Out-Law Analysis 7 min. read
08 Jan 2021, 10:09 am
A recent policy announcement by the Financial Conduct Authority (FCA) marks the start of an anticipated toughening up of climate-related disclosure requirements that all UK public companies should prepare for.
In 2020, the FCA introduced a new listing rule on climate-related disclosure for commercial companies with a 'premium listing' on a UK stock exchange. It applies to accounting periods beginning on or after 1 January 2021, meaning the first annual financial reports subject to the rule will be published in early 2022. However, the regulator has now confirmed its intention to extend the new rules to other listed issuers.
The new requirements, which were set out alongside a new technical note clarifying existing disclosure obligations, are aligned with global standards set by the Task Force on Climate-related Financial Disclosures (TCFD). They reflect a broader push by policy makers and regulators around the world to address climate risk through the financial markets system.
Here we identify some of the main takeaways from the FCA's statement and look at some of the challenges that lie ahead for issuers in identifying and assessing climate-related disclosures so as to ensure regulatory compliance.
The global push to improve the information made available by industry about climate-related risk can be traced to the establishment of the TCFD in 2015 in the immediate aftermath of the historic Paris Agreement on climate change.
In response to a mandate set by the G20's Financial Stability Board, the TCFD in 2017 set out recommendations on climate-related disclosures designed to better inform investment, credit, and insurance underwriting decisions and improve understanding of where carbon-related assets are concentrated in the financial sector and the financial system’s exposures to climate-related risks.
The TCFD's recommendations fall under four broad headers: governance; strategy; risk management; metrics and targets.
The TCFD's recommendations are voluntary, but steps are being taken to mandate climate-related disclosures in a number of jurisdictions, including in Hong Kong where enhanced disclosure requirements will build on the TCFD's recommendations. In the EU, law makers finalised the Sustainable Finance Disclosure Regulation (SFDR), which applies in the financial services sector, in 2019, while the UK government, in partnership with the FCA and the Pensions Regulator, published a roadmap towards mandatory climate-related disclosures in November 2020.
The UK roadmap envisages rising coverage of disclosure requirements over the period to 2025, with one of the first steps the FCA's new rules for premium listed companies.
The FCA's new listing rule requires a company with a UK premium listing to include a statement in its annual financial report setting out:
In line with the UK roadmap, the FCA confirmed in its policy statement that, while its new rule applies only to premium listed issuers, it will consult in first half of 2021 on extending the application of the rule to a broader range of listed issuers.
This graduated approach seems sensible, particularly in wake of Covid-19 and the time it will take for certain smaller listed companies to build relevant capabilities. Companies in that category will therefore need to give consideration as to how well placed they are to meet these requirements in the near future. There is also a question of when and on what terms the scope may widen beyond listed companies to AIM-listed companies and private businesses as part of a wider strategy to implement TCFD-aligned disclosures across the UK economy.
In its statement, the FCA also outlined its specific expectations of asset managers with premium listing, flagging that they have "two distinct audiences" for climate-related financial disclosures: shareholders and clients. The FCA expectation is that in-scope asset managers and insurance companies with asset management businesses will prepare shareholder-focused disclosures in their capacity as listed companies. The FCA said it will continue to develop policy in relation to client-focused disclosures by these firms – a consultation is planned during the first half of 2021.
Whilst the UK is no longer proposing to transpose the EU Sustainable Finance Disclosure Regulation (SFDR) into UK legislation, asset managers are likely to be subject to additional sustainability-related reporting obligations either because of their doing business in the EU or because they are caught by substantially similar legislation implemented by the UK, or both. This means listed asset managers will need to monitor a number of regimes to ensure full compliance with sustainability related disclosure requirements both to their shareholders and their clients.
Placing an emphasis on greater transparency and consistency, the FCA has aligned its new listing rule and supporting Handbook guidance with the TCFD's recommendations and guidance materials. Companies should ensure their disclosures are informed by detailed assessment of the materials the FCA has referenced.
The FCA has also provided some high-level guidance on the scope and detail of disclosures. Referring to the TCFD's first fundamental principle, it said that, in determining whether its climate-related financial disclosures are consistent with the TCFD’s recommendations and recommended disclosures, a listed company should consider whether those disclosures provide sufficient detail to enable users to assess its exposure and approach to addressing climate-related issues. In that regard, companies should take into account factors such as the level of their exposure to climate-related risks and opportunities, and the scope and objectives of their climate-related strategy, which may relate to the nature, size and complexity of their business.
