Consultation on Mandatory Climate Reporting – The building of a "new, sustainable financial system"

The TCFD is a market-driven climate reporting initiative, set up by the Bank of England ("BoE")'s Financial Stability Board, to develop a set of recommendations for voluntary and consistent climate-related financial risk disclosures in mainstream filings. These recommendations were published in 2017 and have been widely adopted internationally, with status reports and monitoring carried out on an annual basis by the TCFD.

The TCFD recommendations cover reporting in four main areas: (i) Governance, (ii) Strategy, (iii) Risk Management and (iv) Metrics and Targets. Each of these areas contains specific examples of recommended disclosures, as outlined in the table below. These categories are deliberately broad to allow companies to decide how best to disclose information on a particular topic.

Mark Carney (former governor of the BoE) stated during his speech at the UN Secretary General’s Climate Action Summit 2019 that the demand for TCFD disclosure is increasing and "current supporters [of the TCFD] control balance sheets totalling $120 trillion and include the world’s top banks, asset managers, pension funds, insurers, credit rating agencies, accounting firms and shareholder advisory services."

According to Mr. Carney, four-fifths of the top 1,100 global companies are already disclosing "climate-related financial risks in line with some of the TCFD recommendations." However, making the TCFD reporting mandatory for premium-listed companies goes further than the current voluntary regime. The Consultation explicitly states that whilst voluntary adoption of TCFD recommendations has been increasing, there is evidence to support the need for active intervention to accelerate progress in this area. As such, these changes are primarily aimed at increasing transparency and ensuring that capital is allocated by companies and investors in a way which reflects climate risks and is in line with consumers’ climate-related preferences.

Proposed amendment to Listing Rule 9.8

The proposed amendments would require premium-listed companies to confirm in their annual financial reports (or in a separate document, clearly referenced in their annual report with an explanation as to why it cannot be published in their annual report) that they have published information consistent with the recommendations and disclosures outlined by the TCFD. This would include both overseas listed companies and state-owned entities. The intention is that rules will apply for financial years commencing 1 January 2021 (i.e. entities would need to report for the first time at the earliest on 1 January 2022).

Under the new rules, entities would need to make a statement setting out:

1 whether they have made disclosures consistent with the TCFD;

2 where they have either:

(a) not made disclosures consistent with some or all the TCFD recommendations/disclosures, or

(b) included some or all of the disclosures in a document other than their annual financial report

explain why (the so called "comply or explain" requirement)

3 state where their the disclosures can be found

Proposed Technical Note

As part of the Consultation, the FCA is also considering its guidance on existing obligations set out in EU legislation and its 'Handbook' of rules and guidance that already require certain issuers to disclose information on climate-related and wider environmental, social and governance ("ESG") matters. The proposals include the creation of a new "Technical Note" to clarify existing climate-related disclosures that are required to be made by all companies that are subject to the Listing Rules, Disclosure Guidance and Transparency Rules, Prospectus Regulation Rules and/or the Market Abuse Regulation.

The aim of the FCA in this Technical Note is to gather existing disclosure requirements in a single place and encourage a uniform approach to the disclosures made by issuers. Although it should be noted that the Technical Note does not introduce any new requirements, it does provide issuers with clearer guidance as to what obligations they should already be meeting and seeks to remove any potential uncertainty as to what is required of them.

The Consultation acknowledges the potential overlap with Streamlined Energy and Carbon Reporting requirements, which are further discussed in our article here.

The proposed amendment to Listing Rule 9.8 will impact those entities that are premium listed (i.e. main market of the London Stock Exchange).

The Consultation also affects:

• other entities in scope of requirements under the Market Abuse Regulation (MAR) and the Prospectus Regulation (PR), and
  
  
• financial sponsors, who will need to consider whether companies have established a framework "to enable them to comply with the new rules" and equally will need to confirm that "a significant transaction will not have an adverse impact on a listed company's ability to comply with its obligations under these rules."

A materiality threshold is embedded in this Consultation e.g. disclosures relating to strategy, metrics and targets are only disclosable where the data is considered to be material. However, given that the FCA considers climate-related issues to be key to governance and risk management, this means in practice they could only be excluded in very exceptional cases. Additional guidance on materiality is referred to in the Consultation in the form of Chapter 2 of the International Accounting Standard Board (November 2019), which assists entities when forming materiality judgements.

As is emphasised by the Consultation itself, companies are increasingly faced with a range of different competing concerns and industry guidance when it comes to making climate-related disclosures. The gradual move towards an agreed international framework has, in the last few decades, been a somewhat fraught and lengthy process. It would appear that the UK Government is actively encouraging and promoting the TCFD, noting that other common international standards are still used elsewhere, such as those set by the Global Reporting Initiative and the recently formed Sustainability Accounting Standards Board.

It may well be the case that global consensus begins to coalesce around one unified reporting standard. However, the position for now remains somewhat fragmented and there is still discussion of hard-wiring ESG factors into international accounting standards so that they immediately have an impact on companies' balance sheets.

Given the emphasis placed on the TCFD by the BoE and the Government's Green Finance Strategy (published 2 July 2019) since the TCFD recommendations were published in 2017, it is widely anticipated that the FCA's proposals will be adopted in full. For now, the outcome of the Consultation should be monitored closely by relevant stakeholders who should begin establishing a framework to ensure that they are ready to comply with the reporting requirements. Relevant organisations should also consider how a wide variety of climate-related risks could impact their businesses, which includes creating targeted plans to reduce these risks going forward.

The Consultation's one-off compliance cost analysis for the 480 issuers who will be immediately impacted has been estimated to total nearly £120m, albeit with the caveat that the benefit is expected to be "substantially in excess of the cost compliance". This further supports the argument that ESG compliance is integral not only to corporate reputations but also to an organisation's future success.

There is still ample opportunity for organisations and stakeholders to review the consultation in full and respond, although it remains to be seen how much of the Consultation is likely to change prior to January 2021. The wider view is that the changes proposed in the Consultation would not only be in the public's interest, but also of great benefit to the listed entities themselves in order to enhance ESG reporting and strengthen long term and sustainable financial success. As stated by the chair of the TCFD, Michael Bloomberg, “increasing transparency makes markets more efficient, and economies more stable and resilient” – aims that are all the more important in our current climate.