UK Sustainable Investing: follow the green brick road

The UK's Green Finance Strategy

The Roadmap represents the next phase in the Government's commitments as set out in its Green Finance Strategy (July 2019). That Green Finance Strategy is based on two key pillars:

• "Greening Finance" – mainstreaming climate and environmental factors as a financial and strategic imperative – i.e., broadly, this is an attempt to support the financial services sector to align with the UK's net zero commitment and other environmental goals;
  
  
• "Financing Green" – mobilising private finance and channelling it to support clean, sustainable and resilient growth.

The first pillar, greening finance, has three identifiable phases:

• Phase 1: Informing investors and consumers – i.e., addressing the information gap for market participants by ensuring that "decision-useful" information on sustainability is available to financial market decision-makers.
  
  
• Phase 2: Acting on the sustainability information – by ensuring that it is integrated into mainstream business and financial decisions.
  
  
• Phase 3: Shifting the financial flows across the economy - to align with the UK's commitment to have a net zero and nature-positive economy.

The Roadmap published on 18 October 2021 focuses on that first phase, which will be delivered through a new set of Sustainability Disclosure Requirements and a UK Green Taxonomy (see below).

However, the government will update the Green Finance Strategy in 2022 which will look beyond the timescales envisaged by the Roadmap – this will include an indicative timeline out to 2050 to align the financial system with the UK's net-zero commitment.

TCFD-aligned disclosures

However, this is by no means a standing start. The UK government has already taken a number of steps to implement Phase 1 of the Green Finance Strategy which will have a direct impact on UK companies and financial services firms. These include a commitment to implementing the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD), by making TCFD-aligned disclosures mandatory across the economy by 2025. This commitment has largely been realised through a number of sector-specific consultations with new rules applying to different types of firms on a phased basis:

• In December 2020 the FCA published a policy statement finalising its TCFD-aligned disclosure rule for UK premium listed companies, which applies to accounting periods beginning on or after 1 January 2021 (you can read our July 2020 briefing on the consultation here and our December 2020 briefing confirming, among other things, the amended Listing Rules here);
  
  
• In March 2021 the BEIS consulted on mandatory climate related disclosures for large private companies, LLPs and certain other publicly listed companies (you can read our briefing here);
  
  
• In June 2021, the FCA consulted on mandatory public, investor-facing mandatory climate-related disclosures for asset managers, life insurers and FCA-regulated pension providers (you can see our briefing here); and
  
  
• In July 2021 the DWP laid legislation before Parliament relating to mandatory TCFD disclosures and effective management of climate related risks/opportunities for certain UK pension schemes.

SDR: introduction

In terms of the phase 1 ambition of getting the right information to market participants, the Roadmap sets out more detail on the new SDR regime as announced by the Chancellor in July 2021. It is clear that this will build on the TCFD-aligned disclosures that already apply, or will apply, to various sectors as outlined above. It is unclear as to just how different in detail and in practice the SDR will be compared to the EU SFDR regime. Although the government mentions the EU Taxonomy Regulation several times when developing the outline framework of the UK Taxonomy, it is silent on EU SFDR.

The direction of travel is towards a single, integrated framework in the UK, but one that may be very different from EU SFDR.

SDR: outline - three types of disclosure

Building on (and going beyond) the TCFD-aligned disclosures, therefore, the SDR will cover three types of disclosure:

• Corporate disclosure – sustainability disclosures by certain companies, including those in the financial services sector, comprising reporting under international standards and under the UK Green Taxonomy (see below);
  
  
• Asset manager/asset owner disclosure – new requirements for asset managers and asset owners that manage or administer assets for clients and consumers (including occupational pension schemes) to disclose how they take sustainability into account; and
  
  
• Investment product disclosure – including the introduction of a new sustainable investment product labelling regime.

See the sections below that expand on each of these types of disclosure.

The intention is to establish a unified framework across the economy, using the same metrics which will be drawn from international standards, where they exist. The aim is to ensure that environmental sustainability information can flow from companies to the financial sector which, in turn, in offering its products, should make disclosures to the end investors/consumers to allow them to make financial decisions based on reliable and comparable data.

It is unclear, at this stage, as to how the government and the regulators will ensure that the new SDR requirements will dovetail with the TCFD-aligned disclosures to which firms will be subject.

SDR: the framework

The existing TCFD recommendations establish a framework for climate-related disclosure based on four pillars:

• Strategy
• Governance
• Risk Management
• Metrics and Targets

The government expects that the standards developed by the International Sustainability Standards Board (ISSB) (see below) will build on these four TCFD pillars, focusing on information which is material to investors. Since the current intention is that SDR will integrate ISSB's standards into its own disclosures, SDR will likewise adopt the above four pillars. The ISSB will be established later this year. Early in 2022 it is expected that it will consult on a draft set of climate-rated corporate reporting standards, before going on to set standards in relation to a broader set of environmental and sustainability factors.

