Taking the long-term view
Hannah Armitage and Claudia Chapman of the Financial Reporting Council (FRC) explain why TCFD is so important for climate risk reporting and how the revised UK Stewardship Code will help drive better integration of ESG into investment decision making.
What were the main findings of the FRC Financial Reporting Lab’s report into climate-related corporate reporting, and are companies falling short of investor expectations?
Hannah Armitage (HA): The Financial Reporting Lab’s project on climate-related corporate reporting highlighted that there is a lot of support in the market for disclosures according to the TCFD recommendations.
The TCFD framework consists of four elements: governance, strategy, risk management, and metrics and targets. While the Lab’s project did not use the TCFD as a starting point for our discussions, it became clear very quickly that companies and investors were supportive of the framework for thinking through and reporting on climate-related challenges. Because of this, the Lab’s report is based around these four elements.
Investors are really interested in this issue. In fact, of all the Lab’s projects over the past nine years, this one attracted the highest number of participants. Investors view climate change as relevant to a wide range of businesses, with many believing that companies should consider it to have a material impact.
For this project, we looked at disclosures from 2018 and 2019 by companies across the world. We spoke to companies and investors as well auditors, advisers, sustainability experts and communication agencies.
In terms of reporting, this is very much a developing practice. It’s fair to say there are different levels of sophistication. Investor participants told us that insight into whether the business model remains sustainable, the importance of disclosures on scenario analysis, and the strategic alignment, reliability and transparency of disclosures are key.
What steps should boards take to integrate climate risks into their reporting?
HA: In some ways it’s a very new challenge, but on the other hand, many companies already have robust risk management processes in place and climate risks should form part of these existing processes. There’s a lot of uncertainty around climate change outcomes but it’s important that boards don’t see this as an entirely separate issue and instead think through scenarios of how the business might be impacted, either in the shorter or longer term, and how they plan to respond.
There are 11 recommended disclosures under the TCFD framework, as well as a set of questions defined by the Lab’s project, that investors are asking companies – and therefore questions that companies should ask themselves.
Boards aren’t necessarily expected to have the answers straight away and different companies will be affected in different ways. However, a great starting point is to begin to explain to investors how a company’s management and governance systems are addressing climate-related challenges, the biggest challenges the company might face and how they could begin to address those challenges.
The Lab’s report recommends that companies use TCFD as a framework for thinking about and reporting on climate change. What advice would you give to preparers who want to start using the TCFD framework?
HA: The TCFD is a really useful resource, so use it! The 11 recommended disclosures of the framework are high level, which means that companies can still tell their own story within the framework.
That’s not to say it’s straightforward. There are challenges to following the TCFD framework: trying to get to grips with what this means for a company can be tricky and uncomfortable, as elements of the impact of climate-related challenges on companies remain uncertain. However, investors are keen for companies to disclose more information on this issue. The Lab’s report, which is framed around the TCFD, also includes a set of questions companies should ask themselves in thinking about these issues and developing their reporting. Hopefully these provide a useful starter for companies struggling to work out what to report.
One of the regulatory elements that companies should be aware of is the Green Finance Strategy published in 2019, which states that the Government’s expectation is for listed companies and large asset owners to be disclosing against the TCFD framework by 2022. Implementation options are still being considered, but there’s a clear direction of travel for the expectations around reporting.
The FRC has launched a thematic review across a number of its functions, which will, in part, highlight best practice against the TCFD framework. Regulatory change is moving quite quickly in some jurisdictions and we’re seeing lots of global best practices, so we want to highlight these to assist companies to improve their reporting.
What is the UK Stewardship Code and how does it encourage investors to consider ESG factors?
Claudia Chapman (CC): The revised UK Stewardship Code, which took effect on 1 January 2020, is a voluntary code of best-practice principles for asset owners such as pension funds and insurers, investment managers, and service providers such as proxy advisers, investment consultants or – increasingly – those that provide data and information particularly in relation to ESG.
The principles are truths or beliefs about the activities and behaviours that underpin effective stewardship. For example, “Signatories systematically integrate stewardship and investment, including material ESG” and “Signatories actively exercise their rights and responsibilities.” If you do these things, you’ll be an effective steward of the assets entrusted to your care.
In revising the Code, the FRC redefined stewardship through extensive consultation with a broad range of stakeholders – including pension funds, NGOs, industry bodies, asset managers and other regulators. Stewardship is now a much broader set of activities and behaviours, intended to benefit clients and beneficiaries, leading to sustainable benefits for the economy, the environment and society. Every aspect of stewardship should take this new definition into account and this puts ESG issues at the heart of the Code.
How can the Code drive better reporting, and what are the ESG-specific reporting expectations?
CC: Originally, the Stewardship Code’s primary focus was on making sure UK-listed companies performed well and were well governed, and in turn the capital invested by pensioners and savers would be protected and grown. When we revised the Code this time, we changed the primary purpose of the Code and stewardship to be to be in the interest of UK pensioners and savers.
Although there’s a drive from asset managers themselves to focus on climate change, they are also being pushed by their underlying asset owners to focus more on climate change and other ESG issues – and that’s been driven by legislation, too. There’s a long-term benefit to companies, the economy, the environment and society by focusing on ESG.
Hannah Armitage
Claudia Chapman