On 28 October 2021, the Department for Business, Energy and Industrial Strategy (BEIS) published the UK government’s response to their spring 2021 consultation on proposals to introduce mandatory climate-related financial disclosures for publicly quoted companies, large private companies and LLPs. The consultation sought views on the scope and depth of requirements, appropriate guidance, and the monitoring and enforcement regime. Following the consultation, draft regulations have been published with the intention that they come into force for accounting years on or after 6 April 2022. The government hopes that these new requirements will lead to climate related risks being more accurately priced in financial markets and as such, introduce an incentive for ‘green’ investments and stimulate a more informed understanding of climate risk for both businesses and investors. The announcement was foreshadowed in the recent Roadmap to Sustainable Investing, aligns with the UK’s Net Zero Strategy and is intended to signal clear ambition in advance of COP26.
Feedback was generally supportive of the proposed scope of the disclosure requirements with dissenting views calling for a wider scope aligned with the lower thresholds under Streamlined Energy and Carbon Reporting (SECR) requirements for quoted companies, large unquoted UK companies and large LLPs. However, the government proposes to implement an expanded version of the original scope, outlined in the policy developments section below.
The entities covered by the scope will be required to disclose climate-related financial information in their Strategic Report or Energy and Carbon Report. Disclosures will be legally mandated by new regulations aligned to the Taskforce on Climate-Related Financial Disclosures (TCFD) framework and will require the inclusion of scenario analysis. The required content will be wide ranging but there will be exceptions for information if such omissions are justified.
These changes are to be implemented through a statutory instrument, using powers under the Companies Act 2006, and powers under the Limited Liability Partnerships Act 2000, with further guidance to be issued before the end of 2021 and regulations coming into force on 6 April 2022, subject to parliamentary approval. The disclosure requirements will be implemented by two sets of regulations – one for companies and another one for LLPs. The draft regulations applicable to LLPs are to be published following the approval of those applicable to companies after parliamentary scrutiny.
The draft regulations provide for the following entities to fall within the disclosure requirements:
- 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 either transferable securities admitted to trading on a UK regulated market, or are banking companies or insurance companies (Relevant Public Interest Entities (PIEs));
- UK registered companies with securities admitted to AIM with more than 500 employees;
- UK registered companies which are not included in the categories above, which have more than 500 employees and a turnover of more than £500m; and
- LLPs which have more than 500 employees and a turnover of more than £500m.
Climate-related disclosure content
In the draft regulations for companies, the draft Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021, climate-related disclosures will include the following:
- 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; and
- 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.
The disclosure of this information will, the government hopes, allow investors and businesses to better understand the financial impacts of their exposure to climate change and to better manage climate related risks.
Lawful omission of information
The draft regulations allow information to be omitted from the disclosures subject to conditions. The directors of a company can omit climate related disclosure in whole or part if they:
“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 a part of a climate-related financial disclosure required by subsection (2A)(e), (f), (g) or (h) is not necessary for an understanding of the company’s business..”
Although this exception will allow businesses to omit certain factors, they will still have to “provide a clear and reasoned explanation of the directors’ reasonable belief” as to why the omitted information is not necessary.
Policy amendments as a result of the consultation
The government in its response highlighted two policy changes made following the consultation process. First, a qualitative scenario analysis requirement will be introduced although it did not form part of the initial proposals, because the government received compelling feedback on the importance of scenario analysis to meaningful climate disclosures. The requirement will be to demonstrate in qualitative terms the resilience of a company’s business model and strategy in relation to different climate-related scenarios.
The second amendment will be closer alignment of the regulations to the language used in the TCFD recommendations themselves.
Some businesses are already reporting or proposing to report against the TCFD framework (see our previous lawnow FCA implements new climate-related disclosure rule for premium listed companies (cms-lawnow.com)) but this new legislation will expand its application significantly. Given the real physical and transition risks associated with climate change happening right now this will be a welcomed announcement for investors. The ability to omit details of impacts, resilience analysis, targets and KPIs will need to be monitored so that adequate explanation and meaningful analysis is available to inform investment decisions.
UK to enshrine mandatory climate disclosures for largest companies in law - GOV.UK (www.gov.uk)
Article co-written by Josh Vickery.