Mandatory Climate-related Disclosures Set to Become Law in the UK
On 29 October 2021, the UK government introduced The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 20211 (the “Draft Regulations”), which would, once in force, amend the Companies Act of 2006 and require mandatory climate-related financial disclosures by large UK registered companies and financial institutions. The adoption of the Draft Regulations would make the UK the first country in the G-20 to promulgate legislation requiring the disclosure of climate-related risks. The Draft Regulations, which also follow the publication of the UK’s Net Zero Strategy2 that sets out how the UK government plans to deliver its emissions targets of net zero by 2050 and a 78% reduction from 1990 levels by 2035, will also make the UK the first G-20 nation to require disclosures aligned with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (the “TCFD”) recommendations.3
The Draft Regulations reflect the UK government’s view that companies with the greatest economic and environmental impact should take the lead in assessing and disclosing that impact and the associated risks, and enshrine the UK’s commitment to allowing investors and business to better understand the financial impacts of their exposure to climate change and to better manage climate-related risks.
The Draft Regulations take into account the responses to the UK government’s consultation on mandatory climate-related financial disclosures, which was carried out from March to May 2021 (the “Consultation”).4 Further details about the Consultation can be found in our earlier insight here. Based on feedback received during the Consultation, the main changes in the Draft Regulations include: (i) closer alignment with the recommendations of the TCFD than initially proposed, which is largely driven by stakeholder feedback, and (ii) a new requirement for “qualitative scenario analysis” of the resilience of the company’s business model and strategy in different climate-related scenarios.5
Which organisations will be affected?
The Draft Regulations are applicable only to the following large UK companies and financial institutions:
- all UK companies6 that are currently required to produce a non-financial information statement, being UK companies that have more than 500 employees and have transferable securities admitted to trading on a UK regulated market, banking companies or insurances companies (i.e., Relevant Public Interest Entities with more than 500 employees (“PIEs”));
- UK registered companies with securities admitted to the Alternative Investment Market (“AIM”) with more than 500 employees; and
- UK registered companies which are not included in the categories above, which have more than 500 employees and an annual turnover of more than £500 million.
Reporting for affiliated companies will be made at the group level on a consolidated basis and the employee size and turnover thresholds which determine applicability of the disclosure requirements would also apply on a consolidated basis.
A separate set of regulations applicable to limited liability partnerships (“LLPs”) are expected to be published in due course following parliamentary approval of the Draft Regulations, and will take the form of an amendment to the Limited Liability Partnerships Act 2000. The LLP regulations are expected to apply a modified form of the company provisions. The UK government has stated that it expects such regulations to apply to UK incorporated LLPs which have more than 500 employees and an annual turnover of more than £500 million.
What will the new disclosure obligations involve?
The climate-related financial disclosures which will be required to be made by the above companies under the Draft Regulations include:
- a description of the company’s governance arrangements in relation to assessing and managing climate-related risks and opportunities;
- a description of how the company identifies, assesses and manages climate-related risks and opportunities;
- a description of how processes for identifying, assessing and managing climate-related risks are integrated into the company’s overall risk management process;
- a description of:
- the principal climate-related risks and opportunities arising in connection with the company’s operations; and
- the time periods by reference to which those risks and opportunities are assessed;
- a description of the actual and potential impacts of the principal climate-related risks and opportunities on the company’s business model and strategy;
- an analysis of the resilience of the company’s business model and strategy, taking into consideration different climate-related scenarios;
- a description of the targets used by the company to manage climate-related risks and to realise climate-related opportunities and of performance against those targets; and
- a description of the key performance indicators used to assess progress against targets used to manage climate-related risks and realise climate-related opportunities and of the calculation on which those key performance indicators are based.7
Companies will be required to make the above disclosures in the Non-Financial Information Statement, which are due to be re-named under the Draft Regulations to “Non-Financial and Sustainability Information Statement” (“NFIS”) of their Strategic Report. Companies that are not currently required to produce a NFIS will only be required to produce the climate-related financial disclosure elements of that statement.8
The UK government has also indicated that LLPs will be required to make the above disclosure in the NFIS of their Strategic Report, while LLPs that are not currently required to produce a NFIS will be required to make such disclosures in their Energy and Carbon Report.9
What flexibility will businesses have?
The Draft Regulations include a so-called “materiality filter”, designed to give a degree of flexibility to a company’s directors to omit the whole or relevant part of the climate-related financial disclosures which relate to the Strategy and Metrics Targets elements of the TCFD recommendations10 (i.e., the disclosures set out in items (e), (f), (g) and (h) above) if the company’s directors reasonably believe, having regard to the nature of their company’s business and the manner in which it is carried on, that such disclosures are not necessary for an understanding of the company’s business. In such cases, the Draft Regulations provide that the NFIS must provide a “clear and reasoned” explanation of such directors’ reasonable belief as to why the omitted information is not necessary. It’s unclear how much scrutiny such explanations will receive from regulators.
In addition, the Draft Regulations do not specify which specific climate-related scenarios a company must use in its assessment of the company’s business model and strategy resilience, only that intends to make clear in the guidance that “a qualitative assessment of resilience against different scenarios will be sufficient to meet the obligation.”11
How will this impact businesses?
Once the Draft Regulations become law (and subject to any amendments made during the parliamentary scrutiny and approval process), over 1,300 UK-registered companies and financial institutions will be required to comply with the disclosure requirements set out in the Draft Regulations.
However, for some companies, the Draft Regulations may not represent any meaningful change. Under the Financial Conduct Authority’s (“FCA”) Listing Rules, for each financial year beginning on or after 1 January 2021, commercial companies with a premium listing12 are already required to include a compliance statement in their annual financial report stating whether they have made disclosures consistent with the TCFD’s “four pillars” and “eleven recommendations”, or else explain why they have not done so. The disclosures in the Draft Regulations are designed such that they are aligned with the four overarching pillars of the TCFD recommendations (governance, strategy, risk management and metrics & targets) but the Draft Regulations do not require specific disclosures against each of the “eleven recommendations”. As such, companies subject to these FCA requirements are already subject to a slightly higher standard of disclosure that includes the “eleven recommendations.” The Draft Regulations, however, only allow omissions where a disclosure is not “necessary” for understanding a company’s business, whereas the Listing Rules allow companies to provide explanations for non-disclosure for reasons other than immateriality.
For companies that are not already subject to the Listing Rules and for whom the Draft Regulations will be their first mandatory climate-related financial disclosure, this is likely to represent a major shift. The UK government has indicated that it intends to publish guidance before the end of 2021, to support in-scope companies in the implementation of their disclosure obligations.
Presently, the Draft Regulations are expected to be passed into law by 6 April 2022, with a set of regulations applicable to LLPs expected to be passed into law thereafter. Afterwards, the Draft Regulations will be applicable to the relevant companies for accounting periods starting on or after that date.
3 In October 2021, New Zealand became the first country to pass laws requiring large financial institutions, insurers and equity and debt issuers to make climate-related disclosures based on TCFD recommendations, which are expected to become mandatory for financial years commencing 2023. However, the UK requirements discussed in this article are expected to come into force on 6 April 2022, in advance of the New Zealand requirements.
6 Meaning English, Scottish, Welsh and Northern Irish companies that are subject to the Companies Act 2006 and that are subject to the requirements under section 414CA of the Companies Act 2006.
12 UK premium listed companies are those listed on the London Stock Exchange with a minimum free float of 25% and with 75% of business supported by a revenue earning record of three years, and which are required to meet the UK’s highest standards of regulation and corporate governance.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.