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  • Wanda Lopuch, Ph.D.

Disclose or Not-to-Disclose: ESG Strategy Considerations for Private Companies

Environmental, Social and Governance (ESG) disclosure, as mandated by the Federal Reserve Board (FRB) or the Securities and Exchange Commission (SEC), is a matter of compliance for public companies. In general, private companies are not subject to federal regulations. Private entities are regulated by states in which they are incorporated/operate. Most states follow general principles of the Commercial Code of the State of Delaware (CCSD), in which many American businesses are incorporated. The “northern star” for the CCSD is value creation for a corporation; specifically the CCSD does not have any ESG-specific disclosure requirements. Therefore, no laws will be broken if a private company that is a subject to CCSD or similar state codes does not take action on ESG issues while the Board is focused on value creation.

In 2022, SEC proposed guidance regarding the ESG disclosure for public institutions. Final rulings that define regulatory requirements to standardize public companies’ disclosure on climate, cyber governance risk, human capital and board diversity, are expected later this year. From the regulatory risk perspective, is it almost certain the SEC will issue guidelines and regulations for US public markets, parallel to the European Union (EU) framework, though not as far reaching as the EU’s Corporate Sustainability Reporting Directive ́s (CSDR) current legal requirements . Therefore, it is prudent that public and private companies review their strategies against expected SEC ruling and the existing CSRD framework (given the spillover effect between the US and EU markets). Boards need to make informed decisions regarding their companies’ ESG strategy, including the optimal disclosures strategy.

The purpose of this article is to equip Private Company Directors with knowledge and insights to navigate the ESG business landscape in the backdrop of current and expected regulatory requirements in the US and the EU.


... beyond legal compliance

Publicly listed companies need to comply with the SEC and Federal Reserve’ ESG reporting guidelines, meanwhile, private companies have options on how to react to regulatory developments. Business sectors, product and service types in conjunction with client types, (i. e. public companies), growth strategy, culture, and location of operation are just a few variables related to decisions made. Each option will carry certain business consequences depending on the company's unique ecosystem.

Consider these scenarios below that touch on various legal frameworks.

Scenario 1: Scope I, II and III GHG reporting - Value Chain Case

This scenario reflects a private company being a direct supplier to a public company, or a member of a value chain (secondary supplier) of a public company, which is/will be required under SEC regulation to disclose ESG risks. The SEC ́s risk disclosure guidelines give flexibility to listed companies to select which disclosure standards or platform they will follow* (see below: The Major Climate Disclosure Standards and Frameworks). All recommended platforms use the Greenhouse Gas Protocol (GHG) emission framework that organizes emissions into three types: scopes I, II, and III. Scope I details the GHG emissions from an entity's own operations (offices, manufacturing spaces if a direct operation ETC); scope II refers to indirect emissions from purchased electricity, steam, heating and cooling. Scope III accounts for all other GHG emissions in the value chain, both upstream and downstream. Scope III, the most difficult to assess (and most debated by SEC) on average accounts for 1100% of scope I + scope II for a reporting entity; it consists of scope I and scope II of all of its suppliers. CDP (formerly known as the Carbon Disclosure Project) is one of the most frequently used disclosure standards; in 2021 over 13,000 organizations disclosed on the CDP platform scope I, II and III data. As such, CDP became a primary, go-to source for investors to obtain, or request climate disclosure data from their portfolio companies. companies. If a private company has investors or lenders that belong to a group of over 680 financial institutions reporting on climate risk on the CDP platform, the portfolio private company may be asked to disclose certain ESG factors, such as GHG footprint, as a lender or an investor compiles its own data on a portfolio’s climate risk. If a private company applies for a loan or a line of credit from a large financial institution, which is subject to Federal Reserve regulations, the cost of capital offered will be determined among other risks factors, by climate risk, which is assessed based on a private company disclosure, or - a lack of such a disclosure ( in such case, it is likely that a higher cost of capital will be extended, if at all). If a private company is in a value chain of companies that have already made a commitment to climate goals, it most likely will be asked for a disclosure. For example, Unilever has already transitioned its entire operations into net-zero enterprise; its factories, offices, data centers and warehouses worldwide are being run on 100% renewable energy, ahead of its initial 2020 target date commitment. The consumer goods conglomerate has publicly set a goal of being carbon neutral by 2030 and it is regularly reporting on the progress towards that goal, gathering the data from its 60,000 vendors. In October 2019 Google and Amazon made ambitious commitments to renewable energy and carbon neutrality goals. Tracking these goals requires scope III data, which for Google means over 1000 vendors. These are just three examples that represent companies seen by investors as well equipped to deliver attractive and sustainable future returns by tackling climate change risks and opportunities. Their ESG disclosures are guided by regulatory agencies in the US, the EU, or UK. Any of approximately 150,000 private companies worldwide, which are either a primary or a secondary supplier to Unilever, Alphabet, or Amazon (excluding Amazon sellers), should expect a request for disclosure in line with SEC or SCRD recommended standards. In 2022, 10,400 companies received a CDP questionnaire originated by clients, investors, or lenders, who report scope III Emission on CDP.

