The Treasury has just published its Green Finance Roadmap, setting out new rules designed to create greater transparency in the business world. It gives details of the new Sustainability Disclosure Requirements (SDR), which will oblige companies, asset managers and the creators of investment products to report on the environmental sustainability of their activities. What does this mean for businesses in practice?
The current rules
In December 2020, the Financial Conduct Authority (FCA) brought in a rule that applies to companies listed in the Premium segment of the London Stock Exchange. The new rule requires them to include a statement in their financial report about how they are complying with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). These recommendations relate to best practice for reporting on how the climate impacts, or could impact, the business.
This rule applies to accounting periods beginning on or after 1 January 2021. It is not mandatory for premium-listed companies to actually disclose their climate-related information as the TCFD guidance recommends, but if they do not, they must explain why.
The rules are changing so that companies in scope will have to report on the risks and opportunities that climate change poses to their business in a way that meet the TCFD standards.
Although the TCFD recommendations have been widely adopted around the world, they are normally considered a voluntary standard, and the UK is a pioneer in introducing this mandatory element.
The scope of the new corporate disclosure rules is also changing, and will include:
- Companies listed in the Premium segment of the London Stock Exchange (as before).
- Companies listed in the Standard segment of the London Stock Exchange – subject to the outcome of a recent consultation by the FCA. (Investment entities and shell companies were not included in the consultation.)
- Certain financial companies that are either publicly quoted companies, large private companies or Limited Liability Partnerships (LLPs) – again, subject to the findings of a recent consultation and also Parliamentary approval.
- Other companies currently within scope of the TCFD requirements. BEIS consulted on the proposed scope of those requirements earlier this year, but the exact details will be subject to consultation processes and other statutory requirements. However, this group is likely to include publicly quoted companies, large private companies and large LLPs.
Companies in scope must disclose climate-related information in their annual financial reports.
Updated global standards
Various different guidelines for climate reporting have been published over the years, and these are not always consistent with each other. A new body called the International Sustainability Standards Board (ISSB) is currently being established, with the intention of producing a comprehensive global standard, building on the work of the TCFD and other voluntary codes.
The UK government now intends to create an updated set of climate disclosure rules, based on the ISSB standard. These will be known as the Sustainability Disclosure Requirements (SDR) and were first announced by the Chancellor in July.
The four pillars of SDR
The TCFD recommendations are based on four elements, or “pillars”, and the UK government expects the future standards from the ISSB to follow the same pattern.
Governance: How does the governance of the organisation take climate into account? When significant decisions are discussed, such as mergers or serious capital expenditures, is climate taken into consideration?
Strategy. Does the long-term strategy for business growth take into account the changing climate? Are decision-makers in the company aware of how climate change could affect operations in the medium or long term? Are you modelling potential climate scenarios, and do you have a strategy for dealing with each possibility? Have you considered the effect of a changing climate on your supply chain?
Risk management. What is the company’s assessment of climate-related risks, and how do these compare to other risks faced by the business? The TFCD recommends that climate risk should be considered as part of the overall risk management strategy rather than tacked on. What processes are you using to assess these risks, and what is your strategy for mitigating their effect?
Metrics and targets. It is important to “show your working” and make it clear what numbers are underlying your climate-related decision-making. What targets are you setting for emissions reduction, and how do you currently measure up? What are the greenhouse gas emissions of the business in absolute terms? What effect on revenue would you see from the various climate scenarios you have judged to be possible?
Mandatory net zero transition plans
SDR will also eventually require businesses to go public with their plans for transitioning to net zero. However, there is currently no agreed international standard for how such plans should look, so at present the government simply intends to “support and encourage” businesses to draw up credible transition plans. Eventually, as best practice guidance emerges, there will be legislation making it mandatory, at least for certain types of business.
When will the new rules come into force?
Some parts of the new disclosure rules are still subject to consultation or parliamentary approval. But these standards will be a reality for many businesses as early as 2022. It is time for UK businesses to start engaging with the principle of climate-related financial disclosure and familiarise themselves with what is required as soon as possible.