COP26 Features

A Measure of Intent

Greater consistency and comparability in climate reporting requires a shift from voluntary to mandatory disclosures.

Accountability and transparency were key themes at COP26. If we are serious about limiting climate change and cutting greenhouse gas emissions, promises are not enough. Credible and ambitious net zero strategies must be implemented without delay, their targets clear and their impact measured.

Countries were told to come back next year with improved nationally determined contributions; non-state actors were told they would now be closely monitored by a new expert panel.

“There is a deficit of credibility and a surplus of confusion over emissions reductions and net zero targets, with different meanings and different metrics,” UN Secretary General Antonio Guterres said.

“That is why, beyond the mechanisms already established in the Paris Agreement, I will establish a group of experts to propose clear standards to measure and analyse net-zero commitments from non-state actors.”

“A month after COP26, a key question is whether we are really keeping 1.5 degrees Celsius alive,” notes Claire Rogers, Managing Associate at international law firm Linklaters. True visibility of the world’s trajectory to a low-carbon future cannot be achieved unless companies globally are providing transparent and comparable information detailing their progress towards net zero, she says.

Corporates have long used voluntary disclosure standards from bodies including the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) – the latter recently merged into the Value Reporting Foundation (VRF) – to report on aspects of their ESG risks including climate change.

But voluntary approaches don’t necessarily provide a sufficiently consistent and comprehensive view of corporates’ exposures to climate change, leaving both investors and regulators uncertain of the scale of the risks they face. In response, policymakers are now legislating climate disclosures, often leveraging existing frameworks and standards.

Most frequently, this has meant drafting rules based on the recommendations of the Task Force on Climate-related Financial Disclosure (TCFD), first published in 2017 and the closest thing to a global standard for reporting climate risks.

“Corporate disclosures provide essential transparency and accountability for investors, in order for them to invest and develop products with clarity around how holding companies are transforming their businesses to align with increasing expectations,” says Rebecca Mikula-Wright, CEO of the Asia Investor Group on Climate Change (AIGCC) and Australasia-focused Investor Group on Climate Change (IGCC).

Mikula-Wright was encouraged by disclosure-related initiatives at COP26, welcoming an “unprecedented” regulatory focus on developing, strengthening and consolidating regulations focused on enhancing transparency and comparability in climate risk and sustainability reporting.

Kelly Perry, Head of ESG Client Solutions at investment research and advisory firm Edison Group, says the collective move by governments toward mandatory reporting “is a good start”, adding that policymakers should consider introducing fines and penalties for companies not delivering on the goals of the Paris Agreement.

Convergence and divergence

From a disclosure perspective, a pivotal COP26 announcement was the launch of the IFRS Foundation’s International Sustainability Standards Board (ISSB). It aims to address the fragmentation in existing sustainability reporting with a baseline standard that can be adopted by companies across the world, initially focusing on climate-related disclosures.

“Capital markets can have an essential role to play in reaching net zero. But that can only happen when sustainability information is produced with the same rigour, assurance of quality and global comparability as financial information,” said Erkki Liikanen, Chair of the IFRS Foundation Trustees, unveiling the ISSB at COP26’s Finance Day.

He also announced that the VRF will be consolidated into the new board alongside the Climate Disclosure Standards Board (CDSB), further integrating some of the biggest sustainability standards-setters into one cohesive unit.

“A key area of concern has been the number of different (and in some cases diverging/overlapping) standards,” says James Marlow, Lawyer for the ESG team at Linklaters. “The intention of the ISSB standards is that they can be used on a standalone basis or integrated into jurisdictional requirements,” he says.

A Technical Readiness Working Group (TWRG) was appointed by the IFRS Foundation to undertake preparatory for the Climate Prototype and the General Requirements Prototype.

The former is based on the TCFD framework’s four pillars: governance; strategy; risk management; and metrics and targets. The prototype asks entities to outline how climate-related risks are impacting their financial position and performance, the value of their future cash flows over the short, medium and long term, and how they are responding to these risks through strategies and business models. In essence, companies are only expected to report on how climate affects enterprise value.

The General Requirements Prototype will serve as an introductory guide for companies to disclose broader sustainability risks, such as biodiversity, water management and human rights.