In these cases, disclosure requests came not from federal regulators, but were initiated by business partners or financial institutions that have been collecting data for their own disclosures for Scope III emissions.

Private companies in the US do not have legal obligations to respond to such requests. The decision “if to respond” is a business decision. It should be kept in mind that both actions: a response or lack thereof, is a matter of public disclosure on the CDP website. Lack of response may jeopardize business relationships with a client, as it will affect a third party risk score, may impact a brand value and increase reputational risk of a private company. Conversely, providing disclosure upon request, however imperfect, may offer competitive advantage in vendor relationships by lowering third party risks. It may increase a company's brand value and valuation, and build good will and trust in vendor relationships.

Scenario 2: International Activities

In the past decade and into 2021, stakeholders and regulators in the US, EU, UK were seemingly moving in the same directions regarding ESG, with the UK leading the way and European Union codifying its standards last year by enacting two directives: (1)Corporate Sustainability Reporting Directive (CSDR) effective January 1st 2024, with the first reports due in 2025and (2) Sustainable Finance Disclosure Regulation (SFDR) that will require private market investors to disclose ESG metrics and performance starting in June 2023. Any public or private company with a net turnover in the EU of €150 millions will be in the scope of this CSRD ruling. For such companies, the EU lawmakers designated 2023 to assess and build data systems that will allow accurate and transparent reporting from 2024 onward. Scope III GHG reporting proposed by SEC is similar to that adopted by EU in SCRD, therefore it may happen that an American subsidiary with a turnover below a threshold of the €150 millions, which participates in a value chain of an EU-based large company, will be required to disclose the data, either on subsidiary level or the headquarters’ level. Unlike in the US where private companies do not have a legal obligation to disclose, such disclosure requirements in the EU will be a matter of legal compliance.

The climate-related legislative agenda in the UK slowed down in 2021 due to government changes, yet it is expected that the UK will stay its course with its UK-specific sustainability disclosures, which in some cases are further-reaching than the CSRD. Companies listed on the London Stock Exchange must include climate-related disclosures (including scope III GHG emissions) on a “comply or explain'' basis from 2022. Independently, all companies conducting business in the UK with a turnover of £36 million, are required to publish a Slavery and Human Trafficking Statement from 2015. A “Single-Use Plastic Ban'' will be in effect in October 2023.

Therefore a private company operating in the EU or the UK needs to evaluate potential legal obligations under the newly enacted directives, the cost and time needed to collect data, and, conversely -potential liabilities from non-compliance regarding ESG disclosures.

Scenario 3: Public Company Track

Serious consideration to embracing ESG disclosures in private companies’ strategy should be given if a company is on an IPO or SPAC track within the next 3-7 years. Various exchanges have adopted listing rules that may include disclosures of some ESG factors, such as climate risks, GHG emissions, diversity and inclusion, cyber governance and others. Developing data capture systems that will satisfy required listing qualifications takes time and expertise, so companies need to be ready before the IPO/SPACK due diligence process starts. The next two scenarios address cases where “soft” factors: such as human capital, organizational behavior, and culture are to be considered a private company decision within ESG strategy.

