One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions.
Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital. Climate change presents financial risk to the global economy. Financial markets need clear, comprehensive, high-quality information on the impacts of climate change.
The Task Force on Climate-Related Financial Disclosures (TCFD) was created by the G20’s Financial Stability Board with the aim of improving and increasing reporting of climate-related financial information. The TCFD provides a framework for effective disclosure and enhances climate risk and opportunity management.
Its wide adoption internationally will further help to provide a consistent approach. It is the view of the TCFD that, by enabling markets to have effective and transparent climate-related financial disclosures, businesses can take a leading role “in understanding and responding to climate-related risks – and seizing the opportunities – to build a stronger, more resilient, and sustainable global economy”.
What is the TCFD regime?
The Task Force’s 2017 report (74 pages / 2.39MB PDF) outlines the TCFD framework for reporting climate-related financial information. Since then, the TCFD has published further reports and guidance including sector specific guidance which together set out the current TCFD reporting and disclosure regime.
The TCFD reporting and disclosure regime focuses on ‘financial materiality’ or single materiality. This means that climate-related disclosures are aimed at providing information relating to how climate-related risks and opportunities are likely to impact an organisation’s current and future financial position as reflected in its income statement, cash flow statement and balance sheet.
The TCFD regime does not focus on ‘impact materiality’, meaning the impact of an organisation’s activities on wider environmental, social and economic systems from a climate perspective. Looking at both aspects is referred to a double materiality. This is the focus of European climate and sustainability disclosure regulation, for example, such as the European Corporate Sustainability Reporting Directive (CSRD).
Pillars of the TFCD
The TCFD structured its overarching recommendations around four thematic pillars, within which organisations should provide climate-related financial disclosures. These include disclosures as to the organisation’s governance, strategy, risk management, and metrics and targets. There is overlap between these thematic pillars, often illustrated by the concentric circle, which organisations should consider holistically rather than in isolation.
Recommended disclosures
The four pillars are supported by 11 key climate-related financial disclosures which communicate the extent to which consideration for climate-related risks and opportunities are mainstreamed through an organisation’s decision-making.
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Governance |
Strategy |
Risk Management |
Metrics and Targets |
|---|---|---|---|
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Describe the board’s oversight of climate-related risks and opportunities. |
Describe the climate-related risks and opportunities the organisation has identified over the short, medium and long term. |
Describe the organisations processes for identifying and assessing climate-related risks. |
Disclose the metrics used by the organisation to assess climate-related risks and opportunities in line with its strategy and risk management process. |
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Describe management’s role in assessing and managing climate-related risks and opportunities. |
Describe the impact of climate-related risks and opportunities on the organisation’s businesses, strategy and financial planning. |
Describe the organisation’s processes for managing climate-related risks. |
Disclosure Scope 1, Scope 2 and, if appropriate, Scope 3 greenhouse gas emissions, and the related risks. |
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Describe the resilience of the organisation’s strategy, taking into consideration different climate-related scenarios, including a 2C or lower scenario. |
Describe how processes for identifying, assessing and managing climate-related risks are integrated into the organisation’s overall risk management. |
Describe the targets used by the organisation to manage climate-related risks and opportunities and performance against targets. |
Principles for effective disclosure
The TCFD recommends that organisations consider seven principles to produce high-quality disclosures that enable users to understand the impact of climate change on organisations. Disclosure should:
- represent relevant information;
- be specific and complete;
- be clear, balanced and understandable;
- be consistent over time;
- be comparable among companies within a sector industry or portfolio;
- be reliable, verifiable, and objective; and
- be provided on a timely basis.
Guidance
The TCFD has released extensive guidance within the TCFD framework. In respect of the TCFD recommendations and recommended disclosures, this includes guidance for different sectors, supplemental guidance for certain financial and non-financial sectors, and guidance on the principles for effective disclosure. This also includes topic-specific guidance, such as technical standards, targets and metrics, risk management integration, and transition plans.
The climate-related financial disclosures envisaged by the TCFD regime are just the tip of the iceberg. The disclosures are evidenced-based and need to be founded on integrated operational processes and systems which cut across internal departments and functional silos of organisations. These can take significant resource and time to set up, so it is crucial that organisations consider how they will produce their TCFD disclosures well in advance of relevant deadlines.
