The news this quarter is dominated by two main events: the entry into force of the Sustainable Financial Disclosure Regulation, with some legacy effect on UK financial markets actors even after Brexit; and the beginning of the implementation of the UK Government's commitment to achieve economy-wide TCFD-aligned1 reporting by 2024/2025. Other significant developments should not be ignored, however, which are discussed below.
On 10th March, the Sustainable Financial Disclosures Regulation's Level 1 requirements started being applied. The regulation aims at fighting greenwashing in the market for sustainable financial products, with Level 1 being more qualitative and general in nature, to be integrated in time by more technical and product-focused Level 2 requirements.
The Level 1 requirements include policies on sustainability risks, remuneration, and others (for a more specific analysis, see here). Level 2 requirements still need to be fleshed out in detail by EU regulators, and are the object of heated discussions between policymakers and market actors, specifically about the depth and quantity of the indicators against which firms will be required to report. The Final Report on the draft Regulatory Technical Standards was published on the 4th February, and provides in draft form the regulatory technical standards described in the SFDR. For a deeper analysis of these requirements, see here.
How does this affect you?
Although the first drafts of the Financial Miscellaneous Amendments (EU Exit) Regulations 2020, published on 6 May 2020, provided for the SFDR to partially apply in the UK after the transitional period (mainly with regards to Level 1 requirements), eventually the UK government elected not to implement either the SFDR or the EU Green Taxonomy Regulation in UK legislation. Instead, it has vowed to establish its own domestic green taxonomy and ESG disclosure regime, whose possible alignment with the UK regulation is still unclear. As a result, the SFDR regulations coming into effect in Europe will not apply to fund groups or advisers in the UK. It will only apply to UK financial market actors to the extent that they market certain financial products in the EU (for example under the national private placement regime).
The Government has also indicated that it may decide to align itself with the EU with regard to the Taxonomy Regulation, but such a decision would only be taken once the relevant delegated regulations are finalised. In the latest consultation on TCFD reporting (see below) BEIS states that "The UK will be launching a UK Green Technical Advisory Group in 2021 to review the Technical Screening Criteria of the taxonomy and advise Government on an ongoing basis on any improvements or additions that could be made to the taxonomy to better facilitate the UK's environmental goals." It will be interesting to see to what extent the UK Government will take into account other international developments in terms of taxonomies, in particular the Common Grounds Taxonomy currently being developed in collaboration between the EU and China, within the International Platform on Sustainable Finance.
The UK Chancellor announcemed in November 2020 that the UK would become the first country in the world to implement economy-wide reporting in line with the recommendations of the Task Force on Climate-Related Disclosures. Since then a number of regulatory initiatives started being implemented.
First, the Department for Work and Pensions ran a consultation, which closed on 10th March, on a set of proposed new regulations in the area of climate change duties for pension trustees. These are strongly based on TCFD requirements and cover 7 areas, including Governance, Strategy, Scenario Analysis, Risk Management, Metrics, Targets, and Trustee knowledge and understanding. For further analysis of the new requirements, see here.
In addition, the regulation also includes new reporting and disclosure requirements. To comply with these, trustees will need to prepare a yearly "TCFD report" setting out, in detail, how they have met the governance requirements and what they have found. The report must be made freely and publicly available online, and the website address (and other information) will have to be published in the scheme return, annual report, annual benefit statements and (for DB schemes only) summary funding statements.
The timing for the implementation of the new regulation will vary, based on the scheme's nature and size.
Moving on to the other initiatives, on 26th March the UK Department for Business, Energy and Industrial Strategy (BEIS) launched a Consultation on requiring mandatory climate-related financial disclosures by publicly quoted companies, large private companies and Limited Liability Partnerships, which will close on 5th May. The proposed scope for the regulation extends to:
- All UK companies that are currently required to produce a non-financial information statement, being UK companies that have more than 500 employees and have transferable securities admitted to trading on a UK regulated market, banking companies or insurance companies (Relevant Public Interest Entities);
- UK registered companies with securities admitted to AIM with more than 500 employees;
- UK registered companies which are not included in the categories above, which have more than 500 employees and a turnover of more than £500m; and
- LLPs which have more than 500 employees and a turnover of more than £500m.
