ESG lawyers and consultants are working day and night to advise companies in the UK that are subject to mandatory climate reporting. This now includes large private companies. The new regulations impact both large UK group companies, which are part of international companies, and financial sponsor-backed portfolio companies with either UK Topco structures or large UK subsidiaries.
On 17 January 2022, the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 enshrined new mandatory climate disclosure requirements, alongside similar requirements coming into force for large LLPs. The requirements apply in respect of financial years starting from 6 April 2022.
The UK Department for Business, Energy and Industrial Strategy has published non-binding guidance to help companies and LLPs interpret and comply with the rules. The requirements in these regulations sit alongside the FCA’s existing climate change disclosure requirements for listed companies.
Around 1,300 UK companies are expected to be in scope of the new regulations, approximately six times more than the number of companies that currently refer to the TCFD framework in their annual report and accounts voluntarily.
As most UK companies have a calendar financial year, the first time the majority of companies in the scope of the new regulations will need to include mandatory climate-related financial disclosures will be in their annual report for the financial year ending 31 December 2023 (so published mid-2024).
The new rules require large private companies with a group turnover of more than £500 million and with more than 500 employees (which, importantly for PE houses, includes employees of overseas subsidiaries that sit underneath UK top companies) to provide climate-related information in the form of a non-financial and sustainability information statement. In-scope companies are required to include disclosures on material climate change-related risks and opportunities.
In-scope companies must describe:
– Their governance arrangements for assessing and managing climate risks and opportunities
– How they identify, assess, and manage climate risks and opportunities
– How processes to do so are integrated into overall risk management, the principal climate risks and opportunities from their operations and relevant time periods
– Actual and potential impacts of principal risks and opportunities on the business model and strategy
– An analysis of the resilience of the company’s business model and strategy under different climate scenarios
– Company targets for managing risks and opportunities and performance against those targets
– KPIs used to assess progress against climate targets and the calculations on which those KPIs are based
While the BEIS rules require climate-related disclosures to be made, they do not directly reference the TCFD recommendations in the way the FCA rules do for listed companies. However, the disclosures are fundamentally focused on the four TCFD core pillars, namely governance, strategy, risk management, and metrics and targets; and the accompanying BEIS guidance indicates that disclosures made in a manner consistent with all of the TCFD recommendations and recommended disclosures will likely meet the requirements of the BEIS rules.
The UK government commenced a public consultation on the regulations in spring 2021, so companies have already had some time to prepare, although many are only now reckoning seriously with the new regulations. Unlike public companies, whose ESG policy has been a focus of shareholder activism and NGO review for some time, private companies have, until recently, stayed largely out of the limelight in this sphere.
Some large private companies have already been looking at reporting in accordance with TCFD or one of the other voluntary reporting frameworks in existence. The UK adoption of TCFD-aligned requirements recognises that TCFD is already well known to market participants and is currently generally considered to be the global gold standard for climate disclosures.
Still, even companies that were already making TCFD-aligned disclosures may struggle with the new regulations. Where previously companies might have been able to prepare disclosures that focused on certain of the TCFD Recommendations or Recommended Disclosures, the mandatory nature of the regulations brings an added pressure to report more fully, including where useful taking account of the TCFD’s various guidance documents (which the BEIS guidance provides links to, for certain disclosures).
Some of the requirements are complex and take time and expert advice to work through, for example those related to scenario analysis and assessments of strategy resilience in light of different climate pathways. Companies are therefore advised to start considering their disclosures and gathering information well ahead of financial year end.
Private companies may wish to start with the governance pillar of the TCFD. This means making sure they are sufficiently informed on ESG topics and understand the commercial relevance to the business.
Boards should ask themselves whether they need a standalone ESG committee to support them, whether they have or have access to appropriate ESG expertise, and whether they have the right management structures, policies and processes in place to ensure ESG topics are cascaded, operationalised and implemented throughout the business. A governance-first approach serves to create answers to that part of the regulation that requires disclosure of the company’s governance around climate, and provide a basis from which to work on the wider strategy, risk management, and metrics and targets disclosures. It should be borne in mind that while the new regime introduces a disclosure requirement, the effect is actually broader in requiring extensive substantive action by companies to put themselves in a position to make the appropriate disclosures.
Where a company has set targets to help assess progress in managing climate-related risks and opportunities, the regulations state that the targets should be properly explained. The disclosures should include timeframes and how the company monitors and assesses progress in meeting those targets.
Where a private company has yet to set targets for reducing its Scope 1, 2, or 3 emissions (setting targets is not compulsory, but arguably the disclosure regime is structured to force companies to reckon with whether they should), it can be tempting to respond to public pressure by setting overly ambitious emissions targets that the business is not operationally capable of meeting.
Organisations should properly consider any targets and work with consultants and (science-based) initiatives to develop challenging but realistic goals rather than ones set based purely on what others in the market are doing or stakeholder pressure. Stakeholder focus is increasingly moving from target-setting to transition planning, meaning that companies being able to demonstrate how they are going to achieve targets is just as important as setting one in the first place.
While the new regulations represent a challenge for companies, regulators are expected to recognise that these rules are new and complex and take an engagement-based approach to compliance by those companies that are finding their feet within the new regime.
Disclosures represent something of a journey for companies, and processes to prepare them and the disclosures themselves will be refined over time as market practice in various sectors develops. In particular, the guidance notes that companies may need to rely on assumptions or estimates for some of the disclosure and this approach is acceptable where the underpinning of such assumptions or estimates is properly explained. As companies begin their reporting journey, it is important to remember the risk of over-promising and underdelivering, which could open them up to accusations of greenwashing from stakeholders.
For companies that have yet to report in accordance with TCFD, the rules and accompanying BEIS guidance will provide a solid framework for considering their climate exposure and strategy. Compliance with these regulations should also better prepare companies for the new sustainability disclosure reporting (SDR) regime being prepared by the UK government, which will include mandatory disclosures in line with the ISSB sustainability standards, once those have been developed, as well as disclosures in relation to a UK green taxonomy.
These likewise build on, and complement, the TCFD recommendations. Additionally, for groups operating multi-nationally, the regulations are a useful start to compliance, with similar regimes being developed across the world, such as the recently announced SEC climate regulations.
The authors are Sofiya Bumagin, corporate managing associate, Aileen Buchanan, environment and climate change managing associate and James Marlow, corporate associate, at Linklaters