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UK Financial Reporting Council to Review How Companies Disclose Climate Change Risks

On February 20, 2020, the Financial Reporting Council (“FRC”) announced a shift in their reviews of company and auditor climate change risk disclosures. The FRC’s review will focus on ways to improve information quality to enhance both transparency and investor decision-making.

Asset managers have become increasingly concerned about the accuracy of the information provided by public companies, even if audited, and whether inaccuracies could leave them vulnerable to losses. Acknowledging the recent increase in pressure on investors to prove that they are investing responsibly, Sir Jon Thompson, the CEO of the FRC, reminded the financial community that “not only do boards of UK companies have a responsibility to report their impact on the environment and the risks of climate change to their business, but investors expect them to operate sustainably.” With respect to auditors, Thompson indicated they must “properly challenge management to assess and report the impact of climate change on their business.”

The FRC is an independent regulator that oversees auditors, accountants and actuaries in the United Kingdom (the “UK”), and sets reporting standards for all listed companies in the UK through the country’s Corporate Governance and Stewardship Codes. The FRC’s authority comes from delegated statutory powers as well as widespread voluntary support from stakeholders.

Current UK Reporting Requirements

Although the UK does not yet have specific climate change related reporting requirements, existing regulations do impose various reporting obligations on general environmental risks and uncertainties. For example, depending on a company’s size, Section 172 of the Companies Act 2006 imposes a duty on directors of a company to consider the impact of the company’s operations on the community and the environment. The Companies Act also requires businesses to disclose principal risks and uncertainties facing a company through issuance of a strategic report, in which many companies disclose their businesses’ impact on the environment. In addition, the UK Streamlined Energy & Carbon Reporting requirements impose an obligation on certain companies to include in their annual report their greenhouse gas emissions, as well as their energy consumption and efficiency.

FRC Review

The FRC will undergo a “major review” of how firms currently respond to their reporting responsibilities and will encourage implementation of better practices. The FRC anticipates using specific tools to monitor current reporting, including:

  • Industry Sampling: The FRC will review a sample of company reports and accounts across specific industries to generally assess the level of compliance with existing reporting requirements.
  • Auditor Assessments: The FRC will review a sample of audits to determine whether auditors are appropriately reflecting climate risks in company reports and accounts. The FRC will specifically focus on “key areas of judgment”.
  • Available Resources: The FRC will also assess the resources available to auditors to support teams for evaluating climate impact on companies.
  • Disclosure Quality: The FRC will evaluate the quality of disclosures made to date under the new UK Corporate Governance Code, which was issued in 2018 and applies to accounting periods beginning on or after January 1, 2019. The UK Corporate Governance Code imposes various risk reporting requirements on companies in assessing future business success. The FRC will review the quality of such disclosures, by focusing on consideration of both emerging and long-term risks impacting the specific company.
  • Adoption of Recommendations: The FRC will also evaluate the extent to which the recommendations of the Financial Reporting Lab, an initiative of the FRC, have been successfully adopted. The Financial Reporting Lab recommends that companies use the Task Force for Climate-related Financial Disclosures (TCFD) framework for reporting on climate-related risks. The TCFD was established to increase the amount of information available to investors on climate-related risks and to develop a consistent disclosure framework. Under its Green Finance Strategy, the UK government currently expects “all listed companies and large asset owners to disclose in line with the TCFD recommendations by 2022”.

Conclusion

The FRC’s review comes in response to increasing investor demand for greater company disclosure of climate risks. Through increased scrutiny, the FRC’s review could lead to increased reporting data for investors, as well as more rigorous adoption of, and compliance with, current reporting standards. Although the impact remains to be seen, by requiring greater transparency in company decisionmaking processes and climate-related risk evaluations, sustainability-focused investors may reevaluate their current capital allocations and shift to more climate-conscious companies.

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.