This is a feature from the ENDS environmental risk review. Click here to read the full briefing.
With business resilience a primary concern for most organisations, Environmental Social Governance (ESG) performance — including regulatory compliance — has become a crucial indicator of that resilience. And as the ESG regulatory framework develops, it increases risk and cost for companies across all sectors.
There have been considerable changes in ESG regulation in the UK, including Task Force for Climate-Related Financial Disclosures (TCFD) requirements in corporate reports for premium listed companies, and similar obligations for large pension schemes (above £5bn).
On 18 March 2021, the UK Government released a consultation on audit reform and corporate governance, including proposals for external assurance for non-financial data. On 24 March 2021, another consultation followed, on mandatory climate-related financial disclosures by publicly quoted companies, large private companies and LLPs (the TCFD Consultation). Both have significant implications for ESG disclosures.
Alongside the wider voluntary drive for net-zero carbon emissions by 2050, the UK Government is mandating reporting on a ‘comply or explain’ basis in line with the requirements of the TCFD.
A new Financial Conduct Authority (FCA) Handbook Rule, binding on FCA regulated firms, is now in force that imposes new reporting obligations on premium listed companies in the UK with financial years starting on or after 1 January 2021. The obligations include a requirement for disclosure of the potential future impacts of climate change on operations and supply chains under different warming scenarios.
Regulations coming into force under the Pension Scheme Act 2021 impose similar TCFD reporting obligations in the UK on pension schemes. For those above £5bn, the rules enter force in October 2021, with the first reports due in 2022, while pension schemes between £1bn and £5bn must file their first reports from the end of 2023.
It is also currently proposed to extend the reporting requirements to all large private businesses from financial years starting in 2022.
In the EU, the Corporate Sustainability Reporting Directive (CSRD) is due to come into force in 2022. It requires all large companies and listed SMEs operating in the EU to start reporting in line with European sustainability reporting standards, starting in 2023.
The CSRD will directly impact organisations trading on a regulated market — including those that are dual listed and with EU listed subsidiaries. EU unlisted subsidiaries and UK subsidiaries of EU parent companies might also find that there are audit implications where subsidiary information is incorporated into the group reporting.
In summary, the CSRD will amend the existing reporting requirements of the Non-financial Reporting Directive (NFRD) by extending the scope of reporting. It is expected to apply to around 49,000 companies, rather than the 11,500 entities covered by the NRFD.
The European Commission expects the CSRD to improve sustainability reporting and drive the European single market toward a sustainable and inclusive economic and financial system.
The main features of the CSRD are:
extension of scope to all large companies and listed SMEs;
requirement that reported information be audited;
introduction of mandatory EU sustainability reporting standards; and
requirement for reported information to be digitally tagged to feed into the European single access point.
Companies directly affected by the CSRD will need to report on the risks and sustainability issues that they are facing, as well as the impacts of companies on society and the environment — the so-called ‘double materiality' principle.
The CSRD will not require implementation in the UK post-Brexit, but the UK Government is developing its own International Financial Reporting Standards. BEIS is currently consulting on extending UK reporting requirements, although it is unknown at this stage whether the UK will align with the CSRD or diverge.
From an environmental and sustainability point of view, the extended reporting requirements are intended to help organisations achieve a number of goals:
Increase awareness of energy usage and costs
Improve focus on sustainability and achieve improvements
Reduce impact on climate change by taking steps toward net-zero carbon emissions
Acquire data that supports adoption of energy efficiency measures
Achieve greater transparency for stakeholders.
The regulatory changes described above will impact on the value of businesses and on the decisions of investors, consumers and employees. Companies’ performance will also change their ranking in comparative ratings that are based on ESG reporting and ESG performance, including regulatory compliance.
A PwC review of annual reports, sustainability reports and associated websites of FTSE 350, public interest companies and selected inbounds found that in less than a third climate change had affected strategic decisions or been discussed at board meetings, while less than a fifth of companies had at least one board member with climate change-related expertise, or had provided related training.
Ahead of making TCFD or other ESG disclosures, companies should consider the relevant expertise and training of their boards and key employees. They need to plan ahead to ensure that they have appropriate competencies to report on the subject matter.
Corporate governance controls and reporting will need to change to ensure that directors at both parent company and subsidiary level have assurance and oversight of the data — processes and controls that underpin climate change and other ESG reporting. This will be essential to mitigate personal liability, financial penalties and reputational damage.
Many companies are carrying out root and branch reviews of their ESG strategies and market positioning to prepare themselves for the drive to net-zero carbon emissions, against the backdrop of various pledges that have been made.
They are carefully considering the standards of ESG compliance that they wish to achieve — whether driven by the new regulatory reporting requirements or voluntarily imposed targets — and are changing practices and procedures to improve their ESG performance.
Companies caught directly by the CSRD will need to plan ahead in order to ensure compliance with the new reporting requirements. Those not caught directly, including companies with European investors or stakeholders, may also wish to voluntarily adopt the standards in order to align their reporting or satisfy external pressure to meet the standards.
Georgie Messent is the UK Legal Network Lead, Alex Hawley a manager, and Jordan Cope an associate in PwC’s Environmental & Sustainability team