Climate change reporting in annual reports
Alan Simpson CA looks at the evolving area of climate change reporting
In recent years, both climate change and global warming have become highly topical due to their increasingly visible harmful effect world-wide on the environment, society and economic activity. Global warming of the planet is believed to be caused largely by an increase over time in carbon emissions into the atmosphere (greenhouse gas emissions) arising from the use of fossil fuels (that is coal, oil, natural gas). Climate change also encompasses the move to conserve natural resources such as making more efficient use of water and, in the case of forests and woodlands, by reducing deforestation.
In a move to reduce the harmful effects of climate change, nearly 200 countries agreed in December 2015 (The Paris Agreement) to decrease greenhouse gas emissions and to accelerate the move over to a lower-carbon economy. The Paris Agreement’s central aim is to restrict global temperature rise to 2 degrees centigrade above pre-industrial levels, and to pursue efforts to limit the increase to 1.5 degrees centigrade, setting a new ambition for the world’s response to climate change.
The UK Government has set a target of achieving net zero greenhouse gas (GHG) emissions by the year 2050. The Scottish government has set a target by 2030 of reducing GHG emissions by 75% and then a further reduction down to net zero by 2045. Both the City of Edinburgh Council and Glasgow City Council have declared their targets of achieving carbon net zero by 2030. (per April 2020 CA Magazine – “The Road to net zero: a tale of two cities”).
The accountancy profession has also responses to the issue of climate change. The April 2020 edition of CA Magazine included an article entitled “Sustainability – Industry unites on climate change” which reported that, in February of that year, 13 CEOs of the world’s major accounting bodies, including ICAS and our CEO Bruce Cartwright CA, had together issued a powerful call to action to the accountancy profession and ICAS members to play their part.
Environmentalist pressure groups (or activists) are now known to monitor the reporting of climate change disclosure in company annual reports and then report to the FRC any instances of what they regard as inadequate or poor disclosure. They have also been known to write to the auditors of such companies to ask why they had failed to raise the matter in their audit report.
This article considers some of the current requirements and developments in relation to climate change reporting and looks ahead to what climate change-related disclosures might be required in the future.
A more detailed summary of a sample of FTSE 100 company climate change-related disclosures by sector can be found here.
Climate change disclosures
This section gives an overview on the information that larger UK companies are required to give in their annual reports on the impact of climate change and carbon emissions by their business. In the same way that businesses have become aware of the risk that climate change poses to their activities, investors too are increasingly eager to understand the potential risks that climate change presents to their investments and the steps taken by management to respond to and mitigate those risks. As a result, greater requirements to reporting on climate change in annual reports have been introduced. We consider some of these below.
Practical examples of carbon emissions and climate change
Most organisations will have some effect upon the environment, for example through their consumption of energy. Think of a company that produces building materials such as bricks, roofing tiles and drainpipes from clay. The production of these items uses energy and therefore creates carbon emissions. They may also emit carbon emissions from the fuel used by their fleet of vehicles in the delivery of finished goods to customers. An accountancy firm, for example, with multiple branches, may also generate carbon emissions from the energy used to heat, light and power its operations.
The other situation is where climate change has affected a company and its activities by adapting its business model in order to continue to survive and prosper. An example of this would be a motor manufacturer who has traditionally made cars, which were powered by either petrol or diesel engines, now producing a growing range of electrically-powered cars and devoting significant resources to further improve battery technology for electric vehicles.
Climate change reporting requirements in the UK
Under the Companies Act 2006, those companies which are defined as listed companies are required by law to make certain disclosures on climate change in the Strategic Report as follows:
- Firstly, what are the key risks the company’s business model faces from climate change and secondly, what is it doing to address these risks?
- What is the impact of the company’s activities upon the environment and to what measure is the company contributing to overall global warming via its GHG emissions?
Section 172 of the Companies Act 2006 states that:“ A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to— (a)the likely consequences of any decision in the long term… (d )the impact of the company's operations on the community and the environment”.
Section 414CA & 414CB, Companies Act 2006 also provide that " The strategic report must contain… (2)(b) a description of the principal risks and uncertainties facing the company… [and]… The review must, to the extent necessary for an understanding of the development, performance or position of the company’s business, include… (b) where appropriate, analysis using other key performance indicators, including information relating to environmental matters and employee matters.”
