The Financial Reporting Council (FRC) has published its Annual Review of Corporate Governance Reporting. This focusses on premium-listed companies which are required by the Listing Rules to report against the UK Corporate Governance Code. Many of its findings will also be relevant, though, to large companies wishing to follow best practice and the FRC urges all companies pursue a goal of strong, clear and informative reporting.
UK companies starting to prepare for next year’s annual reporting, should read this latest publication alongside the FRC’s Annual Review of Corporate Reporting which was published in October and set out expectations for the accounts and reports of all UK companies in the coming disclosure season.
The summary below focusses on the aspects of the FRC report which are particularly relevant to climate and wider ESG reporting in 2023/24. For our analysis of other aspects of the FRC report, see this briefing: FRC calls for more outcomes-based reporting.
Reporting on the environment and in line with TCFD
Although the UK Corporate Governance Code does not require reports on environmental issues, it does cover risk governance, stakeholder engagement and section 172 reporting. As a result, the FRC’s review considered TCFD-aligned reporting for a third year and was pleased to see that the 100 companies surveyed had taken steps to improve their reporting and strengthen their governance of climate-related issues. The FRC expects this improvement to continue.
Specific findings in this area included the following:
- Section 172 statement - Almost a quarter of companies in the FRC’s sample identified the environment as a key component of their section 172 statement. These were often service sector companies, for example: travel and leisure, industrials, media and software service providers.
- Statement of consistency with the TCFD framework – The FRC has reminded companies that a good statement clearly explains a company’s level of consistency with the TCFD recommendations and recommended disclosures, states any areas where they are not yet compliant, and avoids vague statements. This year, 57 of the companies surveyed stated that they had provided disclosures fully consistent with all the TCFD recommendations and recommended disclosures. The number of companies explicitly stating that they were only partially compliant with the TCFD recommendations has increased (43 compared to only 18 last year). The FRC found it encouraging, however, to see explanations of these situations, such as, that further modelling for specific impacts is required. Many companies provided a table to show the areas in which they are compliant or partially compliant with the TCFD recommendations.
- Governance of climate-related issues - As mentioned last year, better reporting in this area included clear and specific disclosure of the governance structures and processes by which the board considers climate-related issues. Almost all companies outlined the board and management’s oversight of climate-related risks and opportunities. Companies that did this particularly well described engagement with other departments across the organisation and how effective communication between board, executive and business levels is achieved including processes and frequency by which the board and/or committees are informed about climate-related issues. Some companies also included a diagram showing responsibilities for climate-related information across the organisation.
- Committees – The FRC found that this year 46 companies had board-level committees such as sustainability, ESG and corporate social responsibility committees, which are responsible for assessing and considering environmental issues. Almost a quarter were created in the past year and they belonged to an even mix of FTSE 100, FTSE 250 and Small Cap companies. Other approaches include a management or executive level environment committee, or a climate-specific group below board and executive level. For example, one company had an ESG Sub-committee, TCFD Working Group and a Carbon Steering Committee. Only nine companies this year had none of these structures in place.
- Metrics and targets - As set out in the FRC’s CRR Thematic Review in July (see our previous briefing), climate-related metrics and targets, including “net zero” plans, are seen as increasingly important by investors and other stakeholders, who expect comparable, clear information. Most companies disclosed net zero or other climate-related targets but the metrics used to track progress were sometimes unclear and explanations of performance were not always provided. The FRC recommends that, as companies continue to develop their business strategies, they should set out their targets and progress against them, including:
- Commitments – providing clarity on what the commitment includes and importantly what is not included.
- Impacts – explaining how the targets may impact the company’s strategy and business model, including information on transition plans, risks and opportunities, any assumptions made and uncertainties.
- Performance – how progress will be measured in the short, medium and long term and how data quality and accountability will be ensured and by whom.
