In January 2022, two sets of Regulations were introduced requiring publicly quoted companies, large private companies and limited liability partnerships (LLPs) to make climate-related financial disclosures in their annual reports. These were implemented following a consultation by the Department for Business, Energy and Industrial Strategy (BEIS) in March 2021, (see our briefing “BEIS consultation on requiring mandatory climate-related financial disclosures”). Non-binding guidance was published by BEIS on February 23, 2022 to assist relevant companies and LLPs understand and comply with the new requirements (the Guidance).
The two sets of Regulations and timing of implementation
The Companies (Strategic Report) (Climate-related Financial Disclosures) Regulations 2022 (the Company Regulations) and The Limited Liability Partnerships (Climate-related Financial Disclosures) Regulations 2022 (the LLP Regulations) , come into force on April 6, 2022 and apply to accounting periods beginning on or after that date (together, the Regulations).
Companies and LLPs within scope will be required to include material disclosures in their annual reports on climate change-related risks and opportunities based on the four-pillar framework established by the Task Force on Climate-related Financial Disclosures (TCFD) . As a result, the required disclosures should cover:
- how climate change is addressed in corporate governance;
- the impacts on strategy;
- how climate-related risks and opportunities are managed; and
- the performance measures and targets applied in managing these issues.
The Guidance sets out the outcomes desired in respect of each element of the disclosure requirements in the Regulations.
Which entities are covered by the Company Regulations?
In scope companies for the purposes of the Company Regulations are those which meet the following criteria:
- UK companies currently required to produce a non-financial information statement, (i.e. more than 500 employees with transferable securities admitted to trading on a UK regulated market, banking companies or insurance companies);
- UK registered companies with securities admitted to the Alternative Investment Market (AIM) of the London Stock Exchange with more than 500 employees; or
- UK registered companies which are not included in the categories above, with more than 500 employees and a turnover of more than £500m in the relevant financial year.
Which entities are covered by the LLP Regulations?
In scope LLPs for the purposes of the LLP Regulations are those UK banking and traded LLPs with more than 500 employees and other large UK LLPs which have more than 500 employees and a turnover of more than £500m in the relevant financial year.
Scope of the Regulations
The Guidance addresses whether:
- disclosure is required at the group or subsidiary level - companies will be expected to report at the group level (or at the company level if they are in scope at an individual level but are not included within consolidated group reporting). Subsidiaries whose activities are included within a consolidated group report of a UK parent that complies with the disclosure requirements in the Company Regulations will not be required to report separately.
- UK companies should report on their global operations or just their UK operations - when a UK group is in scope, the top UK parent will be expected to report, within its annual report, on the global operations of the UK group (regardless of whether activities are conducted through a UK subsidiary or an overseas subsidiary).
- UK companies with an overseas parent company will be exempt – while there is an exemption from the disclosure requirements at company level where an in scope company’s activities are included in a consolidated report from a UK parent company, if a UK company has an overseas parent which reports on a consolidated basis, the exemption will not apply so that UK company will need to make its own disclosures.
Location of required disclosures and level of detail required
The Guidance confirms that companies should include the required disclosures in their newly named Non-Financial and Sustainability Information Statement in their Strategic Report. LLPs should include their disclosures in either the Energy and Carbon Report of their Directors’ Report or, if they prepare a Strategic Report, in their Strategic Report. Companies and LLPs are referred to the Guidance on the Strategic Report published in 2018 by the Financial Reporting Council (FRC) which encourages companies to consider the importance of linking disclosures with other information disclosed in an annual report noting that linkages help readers to understand climate disclosures in a broader context.
The Guidance also makes it clear that disclosures should enable the reader to understand the information presented without needing to refer to other sources of information produced by the company. Disclosures should enable an understanding of how the climate-related financial disclosures relate to the other information presented in the annual report and should not omit information which, if disclosed, would influence the decisions of investors.
Directors are permitted by the Regulations to exercise discretion to omit some or all of certain disclosure requirements. However, this is on the basis that these are not considered necessary for an understanding of the business. If information is omitted on the basis of this exemption, the directors must provide a clear and reasoned explanation of their belief as to why it is appropriate to omit the information.
There is no prescribed format or structure for the climate-related disclosures. However, if any of the required information is not located within the Non-Financial and Sustainability Information Statement, but is included elsewhere in the annual report, the Non-Financial and Sustainability Information Statement must include a specific cross-reference to where it can be found. If a company chooses to provide information additional to that required for meeting the disclosure requirements of the Regulations, this may be disclosed outside the annual report and can be signposted within the annual report but it should be made clear that the information is for further information only.
Where companies and LLPs use information generated by a third party to help them assess the climate-related risks to their business (for example, by contracting with a data provider to support the assessment and disclosure of physical risks for certain assets or infrastructure), the Guidance reminds directors that the legal duty to make the climate-related financial disclosures will remain with them as directors.
What disclosures are required?
The Guidance looks at the different disclosures required by the Regulations. Points to note include the following:
Description of governance arrangements in relation to assessing and managing climate-related risks and opportunities
Companies and LLPs need to explain how risks and opportunities relating to climate change are identified, considered and managed within their governance structure. This includes which person or committee is responsible for identifying and considering climate-related risks and opportunities, including how frequently those matters are considered (and the extent to which the board considers them), and who has responsibility for managing those risks and opportunities.
Description of how climate-related risks and opportunities are identified, assessed and managed
This requires information to be provided about the systems and processes in place to enable such risks and opportunities to be identified, assessed and managed, including whether they are identified at subsidiary level and reported up through the group or at group level only, as well as the frequency of the risk identification exercise.
