Filling in the Blanks on UK SDRs

Timeline, scope, best practice … questions around the prospective UK sustainability disclosure requirements remain ahead of COP26.

For many, the 26th United Nations Climate Change Conference (also known as COP26) in November is thought to be the last chance saloon for global cooperation towards limiting the effects of climate change.

As host, the UK is looking to demonstrate leadership, building on its November 2020 pledge to be the first country in the world to enforce mandatory Task Force on Climate-related Financial Disclosure-aligned (TCFD) reporting for all UK financial institutions and corporates by 2025.

But managing climate-related financial risks is only the tip of the iceberg for investors, corporates and policymakers looking to transition to a sustainable future.

This is why UK Chancellor of the Exchequer Rishi Sunak announced plans for sustainability disclosure requirements (SDRs) during a speech at Mansion House in July. Under SDRs, companies, pension schemes and financial service providers will be required to report on the impact they are having on both the climate and environment, as well as the risks and opportunities facing their business.

“This represents one of the first indicators of how far the UK may be willing to go on climate action for financial services as part of its COP26 plans,” says Phil Spyropoulos, Financial Services Partner at international law firm Eversheds Sutherland.

The government is also planning to introduce a new sustainable investment label for retail investments using information procured through the SDRs.

The idea is that the SDRs will align with existing climate reporting requirements, ensuring the country has a “coherent, consolidated and streamlined reporting regime”, says Gemma Corrigan, Head of Policy and Advocacy for Federated Hermes.

For now, the government has remained vague on the details, promising further clarification before COP26.

Until UK investors and corporates are clear on the implementation timeline, the scope of reporting requirements and examples of best practice when implementing a double materiality lens, they won’t be able to prepare properly, experts warn.

If the Intergovernmental Panel on Climate Change’s (IPCC) latest report on climate change told us anything, we are fast running out of time to make a difference.

Building on TCFD

The UK government won’t be starting from scratch when developing the SDRs. Created by the Financial Stability Board (FSB) to standardise reporting of climate risks by corporates, banks, insurers and investors, the TCFD framework provides the SDRs with a strong foundation focused on climate-related governance, strategy, risk management, and metrics and targets.

Under UK implementation timelines, pension funds with over £5 million in assets under management must begin preparing their TCFD-aligned reports from next month, publishing finalised reports seven months after their year-end dates. The seven-month extension was granted by UK Pensions Minister Guy Opperman in January.

UK asset managers have until 30 June, 2023, to prepare their TCFD reports.

This deadline ties in with a consultation by Financial Conduct Authority (FCA) on details of the climate-related financial disclosure regime for asset managers, life insurers and FCA-regulated pension providers, requiring firms to annually publish an entity-level TCFD report as well as a baseline set of consistent, comparable disclosures in respect of their products and portfolios. The consultation closes on 10 September.

But it’s the pension funds feeling the heat.

“The government needs to be cognisant of the real-time resource pressures because of TCFD, particularly for smaller pension funds, that are only going to escalate over the coming weeks and months,” warns Will Martindale, Group Head of Sustainability for pensions risk and investment management provider Cardano Group.

And while more extensive climate-related disclosures are useful for pricing risk and to motivate firms to improve their performance, Spyropoulos is concerned that the SDRs may serve as a “recut of existing reporting obligations”.

“A bad outcome would be firms having to report substantively the same information in many different ways under different regimes; since this would be a significant additional burden for very little benefit,” he tells ESG Investor.

The reporting challenge is increased by the fact that TCFD is an evolving framework, both in the UK and globally. On the one hand, the UK may need to adjust its TCFD-based rules in line with market feedback, on the other, it may need to account for changes made by the TCFD itself. This could have implications both for existing rules and SDRs, notes Martindale.

“In the near term, the government needs to ensure that current TCFD disclosure requirements are working and working well,” he says.

In July, TCFD published two consultations reflecting potential avenues of change.

The first updates existing guidelines on climate-related metrics and data, proposing the mandatory inclusion of Scope 3 emissions (indirect emissions throughout the value chain). The second consultation assesses current market developments for forward-looking metrics. Finalised guidance is expected this autumn.

Nature in scope

Crucially, while the SDRs will grow from a TCFD-aligned foundation, the finalised requirements will go a few steps further by expanding the reporting scope to include nature and the environment.

“The focus on climate ahead of COP26 is of course essential, but we know far less detail on the extent to which the SDRs will focus on broader environmental factors,” says Fergus Moffatt, Head of UK Policy for NGO ShareAction.