The Climate Prototype faces further consultation and approval processes over the next six months. Verification and adoption by the International Organisation of Securities Commissions could see it incorporated by national securities regulators as the de facto climate disclosure standard for listed companies in the second half of 2022.

However, the success of the ISSB may depend on its ability to extend its focus beyond enterprise value to align with other developing global standards, such as the EU’s planned sustainability reporting standards (ESRSs).

The GRI is co-constructing the ESRSs alongside the European Financial Reporting Advisory Group (EFRAG). They are expected to be finalised and enforced next year, applying to all companies falling under the remit of the incoming Corporate Sustainability Reporting Directive (CSRD).

The ESRSs will incorporate a double materiality lens, going further than the ISSB by asking companies to both report on the financial impact of sustainability-related issues, including climate, and how their business practices impact the wider environment and society.

“GRI has for some time pressed for a two-pillar structure to ensure robust corporate reporting; [both should be] mandated and on an equal footing,” says GRI Chair Eric Hespenheide.

While the EU and the IFRS Foundation are approaching sustainability reporting from different perspectives, he says they are “complimentary and timely”.

“The co-construction work of EFRAG and GRI can strengthen the sustainability pillar at the global level, while the ISSB has the potential to strengthen the financial pillar,” he says.

“The ISSB standards should be compatible with any domestic reporting requirements, in the EU and elsewhere,” says Mikula-Wright. “There is no suggestion that ISSB standards limit or set a ceiling on the direction of sustainability reporting. It is appropriate for countries to pursue expanded objectives beyond the coverage of the ISSB.”

Nevertheless, there are concerns that the ISSB’s approach is too narrow, with its focus on cash flow providing a backward-looking view of climate risks and potentially leaving the investor blind to the full range of climate risks and impacts in their portfolios.

Mandating TCFD

Many countries are already mandating TCFD-aligned reporting for corporates and financial institutions.

Established by the Financial Stability Board, the TCFD updated its implementation guidance in the run-up to COP26, introducing seven categories of cross-industry metrics to help improve the quality of disclosures. These are: Scope 1-3 emissions; climate-related transition; physical risks; opportunities; capital deployment; internal carbon price; and remuneration.

As the ISSB standards also build on the TCFD’s work, jurisdictions already using its recommendations should be able to more easily incorporate the global baseline standard into their existing and planned legislation.

Subject to parliamentary approval, qualifying UK companies will be obliged to report in line with TCFD-influenced rules from next April. The legislation will apply to all UK-listed companies with more than 500 employees and/or a turnover of more than £500 million.

This scope isn’t as wide as Europe’s CSRD, and investment organisations such as the Institutional Investors Group on Climate Change (IIGCC) have called for the UK to expand the scope to include companies with 250 employees.

TCFD is also being embraced across the Asia-Pacific region. Hong Kong’s Green and Sustainable Finance Cross-Agency Steering Group announced plans last year for mandatory TCFD-aligned reporting by 2025. In November, the Hong Kong Exchange (HKEX) published guidance to help listed issuers prepare for TCFD-aligned reporting.

Further, Hong Kong’s Securities and Futures Commission (SFC) has been exploring ways the ISSB standards can be adopted in Hong Kong, including incorporating them into audit and listing rules.

The regulatory arm of the Singapore Exchange recently published a consultation paper on strengthening disclosure requirements for listed companies in line with TCFD.

“Singapore and Hong Kong’s aim to strengthen climate-related disclosures in line with the TCFD framework by 2023 and 2025, respectively, is a positive signal of improving materiality, quality, consistency and comparability in corporate sustainability reporting,” says Mikula-Wright.

Japan, New Zealand and the Philippines are also introducing mandatory TCFD-aligned reporting for listed companies from 2023.

In Japan, this is in addition to the Financial Services Agency’s existing climate disclosure rules that are incorporated in Japan’s corporate governance code on a ‘comply or explain’ basis.

The Philippines’ Securities and Exchange Commission (SEC) announced sustainability reporting guidelines for companies in 2019 on a comply or explain basis, with a compliance rate of 90% over the last two years.

New Zealand’s Financial Markets Authority (FMA) has asked listed companies subject to the mandate to secure third-party assurance for their climate statements as they relate to the disclosure of emissions.

