Financial services firms need to ensure they are compliant with current reporting standards and also monitor policy developments so that they are ready to adapt to an ever-changing regulatory landscape, both in the UK and EU.
Current regulation
The Taskforce on Climate-related Financial Disclosures (TCFD) was created in December 2015 by the G20 Financial Stability Board. In June 2017, the TCFD published a range of voluntary recommendations, setting out guidelines which companies could follow when providing climate-related disclosures. Despite the initial voluntary nature of the TCFD recommendations, multiple jurisdictions, including the UK, have made reporting in line with the TCFD recommendations mandatory.
Premium-listed companies, AIM-listed companies, large private companies and limited liability partnerships (LLPs), some issuers of standard-listed equity shares and global depositary receipts, as well as those firms regulated by the Financial Conduct Authority (FCA) or Prudential Regulation Authority (PRA)- are already subject to TCFD style reporting requirements. In line with the Treasury roadmap towards mandatory climate-related disclosures published in November 2020, it is expected that further companies will be brought under these mandatory requirements over the next three years.
In addition to this, in an April 2019 supervisory statement, the PRA also said that it expects PRA-regulated firms to “engage with wider initiatives (such as the TCFD) on climate-related financial disclosures and to take into account the benefits of disclosures that are comparable across firms”. The PRA doubled down on this statement in an open letter on 21 October 2022, noting that “firms judged not to have made sufficient progress” in embedding their expectations “should expect to be asked to provide a roadmap explaining how they intend to overcome the gaps”.
Aside from the mandatory requirements imposed upon companies, there an array of independent organisations that create climate disclosure standards. Although reporting in line with standards set by these organisations is voluntary, standards such as those created by the Global Reporting Initiative (GRI) have gained popularity internationally. A survey by KPMG found that the GRI standards have been adopted by 78% of the 250 largest global firms.
GRI standards are set in relation to numerous topics, including anti-corruption, environmental practices, and anti-competitive behaviour. These standards are constantly being refined to adapt to new challenges. For example, a new GRI biodiversity standard is due for publishing in 2023.
Changes on the immediate horizon
Aside from compliance with the current regulatory regime, financial services firms must be aware of incoming regulations. For firms that operate on a cross-border basis, it is not only the evolving UK regulatory landscape that needs to be monitored.
Perhaps the most pertinent example of evolving regulation is the EU Corporate Sustainability Directive (CSD), which was officially adopted by the European Parliament on 10 November 2022 and was approved by the Council of Ministers on 28 November 2022. As part of the CSD, EU Sustainability Reporting Standards (ESRS) are currently being developed by the European Financial Reporting Advisory Group. The draft ESRS were released in May 2022 and have been submitted to the European Commission. The Commission is currently considering these drafts and will adopt the final ESRS as delegated acts in June 2023.
Though the exact details of the ESRS are still to be confirmed, these standards will introduce a detailed set of reporting requirements that EU based companies must follow. The ESRS are likely to take a ‘double materiality’ approach whereby a company will be expected to report on both its impact on the environment as well as the climate’s impact on itself.
The CSD will begin to be enforced from 1 January 2024 for ‘large public-interest companies already subject to the non-financial reporting directive. Between 2024 and 2028 the CSD will gradually apply to more companies, including non-EU companies with a turnover over €150 million in the EU. Given the potential financial sanctions for non-compliance, it is advisable for financial services firms that operate within the EU to pay attention to the upcoming requirements under the CSD and consider how this will affect their climate-related disclosures.
Looking further ahead
Financial services firms must also understand current trends in sustainability reporting to anticipate future reporting requirements. Within the present framework, numerous organisations produce separate sets of standards which can be used by companies in their sustainability reporting. However, it has been recognised that there is a need for collaboration amongst these groups to create a universal standard in approach for reporting requirements.
The establishment of the International Sustainability Standards Board (ISSB) demonstrates commitment to this ongoing collaborative exercise. The ISSB was created in November 2021 by the IFRS Foundation, an independent organisation aimed at developing high quality sustainability disclosure standards. The IFRS has recently integrated two other influential standard-setters, the CDSB and the Value Reporting Foundation, into the Foundation. In March 2022, as part of a collaborative exercise with the GRI, the ISSB issued a draft standard titled ‘IFRS S2’ which aims to provide a global standard for consistent and comparable climate-related disclosures. This standard builds on the existing TCFD Recommendations as well as adding new disclosure requirements.
The publication of IFRS S2 has drawn an overwhelmingly positive response from other standard setters, including the CDP, which has agreed to incorporate IFRS S2 into their disclosure platform. A UK regulator has also spoken publicly of their support for IFRS S2 and noted that the FCA plans to incorporate global standards for disclosing climate-related risks, rather than creating their own framework.
IFRS S2 differs from the standards set out in the CSD as it proposes to use a ‘single materiality’ approach, which covers only a company’s impact on the climate. The EU’s divergence from this approach in the CSD has been noted by the European Banking Authority which recently stressed the importance of developing global standards that are consistent with each other. Mairead McGuiness, the EU commissioner for financial stability, financial services and the capital markets union has said that whilst the ‘double materiality’ approach, where the company also reports on the climate’s impact on it, isn’t popular elsewhere, it is an approach which “tells the whole story”.
There is also a growing consensus internationally that for policy to be effective, there must be a crackdown on greenwashing. Within the UK, the FCA has proposed a general ‘anti-greenwashing rule’ which will mean that any assertion of a product being sustainable must be ‘clear, fair and not-misleading’.
The impact on supply contracts
Looking ahead, whilst the standardisation of reporting standards hasn’t yet been fully achieved, what is clear is that financial services firms must prepare themselves for an increase in reporting requirements as well as stricter enforcement of any sustainability claims made. Compliance with the existing regime, such as the TCFD requirements, even if they are not mandatory, is advisable. Firms must also monitor the EU’s divergence from proposed international reporting standards and consider how this will affect their global reporting policies.
And as we have previously explained, while save in some specific circumstances reporting on so-called ‘scope 3’ emissions – all indirect carbon emissions which are created as part of the institution’s operations, but which come from sources which it does not control or own – is not currently a regulatory requirement for financial services firms, there is growing expectation in the market that firms will do so.
