California Law Mandates Carbon Accounting: How Will This Affect Private Equity and Portfolio Companies?

Article

February 16, 2024

Key Takeaway:

Private equity funds can save significant time and resources by organizing a “fund-wide” strategy upfront to handle their carbon compliance requirements, as opposed to portfolio companies creating independent, unaligned solutions. Cherry Bekaert can advise on private equity best practices to help guide you.

In October 2023, two California laws mandating carbon disclosure were signed by Governor Gavin Newsom. The Climate Corporate Data Accountability Act (SB 253) and Climate-Related Financial Risk Act (SB 261), require businesses to disclose their carbon emissions and climate-related financial risks. Because of its outsized influence on the global economy, the provisions of the laws are likely to shape business practices across the U.S., not just in California.

SB 253 requires all U.S.-organized companies with global revenues exceeding $1 billion and “doing business in California” to measure and report their emissions based on the formal greenhouse gas protocol, categorized as 1, 2, and 3 emissions. SB 261 requires all public and private entities conducting business in California with total annual revenue of at least $500 million to biennially publicly report their direct and utility emissions (Scopes 1 & 2), climate-related risks and efforts to address them. If a reporting entity fails to file, files late or violates the provisions of SB 253, the California Air Resources Board (CARB) has the authority to impose administrative penalties of up to $500,000 per year under these regulations.

The broad reach of the laws makes carbon reporting both national and inclusive of mandatory Scope 3 reporting, which will be a challenge for portfolio companies with significant supply chain calculations.

“Doing business in California” is a broad definition and generally includes all firms selling goods and services within the state or to California customers, retailers and supply chains. It isn’t entirely clear if investment companies will be forced to consolidate revenue among all portfolio companies, but the statute does specifically call out a “partnership, corporation, limited liability company or other business entity.” More guidance is forthcoming.

The Onerous California Carbon Reporting Mandate Requires the Following:

Beginning in 2026 (for reporting year 2025), reporting entities are required to annually report their Scope 1 and Scope 2 greenhouse gas emissions. Scope 1 emissions are defined as all direct greenhouse gas emissions that stem from sources that a reporting entity owns or directly controls, regardless of location, including, but not limited to, fuel combustion activities. Scope 2 emissions are defined as indirect greenhouse gas emissions from consumed electricity, steam, heating or cooling purchased or acquired by a reporting entity, regardless of location.
Then, beginning in 2027, reporting entities must also report their annual Scope 3 emissions, which are defined as indirect upstream and downstream greenhouse gas emissions, other than Scope 2 emissions, from sources that the reporting entity does not own or directly control and may include, but are not limited to, purchased goods and services, business travel, employee commutes and processing and use of sold products.

Preparing for Scope 3 reporting is expected to be a major challenge for most companies and will require detailed planning and effort. Comprehensive Scope 3 reporting will require all affected companies to gather similar data from their supply chains, thus potentially impacting thousands of other middle-market and smaller companies throughout the U.S.

The Federal Executive Order on Emissions Reporting by Government Suppliers

Separate from the California law, the federal government has already published a mandate for the government’s supply chain with similar emissions reduction goals. The executive order was published in August 2022, but additional details and tasks are still forthcoming from individual agencies. The materiality threshold for emissions reporting is expected to be very low, and hence is expected to capture most of the federal contractor supply chain.

United Nations Principles for Responsible Investing (UN PRI) Carbon Reporting Ramp Up

Institutional investors and private equity funds have increasingly joined the United Nations Principles for Responsible Investment (UN PRI) signatory alliance and the mandatory disclosures that are obligated. As of January 2024, the UN PRI was signed by more than 5,000 institutional investors and private funds of which more than 1,000 are located in the U.S. The UN PRI endorses the Task Force on Climate-related Financial Disclosures (TCFD) and publicly discloses members’ annual sustainability reports.

Big Retail To Force Carbon Transparency

Led by Walmart, Target and Amazon, big retail is demanding carbon footprint answers from suppliers in order to win or retain shelf space. For small companies, such mandates are becoming mission-critical to preserve commercial viability. Retailers are requesting annual “carbon scorecards” which estimate the total greenhouse-gas effect of a product’s lifecycle. The calculation can be complicated, as it includes upstream and downstream supply chain emissions.

As the effects of carbon reporting trickle down into supply chains, it is expected that a majority of U.S. industrial and consumer goods businesses will eventually become part of systemwide retail reporting efforts. Brands that have prioritized carbon minimization will have a commercial edge, whereas firms that are “carbon-heavy” will face potential de-assortment from aisle shelf space.

How Cherry Bekaert Can Help

Cherry Bekaert (the Firm) aims to provide comprehensive solutions for private equity carbon sustainability efforts. The Firm’s audit, compliance and advisory groups offer carbon accounting and reporting services in addition to setting up and maintaining carbon digital dashboards by the digital teams. Additionally, the Firm files with federal and state authorities to maximize clients’ tax incentives and credits to reward them for renewable energy efforts.

The cloud-based digital dashboards used to collect and report all this data can be expensive, so clients are able to save costs on their efforts. Cherry Bekaert recommends reporting solutions that will maintain whole portfolios within one carbon accounting platform, saving significant time and resources, and summarizing data for stakeholder’s requests or PRI reporting.

The Firm assists private equity funds with the requirements of these laws and regulatory mandates by assessing their current emissions, overall carbon footprint, supply chain management practices and energy-efficiency measures. By leveraging capabilities in accounting, finance, digital transformation and risk management, Cherry Bekaert helps clients navigate the complexities of both new and immerging legislative actions to ensure compliance and drive meaningful progress.