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SOXification Of Financial Climate Risk Unlikely Based On Biden’s Executive Order

On May 20, President Biden signed an Executive Order on Climate-Related Financial Risk. Industry insiders – especially those in the audit and accounting profession – like to talk about the “SOXification” of financial disclosures on climate risk. By this they mean that the US Senate will implement a Climate Risk Act comparable to the 2002 Public Company Accounting Reform and Investor Protection Act – known as Sarbanes-Oxley or SOX – due to the names of the Senate sponsors Paul Sarbanes (D-MD) and Michael Oxley (R-OH). The Sarbanes-Oxley Act was written into law in response to the Enron and WorldCom corporate governance and accounting scandals. The Act focuses on the legal responsibilities of CEOs and CFOs requiring them to review all financial reports, ensure that there are no misrepresentations, implement internal accounting controls, report deficiencies or material changes in internal controls. It also makes them criminally liable. Tech firms and service providers with climate risk or GHG management solutions are keen for climate change regulations to have similar bite to SOX. And not just for ethical reasons.

SOX Section 404 requires a management assessment of internal controls. Back in 2006, the Manufacturers’ Alliance reported that external audit fees for a Section 404 attestation from one of Deloitte, EY, KPMG or PwC amounted to spend of $2 million on average in year one and $1.6 million on average in year two. The highest spend on an external attestation for Section 404 was an eye-watering $18 million. Non-audit assistance in the form of consulting and risk advisory averaged $2.3 million in year one, falling to just below $1 million in year two. The highest consulting spend in year one was a jaw-dropping $30 million. On average the 43 manufacturers in the survey reported allocating 38,252 internal hours to complete a SOX Section 404 attestation representing an average internal cost of $2.2 million in year one. Total cost of Section 404 compliance in year one was on average $8.9 million in 2006 prices or $11.8 million in today’s money.

Will similar internal and external audit and compliance costs land on the desks of the CFO due to the recent Executive Order? No. The Executive Order on Climate-Related Finance Risk is focused on developing a federal strategy for climate-related risks to the financial system. It does not significantly target corporate governance, risk analysis and GHG emissions disclosures of listed entities. Firms which are “major Federal suppliers” will need to “publicly disclose greenhouse gas emissions and climate-related financial risk and set science-based reduction targets”. This hardly moves the dial on business practices which started in the mid-2000s. By September 17, the US Treasury and Financial Stability Oversight Council will need to opine on the need for “regulated entities to enhance climate-related financial risk disclosures”.

In this week’s memo the VP Sustainability should tell the CFO that they should study the progress of mandatory TCFD reporting in the UK and make it clear that while this is not a SOX-like burden, constant pressure will be applied on the climate risk agenda.

ESG SOXification Of Financial Climate Risk Unlikely Based On Bidens Executive Order

David Metcalfe

CEO, Verdantix
Verdantix
Verdantix

David is the CEO of Verdantix and co-founded the firm in 2008. Based on his 20 years of experience in technology strategy and research roles he provides guidance on digital strategies to C-level executives at technology providers, partners at private equity firms and function heads at large corporations. His current focus is on helping clients understand their market opportunity tied to ESG investment trends and their impact on corporate sustainability strategies. During his 12 years running Verdantix – including 4 leading the New York office – he has helped dozens of clients grow their businesses through fund raising, acquisitions and international growth. David was previously SVP Research at Forrester and Head of Analysis & Forecasting at BT. He holds a PhD from Cambridge University and also worked as a Research Associate at the Harvard Business School.