With this in mind, the recently launched Task Force on Nature-related Financial Disclosures (TNFD) is likely to be pivotal for UK investors and corporates attempting to also disclose their exposure to and impact on nature and the wider environment.

As the TNFD framework also aims to align with the United Nations Convention on Biodiversity’s (CBD) draft Global Biodiversity Framework, it’s vital that the SDRs incorporate this additional framework to ensure international alignment, experts say. Due to Covid-19, the CBD has again been delayed, with part of the conference scheduled to take place online this October, and the physical meeting finalising the Global Biodiversity Framework anticipated Spring 2022.

Recent TNFD reports such as ‘Nature in Scope’ and ‘Proposed Technical Scope’ outline the TNFD framework’s proposed scope, development and research timeline ahead of its official launch in 2023, which will shape nature-related expectations for policymakers, standards-setting bodies, investors and corporates.

Until TNFD and the Global Biodiversity Framework are finalised, it remains unclear how nature-related risks will be effectively integrated into the SDRs, experts say, potentially implying a phased introduction.

The availability of high-quality ESG-related data continues to be a sore point for managers, investors and pension trustees attempting to provide TCFD-aligned – and soon-to-be SDR-aligned – disclosures. Nature-related risks are even harder to measure than climate, which could add further pressure for those in scope.

Nonetheless, the SDRs “could enhance ESG data availability and comparability in the UK through the application of common minimum standards”, Federated Hermes’ Corrigan points out.

The TNFD appears to be aware of the need for pragmatism. Its ‘Nature in Scope’ report said it will incorporate broader definitions of nature-related risks and opportunities in order to counteract present-day struggles with nature-related data, including the identification and categorisation of physical, transitional and systemic risks.

Double materiality lens

The UK government is choosing to adopt a double materiality approach for the SDRs. This means that entities will need to disclose their exposure to and impact on climate, nature and environmental-related risks.

Double materiality is an approach favoured by global standards-setting body the Global Reporting Initiative (GRI) and the European Financial Reporting Advisory Group (EFRAG), which is developing the EU sustainability reporting standards (ESRSs). GRI has committed to aligning its voluntary reporting framework with the ESRSs, which are expected to be published by October next year.

The TNFD has also proposed organisations using its framework should implement a double materiality reporting perspective.
With SDRs reflecting this same approach, future international alignment for global sustainability reporting standards should be easier, notes Corrigan.

Furthermore, many entities within scope of UK reporting requirements “will also be subject to EU reporting requirements under the Sustainable Finance Disclosure Regulation (SFDR), the EU Taxonomy and the proposed Corporate Sustainability Reporting Directive (CSRD)”, she adds.

In comparison, the TCFD framework currently only asks firms to disclose the impacts of financially material climate-related risks on their organisation.

Eric Usher, Head of UNEP FI, has previously said that the materiality definition adopted by TCFD is insufficient, short-termist and unlikely to drive real-world change.

The TCFD framework is more in line with the gradualist approach favoured by the IFRS Foundation, which focuses on the enterprise value.

Its new climate-first standard is currently being developed by the International Financial Reporting Standards (IFRS) Foundation’s new International Sustainability Standards Board (ISSB). It is due to be launched ahead of COP26.

This difference of approach between standards bodies could prove difficult if not resolved soon. GRI Chair Eric Hespenheide recently said the path forward is “less clear” for collaboration between GRI and the IFRS Foundation.

Final countdown

The UK government must fill in the blanks over the coming weeks, experts say. It must balance the urgent need to improve sustainability reporting and practice, thus reducing environmental risks, with a recognition of practical realities.

“What exactly is the substance of these requirements? What will be their legal form: Will it be primary legislation or a repurposing of existing sectoral frameworks like TCFD? Which firms of which sizes will be in scope? When will these obligations apply from?” asks Spyropoulos.

In the nearer term, the first thing UK investors and corporates need to know is what timeline they will be working with.

Many are looking to the government’s staged rollout of TCFD reporting as an example for the SDRs to follow. This would entail the SDR regime being phased-in over the next five years, beginning with premium-listed companies and the largest asset owners before being rolled-out to smaller firms.

Nonetheless, if introduced gradually alongside clear guidance, SDRs have the potential to be a game changer, notes ShareAction’s Moffatt.

“[The SDRs could] help build a financial sector that builds wealth as well as resilience, and one which will play a crucial role in tackling some of the biggest environmental challenges we face as a society,” he says.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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