CapitalQuarter – Autumn 2022
Never has clear communication of climate-related information been more important for businesses.
Businesses, alongside financial institutions and governments, have a hugely influential role in solving the current climate crisis. They have the capacity needed, both in resources and innovative capabilities, to drive the radical transformation our economy must make to stay below the 1.5-degree target set by the COP21 Paris Agreement.
COP26 further highlighted the impacts to business of increasingly ambitious global net zero commitments. These commitments demand more innovative solutions and faster changes to government policy and regulation.
Using a systemic approach business can use this changing landscape as an opportunity to gain or maintain competitive advantage. They can turn risks into opportunities. Through their sustainability strategy, risk management, target-setting, and early-stage data collection, their reporting can be more robust, their stakeholder engagement improved, and they can be more resilient in the long term.
Dealing with physical and transition risks
Effective capital markets rely on quality disclosures for material items. These inform asset pricing and capital allocation. Physical and transition risks relating to climate change could be material for most companies.
Physical risks arise from the climatic impact of higher average temperatures. This may mean reliance on increasingly scarce resources or coping with extreme weather events. Transition risks refer to the effects of our transition to net zero. They may arise from changes to consumer taste, technology, policy and regulation.
Considering the transition, companies not already reporting should perform a gap analysis to assess disclosure gaps and benchmark themselves against peers as well as investor expectations. UK companies should familiarise themselves with the UK Government’s Roadmap towards mandatory climate-related disclosures. The roadmap phases in the requirement for climate-related financial disclosures and is set to cover the whole UK economy by 2024/25.
The reporting landscape
Companies listed on the Main Market will already be thinking about climate-related financial disclosures. The FCA introduced a new Listing Rule for companies to report such disclosures consistent with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations. The new rules apply to premium and standard listed companies, for periods commencing on or after 1 January 2021 and 1 January 2022 respectively.
The next phase of the UK Government’s roadmap brings more UK companies and LLPs into scope for accounting periods commencing on or after 6 April 2022. These include:
- UK companies with more than 500 employees and transferable securities admitted to a UK regulated market, AIM, or which are banking or insurance companies, and
- UK companies and LLPs with more than 500 employees and a turnover of more than £500m.
UK regulations are based on TCFD.
What’s in the guidance?
The TCFD released its disclosure requirements to help companies improve reporting of climate-related financial information. Its objectives are:
- more effective risk assessments on issues of climate by companies, suppliers and competitors;
- better capital allocation;
- improved strategic planning.
The TCFD guidance sets out 11 recommended disclosures around four key pillars:
- Governance – the organisation’s governance for climate-related risks and opportunities
- Strategy – the actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning (where relevant)
- Risk management – how the organisation identifies, assesses and manages climate-related risks
- Metrics and Targets – the metrics and targets used to assess and manage relevant climate-related risks and opportunities (where relevant)
Even with the TCFD guidance, the company should still develop its own robust ESG strategy to align with its objectives. It needs to carefully consider how to achieve ESG objectives, and how they will be embedded into operations and consistent with shareholder and wider stakeholder interests.
10 tips for quality reporting
The majority of companies present climate disclosures in a sub section of the strategic report or a stand-alone climate disclosures report within the annual financials. Here are some top tips for quality climate-related disclosures:
- They must be tailored and relevant to your business and key stakeholders
- Align climate targets to those for the rest of the business
- Include timeframes and set targets over a variety of timeframes
- Make strategy and targets achievable and realistic, to ensure accountability by the company and buy-in from stakeholders
- Do not make them vague or misleading, to avoid any risk of greenwashing
- Disclose the links between climate impacts and financial performance indicators
- Use scenario analysis when discussing strategy for the move towards net zero
- Embed the reporting process into ongoing operations as something that is always evolving
- Use tables and graphs to present the disclosures, where suitable
- Use the guidance
What will happen next?
We expect to see movement towards a global baseline of corporate reporting standards following the IFRS Foundation’s establishment of the International Sustainability Standards Board (ISSB) in November 2021. The ISSB is working quickly to build a global set of standards based on and combining existing frameworks, including TCFD.
At the moment, it’s not obligatory for issuers to have a third-party audit or assurance of their climate disclosures under the TCFD-aligned disclosure rules. But it’s highly likely we will soon see the introduction of at least a mandatory ‘limited assurance’.
Although smaller businesses may not currently be directly impacted by the regulation to either produce financial-related climate disclosures in their annual report or publish net zero strategies, there is a significant ripple effect through supply chains. FTSE350 companies have to disclose Scope 3 emissions (which is largely their supply chain). That means suppliers are being asked to measure their carbon footprint and produce their own net zero plans. Otherwise, they risk losing their biggest customers.
Time to communicate
The increasing focus on climate change and stakeholder expectations around disclosures is clear to see. These expectations are only set to increase.
It’s important for companies to be prepared and ahead of the curve. It’s also vital to appreciate the real benefits of communicating strategy and objectives relating to climate risks and opportunities, as well as wider ESG matters.
Good communication about environmental, social and governance risks and opportunities is increasingly valuable. It provides access to capital, helps to maintain relationships with key stakeholders, and attracts and retains talent. Companies that lag behind will feel the detrimental effect of poor disclosure.
Of course, increased reporting is not without its risks because of the greater exposure it brings. So, it’s important to start early, and invest the necessary time to implement the process well. Allow time, too, where required, to seek assurance or legal advice from a risk management perspective.
If you would like further advice on the issues raised in this article, please contact Jessica Wills.
