Mandatory TCFD disclosures scrutinised for the first time

The FCA review involved a quantitative analysis of 171 companies' disclosures and also a qualitative analysis of 31 companies' disclosures.

FCA

Industry Representation within sample (31 companies across 11 industry sectors). Sample of small, medium and large listed companies (where possible).

FRC

Industry Representation within sample (25 companies across 10 higher impact industry sectors). Sample of Premium Listed Companies.

While the FCA review covered a wider range of company sizes and sectors, the FRC review focused on larger premium-listed companies with a higher potential climate impact (and therefore expected to be further progressed in their climate reporting), such as construction and oil and gas, but also financial services. As a result of the different profiles of the entities analysed, there is some disparity between the FCA and the FRC findings, though there are also common themes. The FRC conducted a similar thematic review of voluntary TCFD reporting in 2020 and now notes that entities have "generally risen to the challenge". Overall, both the FCA and the FRC noted a marked improvement in the consistency of disclosures made in 2021 reports against those made voluntarily in 2020 reports, while requiring companies to continue making progress towards even better reporting. For a reminder of the regulatory requirements on companies at present, see section 8 below.

These numbers are based on companies' self-reported compliance and self-stated consistency with the TCFD's recommended disclosures. By contrast, the FCA's qualitative analysis revealed these numbers to be overstated. In the case of one of the Governance limbs, whereas 98% self-reported their disclosures as being consistent with the TCFD's recommended disclosures, the FCA found only half to be compliant. The FRC similarly observed that entities overstated their own levels of compliance.

* The FRC stated in the report that "we are considering those companies that did not appear to have made a recognisable statement in their [annual financial report] AFR, as well as those that made statements with insufficient detail to be able to determine which disclosures were consistent. We may take action as appropriate." What such "further action" could be is unclear.

When reviewing this year's disclosures, the FCA noted that compliance, in its view, means not just making the required disclosures but also undertaking a detailed assessment of those disclosures in accordance with the TCFD Guidance for All Sectors. Indeed, this is consistent with LR 9.8.6B G which states that listed companies should undertake a detailed assessment of their climate-related financial disclosures to determine whether consistent with the TCFD, taking into account the Guidance for All Sectors and also, where appropriate, supplemental guidance for the financial sector and non-financial groups. LR 9.8.6C G goes on to list other reports and guidance that the FCA considers relevant, including the technical supplement on scenario analysis, guidance on risk management integration and disclosure, and guidance on metrics, targets and transition plans. Similarly, the FRC's view is that where companies indicate that they have disclosed consistently, but the disclosures recommended in guidance have not been included, nor an explanation provided that those disclosures are not considered material, the LR requirements are not being met.

In effect, this introduces a large number of additional points of disclosure; these are phrased as both "should" (mandatory) disclosures and "should consider" (optional/nice to have) disclosures.

The importance of narrative explanations where gaps exist is a consistent theme through the FCA and FRC reports. It is clear that while the FCA will tolerate less-than-full compliance with the TCFD disclosures and guidance (for now), it will be less tolerant of reports which claim consistency with TCFD but fail to deliver it, or which simply contain omissions with no explanation as to why. 

Where the FCA "expects" companies to report, this indicates a low tolerance of non-compliance. For example, the Governance pillar and recommended disclosures under it were a focal point in the report, as the FCA expects all companies to be able to make these disclosures. Despite this, the FCA found that under half of the analysed disclosures were partially/mostly consistent with the Guidance. In particular, companies were not consistently reporting on the processes by which management is kept informed about climate-related issues.

While recognising that in respect of certain disclosures, data gaps were a challenge, the FCA stressed that in the event that a company did not comply, it must instead explain why, the steps it is taking to make the disclosures in the future, and the timeframe for this. The FRC also acknowledges the key role of data in effective TCFD reporting; its Financial Reporting Lab is expected to publish a report on ESG data production imminently, as part of its wider project on ESG data production, distribution and consumption.

In respect of Scope 1 and 2 greenhouse gas emissions, there was an overall higher level of compliance, not least because entities will be required to disclose this data in their Energy and Carbon Reports (SECR), also in the strategic report. The FCA noted that companies were not yet bound to follow the newly released TCFD Guidance on Metrics, Targets and Transition Plans (October 2021), but that those making net zero commitments were "encouraged" to consider it and to ensure that their disclosures were not misleading.