“It is hoped that more countries across the Asia-Pacific region will mandate corporate sustainability reporting, and bring forward the timelines for disclosures on the financial impacts of climate-related risks and opportunities,” says Mikula-Wright.

Three into one?

Hope for global consistency in climate reporting is somewhat tempered by the approaches and timelines of China, Europe and the US.

In June, Yi Gang, Governor of the People’s Bank of China (PBOC), confirmed China would implement the TCFD disclosure framework and “endeavour to explore international, commonly-accepted standards”. In October, China’s Ministry of Ecology and Environment (MEE) conducted a consultation on mandatory ESG disclosures, as part of the country’s efforts to establish a mandatory environmental disclosure framework by 2025.

Published in April and designed to replace the existing Non-Financial Disclosure Directive (NFRD), the EU’s CSRD will apply to all large companies and listed companies with at least 250 employees and a net turnover of more than €40 million from October 2022. First reports will be expected in 2023.

As well as reporting in line with mandatory ESRSs, CSRD also includes the explicit requirement for companies to produce non-financial statements on a series of ESG-related factors outlined by the EU Taxonomy Regulation, and to ensure their CSRD disclosures are audited by a third party, to bolster their value to investors.

Additionally, the European Commission has announced plans for sector-specific and proportionate standards for SMEs to be introduced from 2023.

Originally anticipated in October 2021, the US Securities and Exchange Commission (SEC) will publish its own climate-related reporting framework early in 2022, according to Bryan McGannon, Director of Policy and Programmes for the US Sustainable Investment Forum (US SIF). The US SEC originally consulted on the framework earlier this year.

“We expect to see proposed disclosure regulations from the SEC on climate risk in Q1 2022,” says McGannon. “There will be a public comment period after the proposal is announced and then the SEC may take 12 months or so to finalise the rules, depending on their complexity and the nature of the feedback they have received.”

The US framework is expected to align with the ISSB’s focus on enterprise value and build on the TCFD, but the outcome is uncertain following a difficult gestation.

Some companies have called for a ‘liability safe harbour’, noting that accounting rules and risk data are underdeveloped. This would mean that they are not subject to legal repercussions if their reporting doesn’t fulfil minimum requirements.

Two commissioners have also voiced strong reservations, but the SEC signalled its resolve recently with a warning that its Division of Corporation Finance would send letters to public companies that are failing to satisfactorily disclose in line with the 2010 Climate Change Guidance.

“We also anticipate that the SEC will be considering new rules or guidance on disclosures by funds that describe themselves as ‘sustainable’, ‘green’ or ‘ESG’,” adds McGannon.

Forward-looking guidance

As reflected in the TCFD’s seven key metrics, investors and regulators require detailed forward-looking information on climate risks, as well as accurate and comparable data on today’s emissions. It is increasingly recognised that disclosure of transition plans plays an important part in understanding a corporate’s exposure to climate-related risks and opportunities.

Ahead of COP26, the UK government published its roadmap to sustainable investing, outlining its plans for companies and financial institutions to report on sustainability-related factors on a double materiality basis. During the Glasgow summit, it further announced that transition plans would become mandatory for corporates, asset managers and regulated asset owners.

Initially, companies will be required to disclose transition plans that align with the UK government’s net zero commitment through the Sustainable Disclosure Requirements (SDRs) or provide an explanation if they have not done so. Linklaters’ Marlow expects the SDRs to “leverage off the ISSB standards”.

The transition plans will become more detailed over time. “As standards for transition plans emerge, the government and regulators will look to incorporate these into UK regulation and strengthen disclosure requirements as appropriate,” the roadmap said. When the UK’s Green Taxonomy is introduced, the SDRs will require companies to disclose which proportion of their activities are taxonomy-aligned.

Between now and COP27 in Egypt next year, the regulatory landscape is set to continue evolving. Companies and investors will be working hard to keep on top of changing rules.

But the shift from voluntary to mandatory is highly positive, indicating that climate-related risks are increasingly being taking seriously by governments all over the world.

“Regions and jurisdictions globally are developing their own policy responses,” says Marlow. “While the levers and tactics used in different jurisdictions may vary, overall, the direction of travel is similar. Significant further developments are expected in 2022.”

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