ESG - TCFD and SFDR disclosures: a fork in the road?

The TCFD was set up by the Financial Stability Board in 2015. Its aim was to develop consistent climate-related financial disclosures to be used by industry participants in order to increase understanding of material risks. TCFD published a Final Report in June 2017 which set out a number of recommended disclosures. These were grouped between four core elements:

• Governance - disclosure of an entity's governance around climate-related risks and opportunities.
• Strategy – disclosure of the actual and potential impacts of climate-related risks and opportunities on an entity's businesses, strategy and financial planning.
• Risk management – disclosure of how the entity identifies, assesses and manages climate-related risks.
• Metrics and targets - disclosure of the metrics and targets used to assess and manage climate-related risks and opportunities (the TCFD launched a consultation on forward-looking financial sector metrics in October 2020; consultation closes on 27 January 2021).

Under each of these core elements the TCFD made a number of more detailed recommended disclosures – there are 11 of these recommended disclosures in total across the four core elements. As promulgated by TCFD, the recommendations are voluntary.

The UK government was one of the first to endorse the TCFD. In its 2019 Green Finance Strategy the Government said that it expected all listed issuers and large asset owners would be disclosing in line with the TCFD recommendation by 2022.

This was set up by the 2019 Green Finance Strategy. It is, as the name suggests, a taskforce made up of regulators (the FCA, PRA and The Pensions Regulator) and government (HM Treasury, the Department for Work & Pensions and the Department for Business, Energy & Industrial Strategy). It is chaired by HM Treasury. Its role was to look into the most effective way of implementing the recommendations of the TCFD.

The Roadmap represents the UK Taskforce's "flight path" towards the implementation of climate-related disclosures in the financial and non-financial sector which are aligned with the TCFD's recommendations. The UK intends the TCFD-aligned disclosures to be mandatory, rather than "comply or explain". The timeline for implementation differs depending on sectors.

For instance, the FCA has already consulted on Proposals to enhance climate-related disclosures by listed issuers (CP 20/3 – March 2020); and the Department for Work & Pensions published its consultation, Taking action on climate risk: improving governance and reporting by occupational pension schemes in August 2020. Regulatory action has already been taken in relation to banks and insurers following the Bank of England’s Supervisory Statement (SS3/19), issued by the Prudential Regulation Authority (PRA) in April 2019; a Dear CEO Letter from the PRA was published in July 2020.

Large occupational pension schemes (with more than £5bn of assets), premium listed companies and banks, building societies and insurance companies are all expected to be subject to mandatory TCFD-aligned disclosures by 2021.

This sector comprises UK-authorised asset managers that are: MiFID investment firms which provide portfolio management services, AIFMs (including small AIFMs with managing permissions), UCITS management companies and UCITS funds without an external management company.

The Roadmap envisages phased implementation, with the largest UK-authorised asset managers in terms of assets under management becoming subject to mandatory TCFD-aligned disclosures in 2022. The Interim Report suggests that – for illustrative purposes – the size threshold might be AUMs in excess of £50 billion. All other UK-authorised asset managers (with the exception of very small firms below a certain threshold) will become subject to the mandatory disclosures in 2023.

Other than banks, building societies, insurance companies and FCA-regulated pension schemes, apparently not at this stage (although note that, in terms of constitution rather than regulated status, listed commercial companies and UK-registered large private companies (i.e. larger than a "medium-sized company" under the Companies Act) will be caught).

It now seems clear that the UK will not implement the EU Sustainable Finance Disclosure Regulation (SFDR) in 2021, although it remains possible that there will be a UK version of the SFDR in the future. The Interim Report does make a fleeting reference to ensuring that there will be "interactions with related international initiatives, including those that derive from the EU's Sustainable Finance Action Plan", although beyond that there is no explicit mention of SFDR or any recognition of the fact that it will be coming into effect in the EU in March 2021.

It is notable that, in contrast to SFDR, the TCFD-recommended disclosures are firmly focused, relatively narrowly, on climate-related risks – i.e. not even the full gamut of environmental objectives that are incorporated within the "E" of ESG, and without any reference at all to wider social and governance factors. Climate risks are clearly a priority for the UK, which is perhaps not surprising given that it is hosting the UN's COP conference in Glasgow next year.

However, the UK government did also announce this week that it will adopt the framework for the EU Taxonomy and establish a "UK Green Technical Advisory Group" to review the EU's metrics "to ensure that they are right for the UK market". The EU Taxonomy deals with a wider range of environmental issues than the TCFD and requires assessment of activities by reference to minimum social standards. It therefore seems likely that UK firms will ultimately have obligations to report on their level of alignment with this UK Taxonomy.

In any event, for those UK firms seeking to market into the EEA from March of next year, the EU SFDR is certainly not dead. SFDR disclosures – at least from the perspective of SFDR's product-level obligations – are likely to be highly significant in terms of firms' ability to be able to access investor capital across the EEA and non-compliant firms are likely to find their avenues of access – e.g. under national private placement regimes – denied to them. That is quite aside from the possibility that – assuming, as is likely, EU SFDR and the Taxonomy Regulation gain traction – there will be increasing investor pressure to comply with SFDR disclosure obligations, i.e. regardless of whether or not they are legally enforceable against non-EU firms.

It also remains to be seen what approach the UK will take to implementing amendments to MiFID, AIFMD and UCITS relating to the steps managers must take to embed ESG risks in their due diligence, risk management and other policies. The EU law change which would require MIFID firms to take into account their clients' "sustainability preferences" could not be implemented in the same way if the UK does not implement SFDR.

For asset managers (and life insurers and FCA-regulated pension providers) the FCA proposes publishing a consultation on proposed rules in the first half of 2021, with the aim of finalising the rules by the end of 2021. As outlined above, under a phased implementation, the largest of the UK-authorised asset managers will be subject to the new rules at some point in 2022 followed by the others in 2023.