Americas, Asia Pacific, UK & Europe
Regulatory & Investigations
Year on year, the emphasis on climate-related issues increases, and as COP27 came to an end, emphasis has been placed on who can make the most substantial change.
In the UK a positive burden is placed on large corporate entities and financial institutions to report on how the company is managing issues such as environmental performance and climate-related risks at Board, senior management and whole-company levels.
As a starting point, section 172(1)(d) of the Companies Act 2006 imposes a duty on directors to promote the success of a company, having regard to several broader factors including the impact of the company’s operations on the environment. This applies to all companies, no matter what size. However, combined with the larger environmental and social significance of corporate reporting for climate change, rules and regulations have since been imposed to place a greater responsibility on the largest companies.
UK legislation to date:
The 2022 Regulations
The UK is the first G20 country to make it mandatory for Britain’s largest businesses to disclose their climate-related risks and opportunities, in line with recommendations from the Taskforce on Climate-related Financial Disclosures (“TCFD”). For financial years starting on or after 6 April 2022, over 1,300 of the largest UK-registered companies and financial institutions are obliged to disclose climate-related financial information on a mandatory basis in their annual reports.
The aim is to increase the quantity and quality of climate-related reporting across the UK business community, including among some of the most economically and environmentally significant companies. This will ensure business consider the risks and opportunities they face as a result of climate change and encourage them to set out their emission reduction plans and sustainability credentials.
The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 amend sections 414C, 414A and 414CB of the Companies Act 2006 to place requirements on certain publicly quoted companies and large private companies to incorporate TCFD-aligned climate disclosures in their annual reports. The Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022 amend parts 5 and 5A of the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008 to place requirements on certain LLPs to incorporate TCFD-aligned climate disclosures in their annual reporting.
What should be disclosed?
Companies should include these disclosures in what was previously the Non-Financial Information Statement, now the Non-Financial and Sustainability Information Statement in the Strategic report. The duty of disclosure on company directors includes discretion to omit some or all of the certain disclosure requirements (namely e, f and g) of the regulations where these are not considered necessary for an understanding of the business, but if information is omitted as a result of relying on this exemption, directors must provide a clear and reasoned explanation of their belief as to why it is appropriate to omit the information.
An important aspect to the success of these regulations is the role of regulators, such as the FCA and CMA, in enforcing and implementing them. The underlying issue and catalyst for the regulations is a global social imperative to save the planet, and therefore the power lies in the hands of the world of finance and governments to make a change. With this in mind, the FCA have issued a paper on its expectations and strategy on ESG reporting and actions expected of regulated UK companies. Further, the CMA published a Green Claims Guide in 2021 to help businesses comply with the law and it is carrying out a review of misleading green claims this year. It has said it will take action against offending firms.
The aim of the 2022 Regulations was to apply a common set of requirements aligned with the TCFD recommendations, to provide UK companies with a uniform way to assess how a changing climate may impact their business model and strategy, and ensure they are well placed to harness opportunities with the UK’s transition to net zero. However, until financial years come to an end, it is unclear how successful they will have been. Further, whether the criteria are consistent and properly defined is up for debate. The UK, EU and US positions all differ slightly and for companies with an international nexus, it may be difficult to determine the obligations placed upon them.
Consequently, an inconsistent and unclear approach will allow companies to hide their failures in continuity and transition, which will mean that they are significantly devalued as an asset in any pension or other portfolio as climate legislation bites and investment stops. It is misleading the market as to how robust the business continuity plans are. In addition, it will mean that investment is still being made into companies that are making long term harmful developments such as mines, dirty power plants and heavy industry. For example, data, including from the ratings agencies, should not be trusted as their data on companies is thoroughly inconsistent with no standardised criteria.
The EU has three key pieces of legislation regulating climate-related disclosures:
The NFRD required public-interest companies with more than 500 employees to report on how they deal with issues such as environmental pollution, social responsibility, human rights and diversity. The SFDR then laid down sustainability disclosure obligations regarding investments for end-investors in financial markets. Recently, the EU have evidenced a strong adherence to this cause with the implementation of the CSRD from 2024. This Directive will significantly broaden the scope of entities that will have to report, capturing all listed entities as well as large companies that meet two of the three following criteria:
In May 2022, the Financial Accounting Standards Board (“FASB”) in the US decided to add a project to its technical agenda on the recognition, measurement, presentation, and disclosure requirements for companies that participate in compliance and voluntary programs that lead to the creation of environmental credits. The credits include, but are not limited to, those created under compliance programs, such as cap and trade, and baseline allowance program, as well as renewable energy credits and certificates, renewable energy credits and certificates, renewable identification numbers and carbon offset credits. In the same month, the SEC released its climate disclosure proposal, requiring climate disclosures in annual reports and registration statements as early as for fiscal year 2023. The SEC has also recently proposed new rules on the language a mutual fund can use to describe itself as eco-friendly.
Mainland China Position
ESG reporting in Mainland China has seen rapid growth in recent years, as the country seeks to shift the economy towards the vision of a more sustainable future.
We set out below some key (but not exhaustive) regulations in Mainland China involving ESG reporting.
Among the aforementioned laws and regulations, the Measures for the Administration of Legal Disclosure of Enterprise Environmental Information (the “Measures”) may be said to be the most representative one. The Measures mandate major polluters, publicly listed companies and bond-issuing companies/their subsidiaries (if they have been penalised for ecological or environmental violations the previous year), amongst others, to submit annual reports detailing a range of environmental information. The Measures represent Mainland China’s push to standardise and mandate ESG reporting for companies as the country aims to achieve climate emissions and other environmental targets.
There are no specific provisions under the corporate legislation imposing reporting obligations on companies for environmental matters.
There are, however, recent regulations which were issued by the Brazilian Central Bank and the National Monetary Council in September 2021, requiring financial institutions and corporations regulated by the Brazilian Central Bank, to disclose certain information on environmental, social and corporate governance (ESG) practices.
For example, Resolution nº. 4.945/2021 of the National Monetary Council created the Social, Environmental and Climate Responsibility Policy (PRSAC). The PRSAC must be issued by the financial institutions and companies with shares traded on the stock market and consists of a set of guidelines for social and environmental/climate matters, which must be disclosed to the public and observed by the institution in the conduct of its business and activities.
A new regulation establishing the revision of the content of the Reference Form, which is a mandatory document for making information available to the market on companies with shares traded on the stock exchange, has also been enacted recently. This Resolution requires the disclosure of information on environmental, social and corporate governance (ESG) practices by companies trading in the Brazilian stock market.
The above set of rules aims to bring more transparency to the Brazilian market on the environmental performance of financial institutions and large companies.
However, the motive behind the new regulations is fundamentally good. When so much power for change is vested in these large entities, countries must start somewhere in holding them accountable for their actions. It is hoped that key personnel will uphold integrity in their companies as a force for good in tackling climate change. However, clarity in the regulations is vital, as well as the role of regulators in clamping down on climate-related reporting. Therefore, success will begin to be seen throughout 2023 as financial years come to an end and the regulations start to take shape.