- Scope 3 GHG emissions - Many companies that reported partial compliance with the TCFD recommendations had not achieved full compliance due to the data integrity and availability of Scope 3 greenhouse gas (GHG) emissions. Nonetheless, over 90% of companies reported at least some of the 15 Scope 3 emissions categories. Although this was around a 25% increase from last year, the reporting was often limited to only one or two categories, such as business travel and/or employee commuting. However, more companies assessed which Scope 3 categories are relevant or not relevant to them and for many their Scope 3 emissions will be much more significant than their Scope 1 and 2 emissions. The FRC would like to see disclosure of the methodology used to calculate data and advises companies to offer information on the work that will support future reporting and provide clarity on which of the Scope 3 categories they will include.
- Board expertise - Similar to last year, the FRC found that only around one quarter of companies disclosed senior management expertise or knowledge in the report. Although some companies did highlight board members had expertise, there was little to no description of what the expertise or knowledge was. While it is not a requirement to have a board member with climate and sustainability expertise, good reporting explains how the board and its committees get their decision useful information on sustainability.
- Assurance - Different forms of assurance are being sought by companies. This year, 65% of companies surveyed obtained some form of external assurance over at least some aspect of their TCFD data disclosure, which is an increase on last year. Of the external assurance sought, less than 25% was from audit firms while others used specialist environmental consultancies.
- Climate change risk – This year, the FRC found that 60 companies identified climate change as a principal risk and 17 as an emerging risk. Whilst significantly more companies in 2022 had climate change as a principal risk, compared to 2021, only one company in this year’s sample reported elevating climate change from an emerging to principal risk during the reporting period.
Culture, purpose and values
Reporting on corporate culture continues to evolve with 40% of the companies reviewed included culture among other ESG/sustainability disclosures and often classifying it as a social issue. In addition, the FRC notes that, whilst in previous years the nomination committee was most commonly tasked with oversight of culture, some organisations have now moved this responsibility to a board-level sustainability/ESG committee.
Reporting on purpose and values should consider the examples and guidance in the FRC’s 2022 In Focus: Purpose and ESG briefing.
Companies predominately stated that their engagement was through disclosure. This includes producing annual reports and holding investor relations conferences, as well as presentations on specific topics that are material to the company and/or its shareholders, including sustainability issues.
This year, nearly 70% of companies highlighted examples of issues that each stakeholder group had raised during the year. ESG matters were of high importance to many stakeholder groups and customer feedback highlighted a focus on recyclability of products, decarbonisation and climate change.
Some companies reported well on how they have considered the impact of their operations on the environment, but unfortunately too few extended this to the impact on the communities in which they operate.
Common themes and insights raised by suppliers included health and safety and ESG targets. Payment practices can also be an indicator of the relationship a company has with its suppliers and this year the FRC looked for references to payment policies and whether companies are signatories to the Prompt Payment Code.
In line with reporting on stakeholder engagement, reporting on workforce engagement is generally of high quality and offers meaningful information.
Remuneration and ESG and climate-related targets
Over 70% of companies had ESG targets integrated into executive incentive plans with the most common metrics aligned with social issues and focussed on matters such as employee engagement, diversity and inclusion, safety and corporate culture.
The FRC also found that many companies reported on environmental metrics with targets often relating to reducing carbon emissions, and in some cases, reducing waste, or water and energy intensity. Companies that reported well in this area had clear links between climate-related targets reported in TCFD disclosures and ESG targets. Where environmental metrics were used, these were generally included in long-term incentive plans.
Companies are reminded that they should ensure that their targets are strategically aligned, reliable and credible, so as to satisfy shareholders. Companies should also seek to describe the award’s objectives and current progress towards them.
For a summary focussed on the remuneration aspects of this report, see here.
The number of diversity policies included in annual reports has risen, with 99 companies disclosing that they have a company-wide diversity policy. The FRC also noted that better reporting included the progress made on achieving objectives and targets, and improvements year on year. Most companies were aligned with the FTSE Women Leaders Review and Parker Review targets, and progress has been made in accordance with both.
However, the FRC continues to find weaknesses in reporting on the link between diversity and inclusion policy and company strategy. In addition, few companies reported on diversity targets, other than gender and ethnicity targets, by considering social mobility, disability and LGBTQ+ people in senior management. Further, the FRC found that many companies did not mention the extent to which composition and overall diversity were considered by board evaluation reviews. Enhanced reporting could include focus areas for the review and link these to the evaluation outcomes and recommendations.