Asset managers are not sufficiently reporting on climate risk, TCFD consultation finds
This article was co-authored by Michael Cabot, Trainee Solicitor, London.
Hurricanes, severe flooding and destructive wildfire events have been steadily increasing both in terms of frequency and ferocity. It is generally accepted that the cause of this acceleration is global warming. Changes are being made around the world to move to a carbon-neutral or carbon-zero environment. It is now imperative that regulators, advisers and investors recognise the effect that climate change has on both risks and opportunities in business, now and in the future.
The United Kingdom has become the first country to put in place requirements for mandatory disclosures related to climate change for large companies and financial institutions. This development comes in the form of a five year plan which seeks to implement requirements for such disclosures by 2025.
The UK Government has concluded that mandatory climate-related disclosures should be aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD).
TCFD Status Report
In June 2017 the TCFD released its final report setting out recommendations for helping businesses disclose climate-related financial information. Recommendations included seven guiding principles providing that disclosures should:
- Represent relevant information
- Be specific and complete
- Be clear, balanced, and understandable
- Be consistent over time
- Be comparable among companies within a sector industry or portfolio
- Be reliable, verifiable, and objective
- Be provided on a timely basis.
The TCFD released its 2020 status report in October 2020 which describes the progress that companies are making in the implementation of TCFD recommendations. Whilst interest in and support of the TCFD’s work has risen steadily, the report states that the TCFD “believes reporting by organisations to their clients and beneficiaries may not be sufficient and that more progress may be needed to ensure clients and beneficiaries have the right information to make financial decisions”.
Response from regulators
In response to these findings, a number of UK regulatory agencies have made announcements to indicate their continued support of the TCFD.
HM Treasury intends to make it mandatory by 2025 for large UK companies and financial institutions to make climate-related disclosures in line with those recommended by the TCFD in 2017.
The FCA confirmed that from 1 January 2021 there are new rules requiring premium listed companies to make better disclosures about how climate change affects their business, consistent with the recommendations of the TCFD. The new rules will be introduced on the general ‘comply or explain’ basis and it is predicted that companies will comply, with allowances for modelling, analytical or data based challenges. It is expected that these allowances would be very limited in scope. The TCFD Interim Report notes that the FCA is considering providing guidance on the “limited circumstances” where firms could explain rather than comply, indicating that these changes are effectively mandatory in nature.
Climate-related disclosures are aimed at “clients” and “end-investors”, rather than the shareholders. A new FCA consultation will open in the first half of 2021 with a view to extending the scope of these rules and introduce TCFD obligations for asset managers, life insurers and pension providers. The FCA has said that this implementation is just a first step that must be complemented by more detailed climate and sustainability reporting standards that promote consistency and comparability.
The FRC has highlighted that firms must “do more” to incorporate factors of climate change into planning procedures. The FRC continues to investigate the detail that investors expect in relation to climate-related disclosures and how better practice reporting under the TCFD recommendations can be implemented.
The Prudential Regulation Authority issued a ‘Dear CEO’ letter in July 2020 stating that “climate change represents a material financial risk to regulated firms” and that “good practice continues to evolve”.
Timeline - roadmap
The TCFD have proposed a timeline of regulatory action or legislative measures which spans from 2021 to 2025. This roadmap is subject to further refinements to measures across categories, including in response to evolving best practice.
It would see measures (affecting occupational pensions schemes with a value greater than £5 billion, banks, building societies, insurance companies and Premium listed companies) come into force as of 2021.
The scope of these measures will then be expanded in 2022 to include occupational pensions schemes with a value greater than £1bn, the largest UK-authorised asset managers, life insurers and FCA regulated pension providers, UK-registered companies and a wider scope of listed companies.
By 2025 the timeline projects that new measures will be put in place affecting other UK-authorised asset managers (2023), life insurers and FCA regulated pension providers and occupational pensions schemes (subject to review)
Proposed changes may be made to the Companies Act 2006 that will require large private companies in the UK to make climate-related disclosures in annual report and accounts by 2022.
These announcements indicate that UK regulatory bodies are facing the impending climate crisis head-on and are taking steps to ensure that climate-change risks are properly understood and addressed. UK firms will be required adapt to the shifting regulatory environment. Organisations must consider how they will be impacted by these new disclosure requirements and the steps that need to be taken to comply.
Regulators have been clear that disclosure obligations will be tailored by sector and will consider an organisation’s size and ability to implement change to ensure "proportionate implementation". Nonetheless, smaller organisations may be disproportionately affected by the costs of putting processes in place to meet new disclosure requirements.
Boards will need to take particular care to ensure that they put in place adequate governance to actively review and consider climate-related risks and opportunities and ensure that such are managed and reported accordingly. Boards falling short in this regard are likely to be called to account, not only by regulators, but also by shareholders and investors.