However, SDR will go further than the ISSB's standards insofar as it will also require disclosure of wider information on how the firms impact the environment, including disclosure against the UK's Green Taxonomy (see below).

Taking the three types of disclosure and the four pillars of the framework, the government has summarised what firms will be required to disclose – at a very high level – in tabular format.

_{If you are reading this briefing on mobile, please view the below table in landscape.}

The details of what will need to be disclosed will be set out in high-level, framework legislation, fleshed out with sector-specific rules made by the relevant regulators – these will likely be quite granular.

SDR: corporate disclosure

The SDR will introduce new requirements for certain UK-registered companies and UK-listed issuers, including those in the financial services sector, to make sustainability disclosures in line with:

• reporting under international standards; and
  
  
• disclosures under the UK Green Taxonomy.

These disclosures will be made in the firm's Annual Report. The scope and timing of requirements for companies, and what they will have to report in terms of detail, will be determined following consultation.

The international standards in this regard are those that will be developed by a new body created by the IFRS Foundation: the ISSB. The ISSB will be established shortly and it is expected to consult on a draft set of climate-related corporate reporting standards early in 2022.

There will be specific requirements where asset managers/owners and investment products make ESG claims: they will be required to substantiate these claims in a manner that is "comparable" and "accessible" to clients and consumers and also disclose whether they take ESG-related matters into account in their governance arrangements and in their investment policies and strategies.

As regards disclosures under the UK Green Taxonomy, in-scope companies and financial services firms will be required to report the extent to which their activities align with that taxonomy. This will include disclosures against certain minimum safeguards relating to good business practice.

SDR: asset manager/owner disclosures

There will be new requirements for asset managers and asset owners that manage or administer assets for clients (such as pension scheme trustees, employers, corporate investors) and end-consumers (including occupational pension scheme members, retail investors) to disclose how they take sustainability into account.

Asset managers/owners will be required to disclose at entity level:

• how they are managing their sustainability risks, opportunities and impacts; and
  
  
• how they take sustainability into account in managing or administering investment on behalf of clients and consumers.

Certain UK occupational pension schemes will be required to disclose their sustainability-related risks, opportunities and impacts - subject to consultation, this information will be combined with existing TCFD-aligned reporting requirements and will stand separate from, but be linked to, the annual report/accounts. The scope and timing of the requirements for pension schemes, and the level of detail that they will need to report, will be determined following consultation.

SDR: product disclosures and sustainability labelling

The SDR will introduce a new requirement for creators of investment products to report on a product's sustainability impact and on relevant financial risks and opportunities.

All such disclosures will need to be "consumer-friendly". In outline, firms will need to disclose the following in relation to the products they offer:

• the risks, opportunities and impacts of the product, together with a core set of product-level climate-related metrics; and
  
  
• the extent to which the product is aligned with the UK Green Taxonomy (including minimum safeguards).

Disclosure will be required in relation to all products – even those that are not making any claims about sustainability – on their sustainability performance. Those that do make sustainability claims will be required to substantiate those claims.

The information so disclosed will form the basis of a new sustainable investment labelling regime. The FCA and HM Treasury are working together on the development of this regime.

The aim is to establish a labelling regime that will cover the spectrum of investment products, classifying them objectively against specified sustainability criteria considering:

• each product's objective, policies and strategies; and
  
  
• how the product's investments are allocated.

The FCA will be publishing further detail in a discussion paper, currently expected in November 2021. It will also be establishing an advisory forum.

SDR: transition plans

At the outset, SDR will require certain firms to publish transition plans that align with the government's net zero commitment – or provide an explanation if they have not done so. As standards for transition plans develop, and an accepted template emerges, the disclosure requirements will be expanded.

SDR: investment advisers

Investment advisers are not included within three disclosure types outlined above. HM Treasury and FCA are currently exploring how to roll out sustainability-related requirements for them but, for the time being, there are no concrete requirements.

UK Taxonomy: the outline

The UK Taxonomy will set out the criteria (crudely, a set of common definitions) which specific economic activities must meet to be considered environmentally sustainable and therefore "Taxonomy-aligned".

UK Taxonomy: the framework

The framework for the UK Taxonomy looks very like the framework for the EU Taxonomy Regulation. There is a reason for this: the outline framework of the EU Taxonomy Regulation, including the six environmental objectives – which the UK had helped to design and develop - came into force before the end of the UK's Brexit transition period and was consequently "onshored" into UK law.

That means that there are six environmental objectives:

• climate change mitigation
  
• climate change adaptation
• sustainable use and projection of water and marine resources
• transition to a circular economy
• pollution prevention and control
• protection and restoration of biodiversity and ecosystems

Each objective will be underpinned by a detailed set of Technical Screening Criteria (TSC).

The first two environmental objectives – climate change mitigation and climate change adaptation – will, as under the EU regime, become operational first. The relevant criteria will be subject to consultation in Q1 2022.