Clearly, there is not a 'one size fits all' approach to this and companies will have to balance a wide range of factors, specific to their business, in order to properly assess climate-related disclosure issues. Ultimately, this may involve finely balanced value-judgments which are not always easy to make.
The FCA has confirmed that its new listing rule allows for disclosures to be made in respect of some TCFD recommended disclosures, while providing a reasoned explanation for the non-disclosure of others. This is a continuation of the FCA's 'comply and explain' approach to climate-related disclosures as the capabilities of companies build, but it does not rule out mandatory disclosures in the future. The FCA confirmed that it will consider consulting on proposals to strengthen the compliance basis for the new listing rule in the first half of 2021.
The TCFD's recommendations under the 'strategy' and 'metrics and targets' headers specifically reference the need for the disclosure of specified information where the information is 'material'.
The FCA confirmed that, like with the TCFD recommendations, its listing rule will not require a materiality assessment to be carried out in respect of the required disclosures falling under the 'governance' and 'risk management' headers. This is because – as a large majority of respondents to the FCA's consultation agreed – it is expected that "issuers should ordinarily be capable of providing disclosures consistent with the TCFD’s recommendations on governance and risk management [and]…should ordinarily not need the flexibility to explain non-disclosure". The FCA has taken the same position to description of resilience under the 'strategy' header, the exception being where companies face "transitional challenges in obtaining relevant data or embedding relevant modelling or analytical capabilities".
Whilst materiality thresholds will come into consideration regarding 'strategy' and 'metrics and targets' recommendations, the FCA encourages companies, even before overcoming any data, modelling or analytical challenges, to make all TCFD-aligned disclosures 'as far as they are able'. So there really is an onus on companies to be proactive in this regard. They cannot hide behind operational challenges to avoid disclosure.
The FCA recognised that issuers raised concerns around the lack of a definition of 'materiality' in assessing what information they should disclose, but it avoided providing a definition or guidance on the issue. Instead it has signposted other regulatory bodies' guidance, including that produced by the International Accounting Standards Board and the Financial Reporting Council.
It remains to be seen whether the lack of definition or guidance from the FCA poses a challenge in terms of consistency, oversight and enforcement, or whether there are benefits in avoiding undue prescription.
Alongside stating and explaining its new listing rules, the FCA's policy statement contains a finalised technical note that provides some clarifications on disclosures in relation to ESG matters, including climate change.
In its paper, the FCA acknowledged the difficulty in defining the matters that are commonly grouped under the acronym ‘ESG’. However, citing the broad and dynamic set of topics the term covers, it said it would not be appropriate for it to provide a fixed definition in its technical note. It also said that it does not intend, at this point, to provide further examples of the type of information that the Market Abuse Regulation (MAR) requires be made public, highlighting the fact that the definition of inside information has not changed.
The FCA said that issuers are required to consider whether a specific piece of information meets the definition of inside information with reference to the facts of a particular case and seek advice on this where appropriate.
The refusal to provide further definitions or examples in the context of MAR is not unexpected. The existing definitions and guidance on inside information are well-established. Adding further layers in the context of ESG could complicate matters, and would not necessarily assist issuers' judgment calls on disclosure. The finalised technical note, however, offers a reminder to public companies that they face a series of on ongoing disclosure obligations under various frameworks, including but not exclusively MAR and the listing rules.
In the FCA's view, more comprehensive and high-quality climate-related financial disclosures are intended to help markets allocate capital more effectively, with the cost of capital better reflecting how well companies are managing climate-related risks and opportunities.
In theory, then, those companies most effectively communicating their green strategy in line with coalescing standards should, as a result of these changes, be the focus of investors seeking to fulfil their own ESG obligations and responding to public policy priorities, such as the transition to 'net zero'.
The FCA is clear, though, that its new listing rules are just the "first step" in enhancing climate-related disclosures, pointing to the UK roadmap that envisages further regulation and its plans to consult on the next step by the end of June. Its stated desire to see the development of an internationally agreed reporting standard in the medium term will also be welcomed by companies operating on a cross-border basis.
Co-written by Anthony Harrison of Pinsent Masons.