The cryptocurrency industry is receiving a significant amount of executive and legislative attention. Biden’s Executive Order on Digital Assets in April 2022, several Congressional inquiries, proposed federal legislation, and regulatory frameworks have been introduced seeking to regulate crypto companies. A recent Congressional inquiry examined how much energy the cryptocurrency industry is using, the level of carbon emissions associated with that consumption, and whether such emissions should be tracked and disclosed. On September 8, 2022, the White House Office of Science and Technology Policy called for further research on the energy impact of cryptocurrency mining and for new standards to address the ongoing environmental effects of the growing digital asset industry. And the FTX collapse has turned all eyes onto crypto and how the industry operates.
Many of these inquiries allude to potential reporting requirements. Although focused on cryptocurrency mining companies, such disclosures would be consistent with broader discussions at the Securities and Exchange Commission (“SEC”) and business trends towards corporate responsibility with respect to statements regarding Environment, Social and Governance (“ESG”). Some companies see these developments as a threat; others see ESG and its disclosure requirements as an opportunity. Regardless of how leadership may feel, regulatory requirements regarding ESG disclosures create risks and rewards that need to be addressed.
MINING AND METTLE
Every business requires energy to transform inputs into higher-value outputs. Gross domestic product is strongly correlated to energy consumption for a reason. Certain industries, such as digital currency, have been singled out as being more energy intensive, even though other industries also depend on carbon-emitting inputs, outputs, and processes. Understanding carbon content and a company’s energy consumption is key to responding to potential disclosure requirements.
A proper accounting of carbon emissions requires more than simply a tally of inventory or sales. Most companies may not be tracking the data in the format required to estimate emissions. If the data is being tracked, it may be dispersed throughout the company in multiple locations, requiring centralized collection efforts. Some carbon content assumptions can be standardized, other assumptions may differ depending on geographical location, manufacturing processes, and/or non-point sources of the production. Estimation methodology also can vary, along with what should or should not be attributable to corporate activities. That said, carbon emissions generally can be estimated and tracked, allowing for companies to monitor their decarbonization efforts and report on their progress.
SILVER SALVERS
Public disclosures, even if they are outside of an entity’s public filings with the SEC, are increasingly subject to scrutiny and enforcement. The SEC’s first ESG-related action occurred in May 2022 against a traditional mining company for allegedly false and misleading claims about the safety of its dams. The disclosures at issue were not within the company’s public SEC filings, but rather had been included in other publicly disclosed documents.
Outside of the SEC, state prosecutors have accused companies of greenwashing their public announcements, advertising, and activities. Their lawsuits tend to be tied to state-based consumer protection rules that require truthful disclosures. The truth matters – to markets and their regulators.
Cryptocurrency firms and ESG investment funds need to be particularly careful around sustainability and social disclosures in public statements. Creating processes and controls around documents, data, and disclosures are critical to controlling messaging as well as market position.
THE GOLD STANDARD
In March 2021, the SEC launched the Climate and ESG Task Force within the Division of Enforcement to identify misconduct related to climate and ESG-related disclosure and investment. The SEC’s initial focus aimed to identify any material gaps or misstatements in issuer disclosures of climate risks under the SEC’s existing rules. The SEC also is seeking comment on its proposal to improve disclosures by investment funds that claim to have an ESG focus.
The SEC’s inquiry received a record-setting number of public comments. Those comments responded to the SEC’s proposed disclosure requirements, with accountants and consultants arguing over who should be responsible for verifying ESG truth. General accounting standards and disclosure rules, however, are simply not up to the task of measuring carbon emissions, diversity efforts, equity, inclusion, or other social and governance activities. With ESG claims, truth is not necessarily binary, perfectly quantifiable, or definitive. Qualitative claims are subjective by nature, even if based on objective data. And even quantitative calculations and disclosures may contain subjective assumptions or are subject to interpretation.
Regulatory scrutiny not only focuses on the substance of public disclosures, but also to what a company leaves out. The SEC’s proposed rules ask for companies to disclose climate-related risks “reasonably likely to have a material impact” on operations and results. Prudent companies, therefore, will also be prepared to defend the absence of certain disclosures that were deemed to be immaterial to investors.
Companies going net zero or making claims with respect to ESG in its operations or investments will need to assess risks associated with such claims. Supporting such statements with verifiable information and underlying support will be critical to preventing unnecessary challenges. For those who already have declared net zero goals, be prepared to produce regular updates even if the target is decades away. Identify in advance what your company’s risk may be and establish adequate protocols and processes to ensure veracity in ESG disclosures, along with an audit trail in the event such disclosures are challenged.
EITHER ORE
Investigations into cryptocurrency and carbon emissions may be the harbinger for a much broader set of regulations targeting ESG disclosures. Balance the need to claim ESG activities with the potential challenges to those claims. Develop protocols for creating an audit trail that supports qualitative claims. Track verifiable metrics or obtain independent estimates when moving towards net zero goals, cultural change, and governance practices. If you choose to make claims about your corporate decisions, the entire firm should be singing from the same song sheet.
