The Financial Reporting Council (FRC) and Financial Conduct Authority (FCA) recently published reports following their review of Task Force on Climate-Related Financial Disclosures (TCFD) disclosures. Whether you're preparing TCFD disclosures for the first time or have previously produced TCFD disclosures, these reports will help you prepare for the next reporting season.
Overall, both the FRC and FCA reviews found significant progress had been made in the quality of climate-related information provided in the financial reports of companies required to prepare TCFD disclosures. They identified some areas for improvement, however, including:
- providing more granular information about the effect of climate change on different business sectors and geographies
- balancing the discussion of climate-related risks and opportunities appropriately
- linking climate-related disclosures to other risk management and governance processes
- explaining how they decided which climate-related information should be disclosed
- explaining more clearly how the effects of different global warming scenarios, and their own net zero commitments, may affect the valuation of their assets and liabilities.
Who must make TCFD disclosures?
The UK government and regulators have introduced mandatory TCFD-aligned disclosures across all sectors of the UK economy to help reduce the risk posed by climate change to the planet.
Under listing rules announced by the FCA, companies with a UK premium listing or standard listing (other than investment entities or shell companies) must make 'comply or explain' TCFD disclosures in their annual reports for financial years beginning on or after 1 January 2021 and 1 January 2022 respectively.
For periods commencing on or after 6 April 2022, the Companies Act 2006 and the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008 also requires the inclusion of mandatory climate-related financial disclosures in the annual report in line with the four overarching pillars of the TCFD recommendations: governance, strategy, risk management, metrics and targets.
TCFD-aligned reporting requirements apply to companies or limited liability partnerships (LLP) that meet the following scope criteria:
- All UK companies that are currently required to produce a non-financial information statement, ie, those with more than 500 employees and have either transferable securities admitted to trading on a UK-regulated market or are banking companies or insurance companies (relevant public interest entities/PIEs)
- UK-registered companies with securities admitted to AIM with more than 500 employees
- UK-registered companies not included in the categories above, which have more than 500 employees and a turnover of more than £500 million
- Large LLPs, which aren't traded or banking LLPs, and have more than 500 employees and a turnover of more than £500 million
- Traded or banking LLPs which have more than 500 employees
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What does good TCFD reporting look like?
The transition to a net zero economy will require high-quality information on how climate-related risks and opportunities are being managed within the organisation's business model. The TCFD principles were designed to help organisations make clear the links between climate-related issues and their governance, strategy, risk management, and metrics and targets. This also encourages organisations to consider the impact of climate-related risk on the financial statements, thereby satisfying investors’ concerns on the need for consistency between the front half and back half of annual reports.
A good report contains disclosures that are:
The metrics reported should be relevant to the organisation’s risks and opportunities over a specified period. The financial impacts and operational consequences should include how the organisation manages such risks and opportunities as part of its governance, strategy, and risk management processes. The FCA and FRC reviews found the relevance of the metrics to risks and opportunities identified wasn't always clear.
Specific and complete
The reviews identified some companies where the disclosures were high-level and generic, and didn’t specifically explain the impact on the business. Disclosures need to include all material matters and avoid generic information that doesn't provide enough information to measure and track progress against targets. Stakeholders should be able to understand from reading the report where specifically the organisation is impacted by climate change.
Although the FCA and FRC aren't encouraging a ‘checklist’ approach, you're expected to clearly explain how you've determined materiality when preparing your TCFD disclosures. This will minimise challenge from regulators, auditors and alike.
Clear, balanced and understandable
The report should include both positive and negative impacts of transitioning to a net zero economy, in a balanced way and without material error. For example, when explaining opportunities arising, you should indicate the size of the opportunity, so readers can understand the size of this relative to current revenue streams. You should also discuss the challenges that might be faced in realising these opportunities, such as the development of new technologies.
It's increasingly common for companies to have set 'net zero targets' but it's often not clear what this means, for example:
- does this rely on carbon offsetting
- does this include Scope 3 emissions
- which group companies does this include
- are associates and joint ventures also included?
It’s important that disclosures of targets are clear and unambiguous to avoid greenwashing.
Climate-related metrics and targets should be consistent over time and in a way that enables comparison and trend analysis over the identified time horizon.
TCFD disclosures should be consistent with other narrative and financial disclosures in the annual report. The FRC has said it will "challenge companies who disclose significant climate risks or net zero transition plans in narrative reporting, but who do not appear to adequately explain how this has been taken into account when preparing their financial statements”. We discuss this further in How climate change is impacting financial statements.
Climate-related targets should be linked to defined metrics in order to measure and track progress against targets. The metrics should consider a common set of scenarios and inputs (eg, parameters, timelines, industry-specific metrics, methodologies) that provide greater reliability, relevance and comparability across companies within the same industry sector or portfolio.
The FCA encourages organisations to consider the relevant intensity metrics for their sector and business, and provide clear explanations of the choice of metric where they're not standard for the industry. This will provide information that aids the assessment of climate-exposure of an organisation.
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What does this mean for the mid-market?
We encourage mid-market companies outside the TCFD-aligned reporting threshold to begin to evaluate and disclose climate-related risks and opportunities that are most pertinent to their business activities, even if the reporting threshold has not been met. This will aid easy adoption when the time arrives and assist with reporting within your supply chain to those suppliers who are caught by the regulations.
Mid-market companies need to pay attention to their ESG credentials to maintain cost-effective access to capital. This can be achieved through clear, consistent and specific climate-related financial disclosures.
Preparing for your next reporting season
When drafting your TCFD disclosures, we recommend challenging yourself on the areas above and the Fundamental Principles for Effective Disclosure set out within the TCFD recommendations.
The FRC and FCA reports set out their expectations of good disclosure, include examples of good practice and highlight areas where they found improvement is required. The contents of the reports are likely to be useful in preparing your TCFD disclosures for the upcoming reporting season.
For feedback on your TCFD disclosures or help preparing for the next reporting season, get in touch with Laura Tibbetts.