Mandatory climate-related disclosures coming soon
On 28 October 2021, the government published its response to its consultation on mandatory climate-related disclosures by publicly quoted companies with more than 500 employees (including AIM companies as well as those admitted to the Main Market), large private companies and LLPs. The response was accompanied by draft Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021 (Regulations), which amend sections 414C, CA and CB of the Companies Act 2006 (CA 2006). Companies that fall within the scope of the Regulations will be required to disclose climate-related financial information in line with the four overarching pillars of the TCFD Recommendations (defined below).
Equivalent regulations for LLPs (LLP Regulations) will apply a modified form of the Regulations, and therefore, the LLP Regulations will be made after the Regulations have been approved by Parliament.
Subject to Parliamentary approval, the Regulations and the LLP Regulations will come into force on 6 April 2022 and shall apply in respect of any financial year of a company or LLP which commences on or after that date.
Whilst publicly quoted companies and large private companies and LLPs will be directly affected by the Regulations, the requirements imposed will affect many more entities indirectly as, in order to assess the climate risks associated with their operations, business model and strategy, in-scope companies and investors will require companies in their supply chain and/or their investees to disclose more information about climate risks.
What are the TCFD Recommendations?
The Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (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 Target: 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 will fall within the scope of the Regulations and LLP 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 and insurance companies;
- UK registered companies with securities admitted to AIM with more than 500 employees;
- UK registered companies which are not included in the categories above and have more than 500 employees and turnover of more than £500 million; and
- LLPs with more than 500 employees and turnover of more than £500 million.
Both the scope thresholds and climate-related reporting will apply on a consolidated basis. When a UK group is within scope, all the subsidiaries (both UK and overseas) belonging to that UK group, are expected to bear some degree of reporting burden. The top UK parent entity is expected to report on their global operations, including on both activities conducted through a UK subsidiary or an overseas subsidiary, provided these companies are included in the consolidated reporting.
The government's Final Impact Assessment relating to the Regulations anticipates that 1,350 groups of companies will fall within scope and 10,700 active UK subsidiaries will be affected.
In scope companies will be required to make disclosures in the Non-Financial Information Statement (NFIS), which forms part of the Strategic Report, and which is to be renamed the Non-Financial and Sustainability Information Statement. In scope LLPs will be required to make disclosures in either the NFIS or the Energy and Carbon Report, which forms part of the Annual Report.
The disclosures required will be inserted into s414CB (2A) of the CA 2006 as follows:
- A description of the company's governance arrangements in relation to assessing and managing climate-related risks and opportunities.
- A description of how it 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 its overall risk management process.
- A description of the principal climate-related risks and opportunities arising in connection with its 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 its business model and strategy.
- An analysis of the resilience of the business model and strategy, taking into consideration different climate-related scenarios (Scenario Analysis).
- A description of the targets used to manage climate-related risks and to realise climate-related opportunities and of performance against those targets.
- A description of the key performance indicators used to assess progress against targets used to manage climate-related risks and realise climate-related opportunities and of the calculations on which those key performance indicators are based.
Following consultation on the draft Regulations, the government chose to introduce a qualitative Scenario Analysis requirement in the final Regulations. The TCFD report describes Scenario Analysis as "a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty... scenarios provide a way for organizations to consider how the future might look if certain trends continue or certain conditions are met. In the case of climate change, for example, scenarios allow an organization to explore and develop an understanding of how various combinations of climate-related risks, both transition and physical risks, may affect its businesses, strategies, and financial performance over time."
The Regulations provide flexibility, in some circumstances, for a company’s directors to omit all or part of the climate-related disclosures required, taking account of the nature of the business and how it is conducted. This materiality filter will only apply to disclosures made under the Strategy and Metrics and Targets TCFD Recommendations, where directors reasonably believe these disclosures are not necessary for the understanding of the business. Directors will be required to provide a clear and reasoned explanation as to why they are making any such omission.
What this means in practice?
It is anticipated that entities will need to make governance changes in order to meet the requirements of the Regulations / LLP Regulations and that compliance costs will increase accordingly. Anticipated additional costs include one-off familiarisation and legal costs and the following ongoing costs:
- Costs to subsidiaries of collecting and submitting information - all active subsidiaries are expected to provide information to their UK parent on an annual basis for analysis and reporting purposes.
- Cost to parent companies of processing information - once a UK parent company receives information from their subsidiaries, companies must to evaluate the information in order to determine which matters are material to the group.
- Governance - entities are likely to incur costs when adapting their governance structures and in the course of documenting and disclosing their governance of climate-related risks and opportunities.
- Strategy - costs relating to the identification, documentation and disclosure of climate-related risks and opportunities, as well as reporting on the impact of these risks on the business, strategy and financial planning. Costs are likely to include the cost of performing research, quantification and writing of scenarios to deliver scenario analysis.
- Risk Management - costs relating to the identification and assessment of risks and their integration into the company’s overarching risk-management strategy.
- Metrics and Target - costs relating to development, calculation and disclosure of the metrics and targets used to assess and manage climate related risks and the collection of data to report against such metrics and targets.
- Publication and sign-posting - costs of dispersing information publicly.
- Quality assurance and Internal verification - costs relating to the internal verification and quality assurance of disclosures.
- External audit - companies are not formally required to audit climate related financial information. However, auditors may need to perform verification and checks for consistency and completeness if the outcomes from scenario analysis reference any of the other information subject to audit from the Annual Report or, if risks are identified to be material, auditors might need to assess whether such risks have been reflected in the Annual Report.
A full cost benefit analysis can be found in the government's Final Stage Impact Assessment which can be viewed here.
The government intends to publish non-binding Q&A guidance to help companies and LLPs comply with the new disclosure requirements which will follow in due course.