It is worth pointing out that the FCA’s December 2020 Policy Statement (20/17) already obliges all commercial companies with a premium listing to include a statement in their annual financial report of whether their disclosures are consistent with TCDF recommendations and to provide an explanation if they are not.
What does it mean for you?
At the time of writing, no reporting obligation under the BEIS consultation is in place. However, it is important that any company or institution that may be subjected to the requirements (and also those that will not) start considering climate as an factor in its business and investment decisions. This is the right moment to familiarise yourself with the TCFD requirements, to think about how the internal strategy and management of your firm's operations can be adapted, and to start making plans (if not already in place) to gather the necessary data to respond to the various reporting obligations.
It is important to note that this move towards TCFD-aligned reporting is unlikely to be a temporary fad, and we are already seeing that many other governments around the world are discussing such measures. For example, New Zealand's External Reporting Board (XRB) is in the process of developing a mandatory reporting mechanism for actors in its financial sector. Other developed and developing economies, including Switzerland, Hong Kong and Brazil are moving in the same direction, and the trend is expected to grow.
In addition, other UK authorities are planning to launch consultations in the coming months on the same subject. In the FCA Policy Statement mentioned above, the regulator revealed plans for two separate consultations in the first half of 2021:
- On proposals to extend the application of the disclosure rules to a wider scope of listed issuers, and consider strengthening the compliance basis; and
- On potential TCFD-aligned disclosures by UK-authorised asset managers, life insurers and FCA-regulated pension providers designed to better inform their clients and end investors.
Central Banks and Climate
The UK Government recently announced its decision to adjust the Bank of England's mandate to reflect climate risks, a suggestion made by the Network for Greening the Financial System (a network of 83 central banks and financial supervisors that aims to accelerate the scaling up of green finance and develop recommendations for central banks' role for climate change). This can be seen as formal recognition of a situation already existing in practice, with the BoE being one of the most active central banks in the world when it comes to recognising climate change risks. During a speech at the Green Horizon Summit last November the Bank's Governor, Andrew Bailey, announced a new deadline for banks and insurers to publish climate stress tests, after it was postponed this year when the pandemic hit. This new deadline is set for June 2021.
A number of european central banks have announced their plans to commence reporting against TCFD, including with regards to their investment portfolio. This comes in the wake of strong signals given by the European Central Bank president, Christine Lagarde, about the Bank's move towards stronger integration of climate risks in its governance.
UK Budget and Green Finance
With the 2021 Budget, it was announced that the UK government will issue its first sovereign green bond - or green gilt - this summer, with a further issuance to follow later in 2021 as the UK looks to build out a "green curve". This represents a change in direction compared to the UK Green Finance Strategy, where it was stated that "the Government does not plan to issue a sovereign green bond, given the absence of significant barriers to market for corporate issuances in the UK", and goes to show how much, in the space of less than 2 years, green finance has come to occupy a central space in may governments' plans, especially with in the wake of the pandemic and the need to raise funding for the necessary relief and recovery spending.
Planned green gilt issuance for the financial year will total a minimum of £15 billion. A green gilt framework, to be published in June, will detail the types of expenditures that will be financed to help meet the government's green objectives.
The Government also announced plans for the creation of a new UK infrastructure bank in Leeds, which will be allotted £12 billion in capital and aims to fund at least £40 billion worth of public and private projects, beginning in the Spring.
1 The Task Force on Climate-Related Financial Disclosures was established by the Financial Stability Board with the goal of improving and increasing reporting of climate-related information. It published a set of recommendations, calling for the inclusion of climate-related considerations in the governance, strategy, risk management processes and metrics and targets employed by financial market participants.