To be UK Taxonomy-aligned an activity will have to meet three tests:

• make a substantial contribution to one of the six environmental objectives – the criteria for determining a substantial contribution will be set out in the relevant TSC;
  
  
• do no significant harm to the other environmental objectives – again, the concept of doing no significant harm will be defined in the relevant TSCs for the activity; and
  
  
• meet a set of minimum safeguards – these are the minimum standards for doing business, constituting alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

Although UK Taxonomy-alignment will be predicated on reported data and not on forward-looking projections, it will nonetheless recognise transitional activities and enabling activities.

As regards the first, given that it will not be possible for some economic activities to be conducted in a Taxonomy-aligned way, the TSCs will – for some at least – set the threshold for UK Taxonomy-alignment at the level of best-in-sector emissions (the example of cement is given).

The UK Taxonomy will also recognise activities which currently support the transition by enabling substantial contributions to environmental objectives in other sectors, but which are not yet sustainable themselves. Here, the example given is that of the manufacture of components for wind turbines.

The government will review the effectiveness of the UK Taxonomy every three years.

UK Taxonomy: the TSCs

Technical screening criteria will be developed for each of the six environmental objectives. Each set of TSCs will be consulted on and will become law by way of statutory instruments. In terms of timing, the disclosure requirements for corporates will come into force before those for investment products.

The priority will be the development of the TSCs for the first two environmental objectives: climate change mitigation and climate change adaptation. Importantly, the government has confirmed that these will be based on the TSCs developed for the climate change relatedobjectives under the EU Taxonomy Regulation. This should mean that those firms that have had to prepare for the onset of EU SFDR and EU Taxonomy-aligned disclosures – including the highly-detailed EU TSCs for the climate change mitigation/adaptation objectives – should be able to leverage off those preparations for the purposes of their preparations for the UK regime.

The government is in the process of reviewing the EU TSCs and expects to consult on draft UK TSCs for the climate change mitigation and adaptation objectives in Q1 2022, ahead of legislating by the end of 2022.

It says it will consult on the TSCs for the remaining four environmental objectives during Q.1 2023. It is not clear to what extent, if at all, the UK will have regard to work done in the EU on the TSCs for the four corresponding environmental objectives under the EU Taxonomy Regulation.

UK Taxonomy and SDR disclosures

Certain companies will be required by SDR to disclose the percentage of their capital expenditure, operational expenditure and turnover that, in each case, relates to UK Taxonomy-aligned activities. Those companies that do not fall under the scope of the SDR mandatory reporting regime, but which conduct activities within the UK Taxonomy, may choose to report their alignment.

With that disclosed data, providers of investment funds and products will be required to disclose the extent to which their products are UK Taxonomy-aligned based on the underlying assets; so, for instance, private equity managers will be required to make UK Taxonomy disclosures in respect of their portfolio companies. 

Although the Roadmap is dominated by the plans for the SDR and the UK Taxonomy, it also makes a pit stop on the subject of investor stewardship and the UK's pensions and investment sectors.

The government expects that, as SDR increases the flow and sophistication of information from investee companies, the pension and investment sectors – i.e., asset managers and asset owners -  and the service providers that support them – should, with the new data, seek to integrate ESG considerations into their investment decision making, monitoring and engagement strategies, escalation and collaboration and voting practices. In other words, to become effective and responsible stewards of capital in the area of climate change.

The government also expects entities within the investment and pensions sectors to:

• apply to become signatories of the UK Stewardship Code;
  
  
• take into account the information generated by the SDR when allocating capital;
  
  
• actively challenge, monitor and encourage companies (by using whatever rights and direct or indirection influence they have) to promote long term, sustainable value generation – and, if necessary, withholding capital or divesting;
  
  
• be transparent about their own and their service providers' engagement and voting; and
  
  
• join a "Race to Zero-accredited net zero initiative" and, by the end of 2022, to have published a "high quality transition plan", setting out the firm's pathway to net-zero financed emissions.

The government will be looking at how well the pension and investment sectors have performed in meeting those expectations at the end of 2023.

Although it is far from exhaustive and does not pick up every indicative date mentioned in the narrative, the government does set out a useful, "at a glance" table outlining how it envisages the Roadmap unfolding over the next few years, broken down into the three main disclosure types and specific sectors.

_{If you are reading this briefing on mobile, please view the below table in landscape.}

Most immediately, as will be seen from the above table, three discussion papers are planned for publication next month (November 2021) on:

• entity-level SDR disclosures for asset managers, life insurers and FCA-regulated pension schemes;
  
  
• consumer-facing product-level SDR disclosures; and
  
  
• the proposed sustainable investment labelling regime.

If you would like further information or assistance in understanding the impact of the Roadmap or how it will interact with the TCFD-aligned disclosures and/or EU requirements under EU SFDR and the EU Taxonomy Regulation, please speak to your usual Travers Smith contact or any of the individuals below.