UK: FRC review of corporate climate reporting concludes more needs to be done to meet investor expectations

FRC review: key findings

The UK’s Financial Reporting Council (FRC) has published its findings of a thematic review of climate-related considerations by boards, companies, auditors, professional bodies and investors. See FRC summary report and FRC Statement on Non-Financial Reporting Frameworks.

Alongside the summary report, the FRC has also published a suite of reports with more detailed findings from its climate thematic review, see:

• Governance: How are boards taking account of climate-related challenges?
• Reporting: How are companies developing their reporting on climate-related challenges?
• Audit: How are auditors taking account of climate-related challenges?
• Professional Oversight: How are professional bodies and audit regulators taking account of climate change in their regulatory responsibilities?
• Investors: What do investors want to see? (discussed in more detail below)

The FRC summary report concludes that corporate reporting on climate change needs to improve to meet the expectations of investors and other users.

The FRC supports the introduction of global standards on non-financial reporting, but, in the meantime, it encourages UK public interest entities to report voluntarily against the Task Force on Climate-related Financial Disclosures (TCFD) recommended disclosures and the Sustainability Accounting Standards Board (SASB) metrics for their sector.

The TCFD is based on four thematic areas: governance; strategy; risk management; and metrics and targets. Beneath these sit 11 recommended disclosures that provide more granular detail on the information to be disclosed under each of the recommendations. SASB has developed standards/metrics for 77 industries across 11 sectors.

Other key findings in the FRC’s review are as follows:

• Evidence of climate considerations influencing business models and company strategy is limited.
• Some companies have set strategic goals such as 'net zero’, but it is unclear from their reporting how progress towards these goals will be achieved, monitored or assured.
• An increasing number of companies provide narrative reporting on climate-related issues. While minimum legal reporting requirements are often met, users (in particular investors) are calling for additional disclosure to inform their decision-making.
• Consideration and disclosure of climate change matters in the financialstatements lags behind narrative reporting. The review identified areas of potential non-compliance with the International Financial Reporting Standards (IFRS).
• The quality of support, training and review provided to audit practices on climate change varies considerably across firms.
• Audits reviewed indicated that auditors need to improve their consideration of climate-related risks when planning and executing their audits.
• Investors support the TCFD framework, but also expect to see disclosures regarding the financialimplications of climate change. Investors are themselves facing a changing regulatory environment.

As the Chief Executive of the FRC, Sir Jonathan Thompson, put it:

“Users of corporate reports expect more from companies, auditors, regulators and standard setters in terms of climate change reporting. While this review highlights some bright spots of better practice in both corporate reporting and auditing, we also found that more needs to be done. I know that this is a difficult time to ask for more, but now is the time for all of us to raise the bar.”

For more information on the recent announcements from the Financial Conduct Authority (FCA) and the Chancellor on changes to how corporates in the UK will need to report on climate change in the near future, see blog post: UK paves way for mandatory TCFD climate disclosures for companies and other organisations by 2025.

FRC review: what investors want to see

Over the course of 2020, the FRC’s Financial Reporting Lab held discussions with over 20 investors and investor groups to gather views on what they wanted to see from the integration of climate-related issues into corporate reporting and audit. See FRC review: what do investors want to see.

Investors are themselves facing a changing regulatory environment. They are facing calls for more disclosure on their own approach to climate-related issues (e.g. under the UK Stewardship Code). This in turn means they need more and better climate disclosure from investee companies.

The key message is that investors support the TCFD framework but also expect to see disclosures regarding the financial implications of climate change.

In particular, investors need a better understanding of:

• how boards consider and assess climate-related issues;
• how the business model may be affected by climate-related issues, whether it remains sustainable, and how the company may respond to the challenge posed by climate change, including:
  • what changes the company might need to make to its strategy,
  • the risks and opportunities presented by climate change - including the prioritisation, likelihood and impact,
  • what scenarios might affect the company’s sustainability and viability, and
  • how the company is responding; and
• how climate-related issues, and their impact, are measured, including metrics, data and financially-relevant information.

Investors noted that more companies have started disclosing under TCFD. However, current reporting is often non-specific, lacks substance and is considered insufficiently linked to the company’s plans, business model and strategy.

Investors have reiterated the need for consistency between the front half and back half of reports and noted that financial statement disclosures lag behind those in the narrative reporting. They are particularly looking for disclosure of the accounting assumptions made where these may be affected by climate change.

Investors also expect auditors to consider risks facing the company as a result of climate change, and expect appropriate challenge of management, particularly where climate-related risks have an impact on the entity’s accounting estimates.

Investors noted that the questions for boards on climate change published by the Financial Reporting Lab in 2019 remain highly relevant and useful for companies on how best to disclose under the TCFD’s 11 recommendations. The questions are set out in p.10-11 of the FRC’s “What do investors expect to see” report.

The report highlights examples of what investors consider to be better practice on climate reporting. Specific examples relate to reporting from the following companies: QBE Insurance, AXA, Derwent London, Owen Corning, National Grid, ING and Landsec.

However, investors noted that:

“There are definitely reporting leaders, but this is not a static situation and they need to keep moving and they need to keep evolving. There is no one who has worked this out 100%. Given what’s available, there are leaders for where we are today.

”FRC expectations on company reporting for 2020/21

The FRC has also published a letter to CEOs, CFOs and Audit Committee Chairs setting out the FRC’s expectations on company reporting for 2020/21. Not surprisingly, climate change features prominently.

In particular, the FRC encourages companies to:

• Give a balanceddescription of how climate policies and targets have been incorporated into business plans and their expected business impact, making appropriate use of KPIs (where relevant) and without disproportionate focus on ‘good news’ stories in parts of the business that are not material.
• Describe the impact of their businesses on the environment, including their supply chains.
• Provide required segmental and disaggregated revenue disclosures to enable users to understand the relative sizes of operations for which climate change presents substantially different risks and opportunities.
• Provide financial statements that, where relevant, explain the impact of climate-related risks, policies and strategies on both measurement and disclosure, including disclosure of key accounting judgements, estimation uncertainties and related sensitivities.

The FRC letter also points out that many companies did not sufficiently explain how their directors discharged their duty under section 172 of the Companies Act 2006, in particular the responsibility to have regard to the consequences of decisions in the long term. The FRC also noted that a number of companies reported on the methods of engagement with stakeholders but did not reflect a two-way dialogue or explain how the feedback affected decision making. Section 172 requires directors to promote the success of the company, including by having regard to (among other things) the impact of the company’s operations on the community and the environment.

Climate change clearly requires assessment of impacts based on much longer horizons than normal. It is also worth noting that shareholder engagement on climate change is increasing. For example, in September, the Climate Action 100+ coalition of investors wrote to 161 of the world’s largest greenhouse gas emitting companies calling on them to put in place net-zero business strategies and define targets to support delivery. They warned that unresponsive or poorly performing companies may well face shareholder activity in the 2021 AGM season. UK companies would do well to follow the FRC’s recommendation to report on the effectiveness and outcomes of their engagement with shareholders and other stakeholders (be it with Climate Action 100+ or others) and on how that feedback has affected the company’s decision-making.

What does this mean in practice?

We recommend that premium listed companies that are not yet familiar with the TCFD process start preparing now for the reports that will need to be submitted for the first time in 2022. TCFD reporting is not all that straightforward. In particular, it requires time and effort to undertake scenario analysis.

But disclosure is only part of the process. Companies are also being encouraged (though not mandated) to set net zero targets (including interim targets) and publish credible net zero transition plans.

For more information on climate strategy and disclosure for companies, see our publication: Green means go – helping your company and board deal with climate change.