No specific independent external assurance is required on the above mandatory disclosures but the Companies Act 2006 requires that, in the audit report, the external auditor must state whether the information given in the Strategic Report is consistent with the financial statements and has been prepared in accordance with applicable legal requirements and that they did not identify any material misstatements in these Reports.
The UK Corporate Governance Code requires listed companies to disclose in their annual report how opportunities and risks to the future success of their business have been considered.
From April 2019, companies have been required to report in accordance with the Streamlined Energy and Carbon Reporting (SECR) scheme, which introduced reporting requirements for large unquoted companies and for limited liability partnerships (LLP), and include additional disclosure requirements for quoted companies.
Climate change reporting requirements in the European Union
The EU Directive 2014/95 on the disclosure of non-financial and diversity requires companies with over 500 employees to disclose climate-related information on GHG emissions, energy use, land and water use. The disclosure of this information is required to be included in the annual report and accounts or on a website 6 months after the balance sheet date with reference being made in the annual report. This disclosure is mandatory for accounting periods beginning from 1 January 2017.
This Directive has been enacted into UK law and all UK companies, except small companies, must now give some level of detail (which increases for listed companies) in their Strategic Report on climate change as it impacts on them.
Member States must require that statutory auditor checks whether the non-financial statement has been provided in the annual report and accounts. Member States may require independent assurance for information in the non-financial statements.
The TCFD and its guidance
The Task Force on Climate-related Financial Disclosures (TCFD), chaired by the US financier Michael Bloomberg, is an international body created in 2015 by the Financial Stability Board of the Bank for International Settlements. TCFD was formed because there was concern that investors, lenders and insurance underwriters did not have sufficient information to enable them to adequately identify and evaluate climate-related risks and opportunities in organisations. The Task Force has the remit to examine how the financial sector could take account of climate-related issues and to give recommendations for more effective voluntary and consistent climate-related disclosures by such organisations.
It produced its first report in June 2017 in which it described what it calls the four core elements of climate-related financial disclosure for use throughout many different sectors and jurisdictions and not confined narrowly to the financial services industry alone. These core elements are:
- Governance: the system of how the organisation is directed and controlled in the interests of investors and other stakeholders.
- Strategy: describe the actual and potential impact of climate-related risks and opportunities on the organisation’s business model.
- Risk management: describe how the organisation identifies, ranks and manages climate-related risk.
- Metrics and targets: the measures used by the organisation to assess, quantify and report on climate-related risks, emissions and performance against target for managing climate risks.
The Report also lists its seven principles for effective climate disclosures:
- Disclosures should represent relevant information
- Disclosures should be specific and complete
- Disclosures should be clear, balanced, and understandable
- Disclosures should be consistent over time
- Disclosures should be comparable among companies within a sector, industry, or portfolio
- Disclosures should be reliable, verifiable, and objective
- Disclosures should be provided on a timely basis
In June 2019, the TCFD produced its second report which included a survey of climate-related disclosures by over 1,000 companies world-wide in their annual reports, comparing the extent of their disclosures in 2018 with those they made in 2016. The TCFD report published in March 2020 includes a list of categories of climate-related risks and opportunities.
Future developments in climate-change disclosure in UK
It is anticipated that organisations will be asked to provide further climate change disclosures (in line with TCFD recommendations) in their annual reports on how it impacts upon them and describe in what way they are addressing the risks and opportunities presented by climate change.
In July 2019 the UK Government announced, in its Green Finance Strategy, the expectation that listed companies and large asset owners should provide, within their annual reports, climate-related disclosures in keeping with the four core TCFD elements listed above by 2022.
The Financial Reporting Lab of the FRC published a report on Climate Change reporting in October 2019. This looked at the current practice in climate change reporting.
The Financial Conduct Authority (FCA) consulted in 2020 on a proposal whereby all companies (this applies chiefly to financial institutions) with a premium listing on the LSE (London Stock Exchange) will be required to make a statement in their annual report explaining whether they have made the disclosures in line with the TCFD recommendations on a comply or explain basis.