Scenario IV: Consumers’ Brand Sensitivity

Fashion industry, cosmetics and some other segments of FMCG (fast moving consumer goods), an entertainment industry and others are examples of those market pockets where customers frequently hold strong awareness about social issues. Purchasing behavior of such consumers is highly influenced by a “brand value” of products or services. Nike, a book-case example of a tarnished brand value, 30 years after “sweatshop” reports broke in the US and caused a backlash among consumers, still operates in a shadow of the “sweatshops” stain on its brand, despite significant resources dedicated to changing that brand image. One of the deliberate elements of its brand protection is Nike’s transparency about commitment to S factors in ESG: labor practices, diversity and inclusion, respect and dignity, just to name a few. The company works only with suppliers who commit themselves to the “Nike’ Vendor Code of Behavior ”, and pass audits by independent parties.

Today both private and public businesses operate in a “transparent economy” where consumers are only a click away from expressing their views about a product or a company. Brands’ communication strategies that may impact brand value must be carefully crafted and monitored by large and small companies, independently of their formal standing on ESG. It is more and more common in a “client-sensitive businesses” to create a position of a CLO - Chief Listening Officer to implement “consumer-first” strategy, with the goal to elevate consumer input through company ranks, and expedite company reaction to sensitive issues, including those that can be classified as “S'' factors in ESG. Brands such as Pizza Hut, Dunkin Donuts, Northstrom, Apple, or DIsney, pay high attention to consumer input. Apple has fired one of its sizable suppliers with a “show-case” global publicity, after it was disclosed that this supplier violated “Apple’ Vendors Code of Behavior” regarding human capital policies. Boards of private companies that service consumers with high -S factor sensitivity need to carefully consider all strategies to attract and retain such customers, from product design to customer communication, transparency, and reporting.

Scenario V: Company Culture, Human Capital Considerations

Retaining, attracting and motivating talent is one of the top challenges for CEOs, even in the current labor market where high-tech companies (Apple, MS, Amazon) are shaving-off excess labor from the 2020 pandemic hiring spree. Numerous research undeniably documents that employees are motivated not only by material benefits, but increasingly more -by employers’ values and behaviors. Employees actively seek to work for companies that exemplify their own values and beliefs. “Great resignation” during the pandemics gives evidence to the importance of employee-employer value alignment, or what happens when such alignment is not there, or not clearly communicated. Management can energize the workforce and build a sense of “belonging” by clearly stating the company's beliefs and values. Not surprisingly, such vision and value statements have been adopted as an effective tool in human capital strategy. In doing so, the management should be mindful about public market disclosure standards which distinguish between aspirations, inspirations and factual statements. Adopting ESG disclosure standards may enhance discipline and accountability across all levels of a private company, which will help to avoid pitfalls of “green washing” of “green-wishing” by management.

DISCLOSE OR NOT TO DISCLOSE - FINANCIAL CONSIDERATIONS .....It is a journey rather than a destination.

The decision to disclose or not-to-disclose will carry significant financial consequences. In fact, one of the most vocal critical arguments against disclosure is its cost. In weighing the pros and cons associated with disclosure, one should keep in mind that adopting an ESG strategy, including disclosure practices, is a journey rather than a destination, a journey that starts with the mindset.

According to the recommended standards, the cost of adopting ESG disclosure practices can be materially significant factor, especially for a smaller entity. The cost will include:

  • - Developing ESG expertise can utilize various approaches such as: eveloping in-house expertise, or building it gradually by bringing new, dedicated resources inhouse, or acquiring outside expertise from consultants. Each of these options has its own time and cost consequences. Developing in-house expertise will require more time than hiring outside experts for the preparation and production of the first report. However, as ESG reporting is expected to become a standard annual reporting, the decision has to be made as to how much expertise a company wants to retain and nurture in-house.

