe harbor provisions may take.

What does this all mean?

Data, Data, Data: If the quality of your ESG data has not been a focus, now is the time to change that. This shouldn’t come as a surprise; issues with the credibility of claims have characterized the space from the very beginning. Sustainability professionals have operated under a cloud of doubt and incredulity — more often than not seen, both internally and externally, as the engines of greenwash, rather than core drivers of business improvement and value creation. This is no longer the case; voices at the very top of the world of finance (see: Larry Fink) have articulated their view that environmental, social, and governance data and performance are material to long-term value creation and, consequently, to investment decisions.

Despite attacks on the merits of ESG, as a business discipline it is no longer subject to the question, “is this material?” The focus now is answering that question sufficiently on an issue-by-issue basis, within the context of individual organizations. In the near-term, many will look at this as a question of mitigating regulatory risk. But, in the long-term, it should be seen as a measure of the quality of an organization’s management, strategy, and ability to sustain long-term value creation for their stakeholders.

Caesar’s software platform amplifies corporate ESG data effort, saving precious time and energy throughout the data collection process while unlocking enterprise-grade data governance and oversight. The practices enabled by Caesar not only minimize regulatory and reputational risk; they also consistently yield the decision-useful data needed to advance corporate performance.

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