CapitalQuarter – Spring 2024
Climate-related disclosures are not just a compliance exercise. The analysis involved may help you to protect your business. Here’s a guide to the requirements and complexities.
Since 1 January 2021, the Listing Rules have required premium listed companies to follow the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), on a ‘comply or explain’ basis. These rules were extended to certain standard listed companies for accounting periods beginning on or after 1 January 2022.
The effects of climate change are ever more visible and have the potential to impact an increasing number of entities of every nature and size. In response, the Climate-Related Financial Disclosure Regulations 2022 were introduced in the UK to help investors make informed decisions as the UK progresses towards a low-carbon economy.
For periods starting on or after 6 April 2022, certain UK companies must disclose relevant information in their annual reports, as set out in the Regulations. This applies to:
- public interest entities (PIEs) with more than 500 employees
- UK-registered companies with securities admitted to the AIM with more than 500 employees
- UK-registered companies not included in the categories above, with more than 500 employees and a turnover of more than £500m.
Certain LLPs will also be captured by the Regulations but the requirements are complex and should be assessed case by case.
What are the Regulations?
Companies within scope must disclose, under the four pillars (see below) in the non-financial and sustainability information (NFSI) statement of their strategic report, or in their energy and carbon report if they don’t produce a strategic report. These requirements are based on the Task Force on Climate-Related Financial Disclosures recommendations, but are not identical. Minor adaptations ensure the language and format of the content is suitable for UK legislation.
What are the four pillars?
The four pillars of governance, risk management, strategy, and metrics & targets are the overarching areas in which climate-related disclosures sit. Under the pillar headings are eight further specific requirements:
Governance and Risk Management (Pillars 1 & 2)
- A description of the governance arrangements of the company 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 overall risk management process in the company
Strategy (Pillar 3)
- A description of the principal climate-related risks and opportunities arising in connection with the operations of the company and a description of 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 business model and strategy of the company
- An analysis of the resilience of the business model and strategy of the company, taking into consideration different climate-related scenarios
Metrics & Targets (Pillar 4)
- 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
- The key performance indicators used to assess progress against targets used to manage climate-related risks and realise climate-related opportunities, and a description of the calculations on which those key performance indicators are based
Are the Regulations mandatory?
Unlike the Listing Rules, the Regulations are mandatory rather than ‘comply or explain’. But the duty to make disclosures under the Regulations includes discretion to omit some of them where they are not considered necessary for an understanding of the business. However, directors must provide a clear explanation as to why they believe it is appropriate to omit the information.
Group considerations
Companies are expected to report at group level, or at company level if not included in consolidated group reporting. This is particularly relevant to AIM-listed companies in the natural resources sector. These quite often find themselves with a small UK headcount but a large worldwide workforce owing to the labour-intensive nature of the industry. UK subsidiaries whose activities are included in the consolidated group report of a UK parent that complies with the climate-related financial disclosures requirements are not required to report separately.
But UK companies with an overseas parent that reports on a consolidated basis, with all the relevant Regulation disclosures, cannot take advantage of this exemption. Neither can UK companies which are included in an LLP set of financial statements.
Where a parent company does not produce consolidated accounts, the scope criteria should be applied to the aggregated turnover and employee figures of the group headed by that parent. In these cases, the climate-related financial disclosures must relate to the parent company, including how climate-related risks and opportunities may affect the value of the investment in the subsidiaries. A subsidiary of a parent company that does not produce consolidated accounts, and that is within scope on an individual basis, must also make climate-related financial disclosures in its individual accounts.
When a UK group is in scope, the top UK parent is expected to include in its annual report the global operations of the UK group, regardless of whether activities are conducted through a UK or overseas subsidiary.
IFRS S1 and S2
On 26 June 2023, the International Sustainability Standards Board (ISSB) released its first two International Sustainability Disclosure Standards (IFRS SDS or ‘the Standards’) that became effective for periods beginning on or after 1 January 2024.
Although the ISSB has built upon work of several pre-existing frameworks, it is the Task Force on Climate-related Financial Disclosures (TCFD) framework that forms the bedrock of the first two standards that have been issued by the ISSB.
IFRS S1 provides a set of disclosure requirements designed to enable companies to communicate to investors about the sustainability-related risks and opportunities they face over the short, medium, and long term.
IFRS S2 sets out specific climate-related disclosures and is designed to be used in conjunction with IFRS S1. For IFRS S1 and S2 to be available for use in the UK, they must first be endorsed. The UK government is currently consulting on their endorsement, and aims to make decisions on the first two Standards by July 2024. However, this does not mean that accounts preparers can disregard climate-related risks and disclosures.
While accounting standards do not currently refer to ‘climate change’, the potential implications from climate-related risks could impact:
- asset impairment, changes in the useful life of assets, or the fair value of assets;
- increased costs and / or reduced demand for products and services affecting impairment calculations;
- potential provisions and contingent liabilities arising from fines and penalties; and
- changes in expected credit losses for loans and other financial assets.
It is important the preparers of financial statements familiarise themselves with the Standards as the UK government has been a strong supporter of the ISSB since its launch and it is a case of when, not if, the Standards will be endorsed. Companies who understand these requirements sooner will be better prepared to implement them later, especially as these will be reported at the same time as year end financial reporting and will cause additional reporting pressures to the finance team. Additionally, a good understanding of the standards will allow companies the opportunity to gather good quality data and assess whether their policies and procedures for gathering such data, not just within the finance team but the wider organisation, are adequate.
If you would like further information or guidance on issues raised in this article, please contact Ryan Davies.