Description of how processes for identifying, assessing, and managing climate-related risks are integrated into the overall risk management process
Companies and LLPs should explain the extent to which climate-related risk is currently integrated into their overall approach to risk management or whether the identification, assessment and management of climate-related risks are subject to separate processes and procedures. This will indicate the maturity of the approach adopted in respect of climate-related risks, the level of resource assigned to understanding this systemic risk and whether process changes are likely to occur in the future.
Description of principal climate-related risks and opportunities arising in connection with operations (and assessment time periods) and description of actual and potential impacts of those principal climate-related risks and opportunities on business model and strategy
The principal climate-related risks are those which have the potential to have a significant negative or positive impact on a company or LLP’s business model and/or strategy. The Guidance states that, wherever possible, companies and LLPs should categorise the risks and opportunities into short term, medium term and long term, with an explanation of how these time periods have been determined. It notes that the assessment of appropriate time periods should take into account the nature of the company or LLP’s business and operations and gives examples of factors that may be relevant, such as the budgetary cycle, asset lives, length of financing arrangements and the periods over which climate risks and opportunities are expected to affect the business. It also notes that it may be relevant to distinguish between “physical” climate change risks (such as increased frequency of extreme weather events or sustained impacts from temperature rises, for example, to supply and distribution arrangements), and “transition” risks (risks associated with transition to a net zero economy) which might prompt review or adaptation of business models. The Guidance provides examples of transition risks and opportunities that may be relevant to some companies and LLPs.
The Guidance states that the description of the actual and potential impacts should be as “granular as is necessary to understand the impact of crystallisation of that risk and should be specific” and in describing the actual or potential impact, both the actions being put in place now and contingency plans for possible future actions should be considered. The Guidance provides examples concerning consideration of the impacts of physical risks, of technology or policy-related transition risks, of market-related transition risk and of legal or reputational-related transition risk.
Analysis of the resilience of the business model and strategy, taking into account consideration of different climate-related scenarios
The Guidance advises that companies and LLPs should select scenarios which are most relevant to their business. Disclosures should enable a reader to understand which scenarios have been used, including, where appropriate, the source of those scenarios, and the effect that operating within them would have on the resilience of the current business model and strategy. Disclosures should also enable a user of the accounts to understand why a particular scenario has been chosen (for example, where the use of a particular scenario has become the industry norm).
It is acknowledged that assumptions and estimates may be needed to complete scenario analysis and these should be disclosed so that a reader can judge whether they are reasonable and in line with similar companies or LLPs. The Guidance notes that the government expects that the complexity and sophistication of the assumptions and estimates will grow over time as companies and LLPs become more familiar with performing scenario analysis. Where assumptions and estimates change year on year, the disclosures should enable a user of the accounts to understand how and why they have changed. While there may be significant divergence in methodology, assumptions and estimates at the outset, the government anticipates natural convergence within industries over time as good practice emerges.
The Guidance points out that while the Regulations do not require quantitative scenario analysis (using narratives to explore implications of different possible climate impacts), some companies and LLPs may find it useful to do so to support their strategy and risk management considerations. It also recommends that the resilience of the business model and strategy is evaluated and disclosed according to the scenarios used as this provides an opportunity to identify options to strengthen business resilience to plausible climate-related risks and opportunities.
Description of targets used to manage climate-related risks and to realise climate-related opportunities and of performance against those targets and KPIs used to assess progress against those targets and description of the calculations on which those KPIs are based.
Targets should be clearly explained, including their relevance to the future operations of the company or LLP. The disclosure should include a timeframe over which the company or LLP intends to meet those targets and how it monitors and assesses progress in meeting them. The company or LLP should also explain which climate-related key performance indicators (KPIs) it uses to assess progress against these targets to manage climate risks and opportunities, how these are calculated, and, if different from the targets set, how the KPIs relate to targets. If a company or LLP changes a climate-related KPI used to manage its climate-related risks and opportunities, the reason for the change should normally be disclosed with explanations of why the new KPI is more effective than the previous measurements.
Interaction with other regulations and frameworks
The Guidance considers the interaction with other existing requirements. Where a UK-registered listed company is subject to the Company Regulations and the FCA’s Listing Rule requirements on TCFD recommended disclosures, then disclosure in a manner consistent with the TCFD recommendations in its annual report will mean it is compliant with the Company Regulations as similar information would be used for the disclosures and requirements of the Company Regulations.
In addition, the interaction with the requirements for occupational pension schemes to take actions on climate risk, the Streamlined Energy and Carbon Reporting requirements, accounting standards and financial statements, and the development of International Sustainability Disclosure Standards are considered in the Guidance with a non-exhaustive list of further guidance produced by other bodies related to the TCFD recommendations.
The Regulations require a greater range of UK companies and LLPs to ensure that their existing climate governance and risk processes comply with and can be mapped against the TCFD recommendations framework, and that there are no gaps in their environmental and climate reporting. This is likely to result in a number of challenges, not least ensuring they have the necessary systems in place to be able to track climate change-related targets and progress in meeting them.
Failure to include climate-related disclosures in the Strategic Report (or the Energy and Carbon Report where applicable), or disclosures that are untrue or misleading could result in claims for compensation against the company and/or directors in their personal capacity, as well as sanctions from the FRC as regulator, shareholders or members and/or a requirement to prepare a revised report.
Across our Legal, Technology and Risk Consulting teams we have significant experience of supporting businesses with change programmes and sustainable finance initiatives and requirements. This includes assisting organisations to assess impacts, conduct gap analyses, build programme plans and policies to deliver the required changes as well as providing ongoing support to them as they develop their governance, oversight and reporting processes.