In a recent speech, SEC Commissioner Crenshaw, one of the Democratic appointees to the Commission, focused on the role internal controls play in assessing and monitoring ESG risks. Specifically, after noting that the SEC received "[a]n overwhelming number of comment letters stat[ing] that investors view ESG information as material to financial performance and that investors need consistent and reliable disclosures of ESG information to inform their investment decisions," Commissioner Crenshaw noted that she "encourage[d]" her audience to "think about" "ESG risks" "in the context of your internal accounting controls and audit functions." In other words, Commissioner Crenshaw emphasized that companies should begin developing internal procedures to generate the information necessary to properly respond to the regulatory disclosures the SEC will promulgate concerning ESG risks, and to implement policy changes to adapt to such risks.
In particular, Commissioner Crenshaw highlighted "a few specific ESG risks where internal corporate accounting controls plays a critical role." With respect to "climate change risk," these issues included: (1) "whether assets are at risk of depreciating more quickly or becoming 'stranded' in response to climate change"; (2) "whether supply chain or transportation networks are at greater risk of being impacted by extreme weather events"; and (3) "whether existing revenue streams depend on the status quo, such that new regulations pertaining to deforestation or carbon emission could potentially reduce income." Of course, these are only a few examples of "how climate change risk impacts revenues and expenses."
Overall, Commissioner Crenshaw emphasized that "[n]o matter where public companies come out on these topics--or how they assess climate risk risk--[she] would like to understand the underlying internal accounting controls that guide decision making." (emphasis added). Notably, Commissioner Crenshaw indicated that there was a need to provide information as to "how companies are determining whether and how financial statements are impacted by climate change risk; how assumptions used to reach these determinations are set, tested, and reevaluated over time; and how any existing disclosures are being formulated." In other words, the interest of the SEC will likely extend beyond climate change disclosures themselves (e.g., the extent of emissions) to the processes and analysis that led to the ultimate climate change disclosure. And, in order to properly respond to such regulatory disclosures, companies need to begin developing such processes and internal controls.
This speech by Commissioner Crenshaw serves to provide notice that companies should be "identify[ing] and assess[ing] the ESG risks that might impact [them] . . . not just in this year, but in future reporting periods too" as "investors are [not only] evaluating how ESG risks might impact impact their investments in companies . . . [but] also assessing corporate readiness to manage new and emerging risks." In effect, Commissioner Crenshaw is identifying "ESG risks" as an issue that companies need to manage, and that the internal corporate accounting controls should be in place to properly address this issue. Since implementing proper controls takes time, companies should begin doing so to the extent they are not already engaged in such efforts.
With ESG now front and center, the reliability of corporate ESG risk disclosures, and their potential impact on and connectivity to financial statements, is critical. As you know, corporate internal controls play a crucial role in ensuring such risk disclosures are consistent and reliable. The term “internal accounting controls” refers to an organization’s plan, methods, and procedures related to safeguarding a company’s assets and ensuring the reliability of corporate financial records.