In relation to Scope 3 emissions, the FCA notes the challenges posed in collecting data and applying available methodologies for accurate Scope 3 emissions reporting. Companies who do disclose should also report on their methodology, including how far into their value chain the emissions reporting/measuring extends.

The FCA also noted its expectation that compliance with the scenario analysis recommendations under the Strategy pillar (recommended disclosure (c)) would be a significant challenge for companies. That said, around two thirds of companies in the sample provided at least a qualitative scenario analysis. The FCA noted tools such as the Climate Financial Risks Forum guide and narrative tool to assist with scenario analysis.

The FRC report contains a section on "Paris-aligned accounting", where it describes how companies should take into account what impact the various pathways towards a Paris-aligned outcome are likely to have on their financial assumptions and sensitivities. This goes to the valuation of assets and liabilities in particular, as measured by international accounting standards such as IFRS. "Boilerplate" statements that climate has been taken into account will not be deemed sufficient.

Importantly, the FCA intends to adapt the disclosure regime to take account of the ISSB standards on climate-related disclosures, currently under development, once they become available for use in the UK. The FRC similarly notes that the use of such standards will enhance comparability. See our related briefing and podcast. A consultation (most likely in 2023) will be run on adopting these standards, as well as moving from a "comply or explain" regime to mandatory compliance for in-scope listed companies.

The FRC identified five ways in which entities may improve their TCFD report:

1. Granularity and specificity – Generic information about climate change is not sufficiently specific to meet the requirement for information on risks and opportunities to the business.
   
   
2. Balance – Failure to address the size of an opportunity relative to a business as usual scenario, and to identify dependence on new technology (i.e. to enable them to meet their emissions and/ or climate targets) were described as impediments to balanced reporting.
   
   
3. Interlinkage with other narrative discussions – interconnected parts of the strategic report, such as discussion around business model or strategy, should be tied back to the narrative on climate risks, opportunities and strategy.
   
   
4. Materiality - While companies consistently reported how far they had complied with the TCFD framework in their annual financial report ("AFR"), they did not always go on to explain gaps in their compliance and whether these were due to lack of materiality, lack of data or some other issue. The FRC notes that it may challenge companies claiming consistency with TCFD disclosure requirements where it is not clear that all relevant and material elements have been taken into account, including not only Guidance for All Sectors but also supplemental guidance for the financial sector and non-financial groups, as appropriate. If companies fail to make disclosures identified by the FCA as "particularly expected", they can also expect to be challenged; "particularly expected disclosures" are all recommended disclosures under the Governance and Risk Management pillars, and recommended disclosures (a) and (b) under the Strategy pillar (giving some leeway for companies not yet able to address scenario analysis).
   
   
5. Connectivity between TCFD and financial statements disclosures – Again, the FRC noted that some companies included extensive generic information on the impact of climate risks on financial statements, but called for companies to report according to their own specific situations. For example, if the company reports significant risks and uncertainties in the narrative, or conversely a net zero transition plan, the FRC would expect that this would be reflected in judgements and estimates in the financial reports.

Both the FCA and FRC reports include helpful commentary and clear statements of the regulators' expectations that any entity looking to disclose in line with TCFD can use. In particular, the FRC's "examples of better practice", extracted from companies' recent disclosures will aid entities at an earlier stage in their reporting journey, and the FCA encourages other companies to use these as reference points. Both reports also highlight particular areas where gaps remain, and the extent to which (and areas where) regulators will be patient with companies while they work towards compliance.

Though at present the range of companies covered by the FCA and FRC comments is quite small, TCFD roll-out across the economy is imminent. Standard listed companies have been covered from 1 January 2022, and the Companies Act requirements, which align with TCFD, have applied to unlisted large companies with more than 500 employees and £500m in turnover, and LLPs of the same size, from 6 April 2022. The UK Government intends to roll out TCFD reporting "across the economy" from 2025 on a mandatory basis. Once this happens, financial and corporate regulators will have a challenging time in consistently enforcing high reporting standards (though investors and shareholders may well do so). In guiding the largest entities towards optimum TCFD reporting, and by introducing mandatory reporting standards, the regulators will no doubt be hoping to set the bar high and allow the market to self-regulate.