UK gives green finance sector an edge with binding TCFD rule

The UK plans to compel its largest companies to keep track of how climate change is creating costs and opportunities, jumping ahead of a group of countries rushing to expand financial reporting rules.

It will require companies to disclose how climate change could hurt their profits through revisions to two acts, according to a 24 March consultation. The plans are based on recommendations published in 2017 by a private sector-led body affiliated with the G20, the Task Force on Climate-related Financial Disclosures (TCFD).

It will see the disclosures in the annual financial reports of banks, UK-registered companies, listed companies, asset managers, life insurers, general insurers, and two different kinds of pension plan provider.

It will first capture the high-earners. The UK has already put into place a separate rule, adding TCFD to "premium listed" companies' reporting requirements in a 1 January update to stock market listing guidance.

Many of the targeted organizations already publish climate-related data in financial reports to shareholders, but more and more are set to submit a larger chunk of data as the UK scales up its scheme from its launch on 6 April 2022 through to 2025.

Risks can come from climate change itself or policy responses to it, according to a paper on a prior consultation by the UK's financial regulator, the Financial Conduct Authority (FCA).

Companies must report on not only the possible costs of climate change, but also the possible impacts of their activities on it. The consultation suggested the "like-for-like" climate impact and risk data would spur green investment and "support a competitive and resilient UK economy" while also raising protection for consumers, for example pension holders.

London's finance sector could gain an edge as global finance turns green, the government said. "Clear disclosure expectations on climate change can also help further underpin the reputation of the London market as a leading venue for high-quality listings, thus ensuring that the UK remains an attractive domicile for internationally active financial intuitions and that London retains its position as a leading international financial center," the government promised in the consultation.

The government also said it is supporting creation of a new global Sustainability Standards Board by the UK-headquartered International Financial Reporting Standards (IFRS) Foundation by the end of September, and the mooted launch of a global sustainability standards board at the UN Climate Summit (COP26) in Glasgow, Scotland in November.

TCFD spreads around the world

In proposing TCFD-aligned disclosures, the UK follows in the footsteps of New Zealand, which announced a partly mandatory climate risk reporting regime in September 2020 that is set to be rolled out in 2023. Australia, Canada, France, Japan, and the EU are each working towards climate risk reporting rules for companies.

Like New Zealand's regime, the UK is allowing an opt-out for companies that have an excuse for not sharing data. But unlike New Zealand, the UK will require reporting outside the financial sector by non-financial listed companies of a certain size, according to IHS Markit Senior Research Analyst Sara Giordano.

Several countries have some rules already in play. Five years ago, France passed Article 173 of the Energy Transition Law to introduce mandatory climate reporting for institutional investors. This followed its introduction of mandatory climate and social reporting for companies in 2002, which was preceded by the 1995 Green Accounts rule requiring reporting for certain companies in Denmark. "For quite some time, however, France has been reckoned as the country with the most advanced regulatory framework in terms of mandatory climate reporting," Giordano said.

Despite departing the EU at the start of the year, the UK shares the bloc's ambitions on green disclosures. The EU in its 2018 non-financial reporting directive (NFRD) required larger companies, banks and insurers to disclose environmental and social data, suggesting in the guidelines that use they TCFD, but use of the guidelines was not made mandatory.

The European Commission plans to adopt an act forcing companies and financiers to classify how green their activities are according to a system still under wraps, a so-called Green Taxonomy, by 1 June, but the UK plans to formulate its own version. The UK is making related changes at its central bank, the Bank of England, following calls for EU banks to urgently address their climate change risk by the Bank of France.

Voluntary reports remain weak

Beyond legislation, many companies with direct exposure to fossil fuel supply chains or causing high emissions (like banking, insurance, financial markets, energy, transport, buildings, food, agriculture, and forestry) voluntarily report to shareholders using TCFD guidelines.

European companies from Spain, France, Italy, and the UK report the most, spurred by the EU's NFRD. Companies in the energy sector, like majors and electric utilities, file some of the most complete TCFD-aligned reports, according to Ernst & Young's 2019 survey of TCFD reporting. This is because of pressure from investors, direct shareholder action, and changing public opinion.

But despite some TCFD adoption, and more recently, the net-zero movement by governments and companies, "limited progress has been made in addressing climate-related financial disclosures" since 2017, said Ernst & Young in the survey. Companies usually don't make climate-related forecasts or include them in enterprise risk management plans, it said.

The UK is no exception when it comes to a lack of strong TCFD reporting. "Last autumn, Ernst & Young found that fewer than half of UK premium listed companies fully or partially adopted TCFD requirements in their corporate reporting, which highlighted the scale of work still to be done even before the expansion of requirements to other listed and non-listed companies," Ernst & Young's Global Climate Change and Sustainability Services Leader Mathew Nelson wrote in a blog on the UK proposal last month.

TCFD acknowledged that, despite progress, many reporting companies had more work to do in its 2020 status report on the regime.

The UK government appears to have latched on to this, saying in its TCFD roadmap, "given the urgency of the climate threat, a voluntary approach to climate-related financial disclosure may not be sufficient." Only a third of the UK's larger listed companies were reporting in 2019, and those that did report often did not fully describe the scope and nature of their strategies, observed the FCA.

Climate risk to go mainstream

Two years ago, the UK introduced mandatory reporting on direct GHGs as well as energy use with the Streamlined Energy and Carbon Reporting rule, covering about 12,000 of the UK's largest companies. The regulations are intended to increase awareness of their energy costs.

The UK appears to be building on this and other emissions reporting regimes. "GHG reporting followed a similar path and international standards now enable consistent calculation and reporting of GHGs which facilitates like-for-like decision making when it comes to investment and procurement decisions considering GHG mitigation," Robbie Epsom, EMEA head of ESG, CBRE Global Investors told IHS Markit.

But it should take care to avoid duplicating the GHG reporting companies face. "To minimize the reporting burden and maximize the benefit, it would be great to see the mandatory TCFD regulation align with the current streamlined energy and carbon reporting regulation, perhaps," said Epsom.

The newly required data reports would be more effective, and have greater impact, if they presented the strategy, targets, metrics, and analysis beside financial data, he added.

The TCFD regime could spur a sea change as smaller companies become active on climate risk, Epsom predicted. "It will catalyze a shift in the market to mainstream the consideration of climate risk, both physical and transitional, as part of business decision making," he said.

The UK's latest move benefits from the net-zero declaration trend of the past year, coinciding with a rise in demand for green investments in Europe. "With access to this information, decisionmakers and investors will be able to make informed decisions to support their sustainability strategies and net-zero targets. Therefore, allowing businesses to take positive and targeted action on climate risk," said Epsom.

Posted 14 April 2021 by Cristina Brooks, Senior Journalist, Climate and Sustainability