  • - ESG data capture systems: Companies may build their own data-capture systems, or acquire a third-party systems to capture ESG data alongside other business analytics. Developing a company's own data systems will require expertise and time: expertise in what data points to capture, and time to build such a data collection system. Outside vendors offer a variety of solutions. For example, utilities provide reports on Scope I and Scope II GHG emission data. Service providers such as MS or Salesforce offer their CRM products enhanced with modules that capture/estimate the scope III GHG emission data. As a response to the regulatory framework, the third-party data capture space is evolving rapidly. It adopts new technologies including AI, which can offer both time and cost advantages as compared to in-house developed systems.

  • - Compiling the data for disclosure according to regulators specifications: Once a company has good quality data, the next step, which also carries financial consequences, is to compile data into one of the recommended disclosure formats. Any disclosure should also be monitored from the legal perspective. Deliberate communication strategy, both internal to employees and external to clients and partners, should become an integral part of a company disclosure. Building a comprehensive ESG disclosure system can be overwhelming for a private company that operates on a tight budget and does not have a deep ESG experience. Large companies, which over the years have developed many layers of ESG expertise, appreciate these challenges, and frequently offer support and guidance to their value chain partners who embark on the ESG disclosure journey. They provide technical expertise and sometimes project management guidance. Some investors, who are subject to federal disclosures and are managing their portfolios through ESG lenses, are eager to actively work with the management of their portfolio companies to create the path towards disclosures. They realize that supporting development of data capture systems and disclosure project, is a win-win proposition for both: an asset-manager and a portfolio company.

At this stage of ESG framework development, the goal for big public companies, investors and lenders or regulators, is not to expect a “perfect disclosure” at the beginning of the journey from all the value chain participants, but rather to gradually develop an expertise and build a system for incrementally improved reporting. Private entities need to be ready to embrace such support, guidance and expertise, which requires an allocation of internal resources. Regulators appreciate that small and large enterprises, that are relatively new to ESG reporting, need time to develop necessary expertise and build data capture systems; such time allowance is built into the CSRD regulations with year 2023 being designated to prepare for reporting for 2024 with the first reports due in 2025. If a private company decides to not embrace the ESG strategy, there may be a residual financial consequences as well, especially for companies operating on the EU/UK markets. Such companies need to consider the cost of non-compliance with CSRD and estimate the size of potential fines. CONCLUSION

Private companies are not subject to ESG disclosures mandated by US federal regulators. However, there are many business cases where private and public disclosures are interwoven. In addition, private companies need to understand the business consequences and legal liabilities of “disclose or not-to disclose” decisions. At this point ESG disclosures for private companies are voluntary. However, such voluntary disclosures should follow the guidelines set up by federal regulators, as these two systems are interrelated especially in the value chains. This will help to avoid intentional or unintentional “green-washing” effects. Below is a summary of pros- and cons- for the ESG disclosure decisions which private companies should consider when discussing the ESG strategy.

The Alphabet Soup of the ESG Disclosure Space - Acronyms

CCSD - Commercial Code of the State of Delaware CDP - Carbon Disclosure Project - reporting platform CSRD - Corporate Sustainability Reporting Directive law in the European Union ESG - Environmental, Social and Governance investment risk framework GHG protocol - GreenHouse Gas emission protocol EU - European Union FRB - Federal Reserve Board SEC - Securities and Exchange Commission SFDR - Sustainable Finance Disclosure Regulations in the European Union UK - United Kingdom Major Climate Disclosure Standards and Frameworks - alphabetically

  • CDP - CDP previously Carbon Disclosure Project (2000) - manages the international climate disclosure systems that helps states, regions, investors and companies to manage their effect on climate;

  • GHG Protocol - Greenhouse Gas Protocol (1998) - the most widely used carbon accounting framework based on scope I, II and III emission classification;

  • PCAF - The Partnership for Carbon Accounting Financials (2015, 2019) - financial industry led initiative to help financial institutions align their financial emissions with the targets of the Paris Agreement;

  • SASB - Sustainability Accounting Standards Board (2011); now ISSB - International Sustainability Standards Board; (2022) - investors led initiative to quantify sustainability information and external risks for companies by sectors;

  • SBTi - Science Based Targets initiative (2015) - defines and promotes best practices in setting science-based emission targets;

  • TCFD - The Task Force on Climate-Related Financial Disclosures (2015) - common global approach for reporting on the risk and financial implications of climate change;

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