Mandatory climate-related financial disclosures requirements for companies and LLPs
This article follows from another previously published: Mandatory climate-related disclosures coming soon.
Internationally, companies are becoming increasingly aware of the risk that climate change poses to their business prospects, value, and access to third party investment. From April this year, the UK Government introduced mandatory reporting requirements, whereby certain companies must make climate-related financial disclosures in the renamed non-financial and sustainability information statement (NFSI) within their strategic report. Disclosure of climate-related financial information is one way that climate-related risks and opportunities can be highlighted, and individual investment decisions supported. Sections 414CA and 414CB of the Companies Act 2006 (CA 2006) set out the relevant requirements, introduced by the Companies (Strategic Report) (Climate-related Financial Disclosure) 2021 (Regulations). The new requirements apply in relation to financial years beginning on or after 6 April 2022.
The Regulations essentially make it mandatory for the UK’s largest businesses to disclose their climate-related risks and opportunities, broadly in line with the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations. The disclosure regime aims to promote the management of climate-related financial risk and opportunities across the UK economy and financial system and forms part of the UK Governments’ wider efforts roll out mandatory climate-related disclosures.
What are the TCFD Recommendations?
The Financial Stability Board’s TCFD was established in 2015, with a view to improve and increase reporting of climate-related financial information. In 2017, the TCFD published a report setting out 11 recommended climate-related financial disclosure obligations, sat under the following four recommendations (TCFD Recommendations):
- Governance: aimed at providing an insight into an organisation’s internal operations, policies and governance around climate-related risks and opportunities;
- Strategy: an assessment of the actual and potential impacts of climate-related risks and opportunities on a company’s business, strategy, and financial planning;
- Risk Management: to provide an understanding of the processes used by an organisation to identify, assess, and manage climate-related risks; and
- Metrics and Targets: providing mechanisms and goals that provide tangible feedback on the effectiveness of a company’s strategy to mitigate climate-related risks.
Entities within scope
The following entities fall within the scope of the Regulations:
- Relevant Public Interest Entities (PIEs) – all UK companies that are currently required to produce a non-financial information statement, being UK companies that have more than 500 employees and have transferable securities admitted to trading on a UK regulated market (as defined in s 1173 of the CA 2006), banking companies (as defined in section 1164(2) and (3) of the CA 2006) and insurance companies (as defined in section 1165(2) or 1165(7) of the CA 2006).
- UK registered companies with securities admitted to trading on AIM with more than 500 employees.
- High turnover companies, where either:
- the company was not a parent company at any time in the relevant financial year, and has a turnover for that year of more than £500 million; or
- the company was a parent company at any time within the relevant financial year, and in that year, a group headed by the company had an aggregate turnover of more than £500 million.
There are also parallel requirements for in-scope LLPs, which include:
- large LLPs, which are not traded or banking LLPs, with more than 500 employees and turnover more than £500 million; and
- traded or banking LLPs which have more than 500 employees.
Small and medium-sized companies are exempt, so an NFSI statement is not required if the company is either:
- subject to the small companies regime in relation to the relevant financial year (sections 382 to 384 of the CA 2006), or
- qualifies as medium-sized in relation to that financial year (sections 465 to 467 of the CA 2006).
What are climate-related financial disclosures?
Section 414CB(2A) of the CA 2006 requires the following climate-related financial disclosures to be included in the NFIS:
- A description of the company’s governance arrangements in relation to assessing and managing climate-related risks and opportunities.
- A description of how the company identifies, assesses, and manages climate-related risks and opportunities.
- A description of how processes for identifying, assessing, and managing climate-related risks are integrated into the company’s overall risk management process.
- A description of the principal climate-related risks and opportunities arising in connection with the company’s operations, and the time periods by reference to which those risks and opportunities are assessed.
- A description of the actual and potential impacts of the principal climate-related risks and opportunities on the company’s business model and strategy.
- An analysis of the resilience of the company’s business model and strategy, taking into consideration different climate-related scenarios.
- A description of the targets used by the company to manage climate-related risks and to realise climate-related opportunities and of performance against those targets.
- A description of the key performance indicators (KPIs) used to assess progress against targets used to manage climate-related risks and realise climate-related opportunities and of the calculations on which those KPIs are based.
It is important to remember that beyond the disclosures themselves, in-scope companies need to embed climate-related financial considerations into their governance structures and business processes to ensure they have appropriate information and capability to assess climate-related risks and opportunities, analyse climate-related scenarios and measure progress against KPIs etc.
To assist in-scope companies and LLPs to comply with these new reporting requirements, the Department of Business, Energy and Industrial Strategy (BEIS) and the Financial Reporting Council (FRC) have each published non-binding practical guidance. The BEIS guidance, which is set out as a Q&A, helps to fills in some of the gaps in the Regulations, in particular how the disclosure requirements apply to groups of companies.
Key points to note regarding group reporting include:
- Companies are expected to report at group level, on a consolidated basis, or at the company level if the relevant in-scope entity is not included within consolidated group reporting.
- The turnover requirements in section 414CA(2A) of the CA 2006 and the requirement for more than 500 employees in section 414CA(4) are aggregated across the group.
- If the company’s strategic report is a group strategic report, the NFSI statement must be a consolidated statement (a "group non-financial and sustainability information statement") relating to the undertakings included in the consolidation (section 414CA(2) of the CA 2006).
- When a UK group is in scope the top UK parent is expected to report on the global operations of the UK group, regardless of whether activities are conducted through a UK subsidiary or an overseas subsidiary.
- While there is an exemption from the disclosure requirements at company level where the company’s activities are included in a consolidated report of a UK parent company, if a UK company has an overseas parent which reports on a consolidated basis, the exemption does not apply.
The FRC also issued an updated edition of its Guidance on the Strategic Report on 16 June 2022 to incorporate the new climate-related financial disclosures and maintain alignment with the Regulations.
One of the key points addressed by the FRC in its guidance is that of materiality and the carve-out included in section 414CB(4A), which permits the directors of a company to omit certain of the climate-related financial disclosures. In order to omit such disclosure, the directors of a company must reasonably believe that, having regard to the nature of the company’s business, and the manner in which it is carried on, the whole or part of the relevant climate-related financial disclosure is not necessary for an understanding of the company’s business. This materiality exemption only applies to the financial disclosures under the Strategy and Metrics and Targets TCFD Recommendations (as described in the last four bullet points under ‘What are climate-related financial disclosures?’ above), and the directors are required to provide a clear and reasoned explanation as to why they hold such reasonable belief.
What’s next for mandatory climate-related financial disclosures?
In 2019, the UK Government established a taskforce (UK Taskforce) to explore the most effective approach to climate-related disclosures in line with the Government’s Green Finance Strategy recommendations. The UK Taskforce subsequently developed a Roadmap that sets out an indicative path towards comprehensive and high-quality information on how climate-related risks and opportunities are being managed across the UK economy.
Following introduction of the Regulations, the Roadmap envisages expansion of the scope of mandatory disclosures to certain Financial Conduct Authority regulated entities and further refinement to existing measures in response to evolving best practice.