Firms’ approach to mandatory reporting will reveal their aptitude for sustainability, says Nicholas Micheli, UK Country Manager at Projective.
Asset managers are becoming increasingly familiar with climate disclosures. At the start of this year, the Financial Conduct Authority (FCA) published its ESG sourcebook, containing rules and guidance for asset managers and certain FCA-regulated asset owners to make disclosures consistent with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD).
In addition, since the beginning of April 2022, the UK has been the first country in the G20 to enshrine TCFD requirements into law. The largest UK registered companies and financial institutions are now required to share mandatory climate-related information in their annual financial reports, in line with the guidelines set by the TCFD. The addition of both new reporting standards will provide deeper insight for asset owners into the environmental and social impacts of firms in their portfolios.
Looking ahead, there’s more to come. The UK’s Sustainability Disclosure Requirements (SDRs), developed by HM Treasury, the Department for Business and the Department for Work and Pensions, should create a comprehensive framework to combine sustainability-related reporting requirements.
SDRs will go beyond existing disclosure requirements, involving double materiality, looking at other environmental impacts, and risks on top of those arising from climate change.
A new dawn
As climate impact and risk reporting are now becoming the norm, expectations are shifting to require greater clarity and transparency on the green credentials of investments as a minimum. Accordingly, investors are looking to firms to show signs of successful implementation of the necessary tools and data frameworks to facilitate mandatory reporting. Indeed, as well as the obvious physical implications, climate change presents one of the largest threats to a fund’s financial gains.
A key change arising from the TCFD-based reporting standards introduced in early April is that supply chains will now be assessed. The supply chain can often be the skeleton in the closet for many businesses looking to reduce their climate impact. While a company can be a proponent of environmental safeguarding, vast international supply chains can make the true carbon impact of a product or service far greater than it would seem. Tracing these long chains can seem an insurmountable feat, especially for more sophisticated products and services.
However, the guidelines laid out by the TCFD require firms to assess their Scope 3 emissions i.e. the emissions resulting from activities and assets not owned or controlled by the reporting institution but still involved with its processes. The TCFD recommendations require a company to report on all climate impacts associated with partner companies in their supply chain.
The intention of the legislation is to discourage acts of greenwashing and promote climate transparency for the benefit of investors, with firms now required to confront and report on the environmental consequences of their supply chains, including their direct and indirect impact.
Those firms prioritising ESG longevity will be the ones assessing all third-party providers, changing the fundamentals of how they view and report their climate impact and considering the role of previously opaque supply chains within the company.
Complete involvement and disclosure training
For those required to meet the new reporting standards, greater emphasis is needed on delving deeper to see the impact of business practices. Prior to 2022, voluntary climate disclosures were the sole domain of the risk and sustainability departments. For the sake of clarity, the increased focus on climate disclosures in mandatory reporting regimes requires a comprehensive picture of a firm’s environmental impact, meaning that reporting now needs input from the entire firm to paint that picture, and managers must apply a company-wide strategy accordingly.
An effective approach must include management training initiatives on disclosures. Starting with board members and managing directors, those affected can familiarise themselves with the requirements for sustainability reporting.
Once understood, a more comprehensive reporting process can be put in place. Without specific frameworks in place, firms will face challenges when collating from multiple sources on their environmental, social and governance impacts.
By implementing a solid data management framework throughout the business, firms will find these pitfalls lessened. This will then feed into more accurate reporting, helping funds evaluate their portfolios’ climate impacts and provide the deeper insight into the environmental and social impacts of firms in their portfolio which asset owners are growing to expect.
Planning for the long term
Now that ESG disclosures are mandatory under law, those affected will have to take a long-term approach and incorporate measures on a rolling basis. The most promising firms will demonstrate through their disclosures that their long-term goals consider sustainability and that their operations have been adapted to meet these.
The transition to mandatory climate disclosures marks an important step in the UK’s net zero ambitions being realised. For many of the largest 1,300 UK listed companies, this will be the first year of climate disclosures with the intention of bringing a new level of transparency to the climate impact of UK business.
Enhanced by this has been the FCA’s ESG sourcebook, guiding asset managers on reporting consistently with the TCFD recommendations for their investment decisions, as well as baseline metrics for their portfolios. This will be furthered by the UK’s Sustainability Disclosure Requirements (SDRs), working in conjunction with TCFD reporting to create a more consistent framework for comparing firms’ climate risks side-by-side.
However, before the kinks in the newly established process are ironed out, the approach of firms to mandatory reporting will likely reveal their aptitude for sustainability. While only the largest firms are required by law at present, smaller corporates and financial institutions would be wise to begin integrating the new practices. Those prioritising the initiatives will be the pioneers of incorporating ESG into business as usual, demonstrating their worth as investment opportunities. The rest, on the other hand, will simply be delaying the inevitable and ensuring a future backlash.