Application of the TCFD framework
The TCFD framework is being progressively applied in the UK, to different categories of organisations, through a complex meshwork of legislation and regulations that apply to different sectors.
Whether the TCFD framework applies to your organisation can be surprisingly complicated to work out, particularly for companies within a group and/ or cross-border structure. Additionally, a single organisation may be impacted by more than one TCFD reporting ‘gateway’, meaning that it may be subject to multiple overlapping but separate disclosure requirements. Further, it can be expected that the sustainability disclosure will ripple the value chain.
The table below provides a high-level indication of the organisations impacted by mandatory disclosure requirements:
|
Overarching ‘gateway’ |
Entity type |
Relevant ‘in-scope’ thresholds |
Applicability & Deadlines |
Disclosure requirement(s) |
|---|---|---|---|---|
|
Company law requirements The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 The Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022 |
Large UK companies |
Companies that are:
* N.B. subsidiaries of parent companies may bring parent companies within scope. |
Applicable to financial years starting on or after 6 April 2022. Applicable if ‘in-scope’ at any time within a financial year. The usual deadline for filing accounts at Companies House |
Company strategic reports must now provide climate-related financial disclosures that are based on the TCFD framework. Certain TCFD framework-aligned disclosures are mandatory. Others are imposed on a ‘comply or explain’ basis, such that companies may opt to merely explain why disclosures are not made. |
|
Large UK LLPs |
LLPs that are:
*subsidiaries of parent companies may bring parent companies within scope. |
Applicable to financial years starting on or after 6 April 2022. Applicable if ‘in-scope’ at any time within a financial year. The usual deadline for filing accounts at Companies House. |
Traded & banking LLPs’ strategic reports, and high turnover LLPs’ energy and carbon reports, must now provide climate-related financial disclosures that are based on the TCFD framework. Certain TCFD framework-aligned disclosures are mandatory. Others are imposed on a ‘comply or explain’ basis, such that companies may opt to merely explain why disclosures are not made. |
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|
FCA regulation: Listing Rules Listing Rules (Disclosure of Climate-related Financial Information) Instrument 2020 (FCA 2020 75) |
Issuers |
Issuers of premium listed shares |
Applicable to accounting periods on or after 1 January 2021. The usual deadline for publication of annual financial reports. |
Annual financial reports must include a ‘comply or explain’ statement confirming:
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|
Issuers of
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Applicable to accounting periods on or after 1 January 2022. The usual deadline for publication of annual financial reports. |
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|
Asset managers |
Assets under management (AUM) > £50 billion |
Rules apply from 1 January 2022. Publication deadline on 30 June of each calendar year for:
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TCFD entity reports must be prepared in respect of the relevant legal entity. TCFD product reports (which include public and on-demand reports), must be prepared in respect of ‘TCFD products’. TCFD framework disclosures are largely mandatory within these reports. |
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AUM > £5 billion |
Rules apply from 1 January 2023. Publication deadline on 30 June of each year. |
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Asset owners |
AUM or assets under administration > £25 billion |
Rules apply from 1 January 2022. Publication deadline on 30 June of each year. |
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AUM or assets under administration > £5 billion |
Rules apply from 1 January 2023. Publication deadline on 30 June of each year. |
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Pensions regulation The Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 /
|
Occupational pension schemes (OPS) |
AUM > £5 billion |
Applicable from 1 October 2021, for scheme years ending on or after 1 March 2020. Publication deadline within 7 months of the end of the relevant scheme year. |
Trustees of OPSs are required to:
|
|
AUM > £1 billion |
Applicable from 1 October 2022, for scheme years ending on or after 1 March 2021. Publication deadline within 7 months of the end of the relevant scheme year. |
Next steps for sustainability regulation
The maelstrom created by the large amount of legislation, regulation and guidance at international and domestic levels is hard to navigate and is constantly shifting. Key pieces include ISO 32210, published in October 2022, which sets out principles and practices to support financial organisations to enable positive environmental and social outcomes, risk mitigation and deliver sustainable value.
In June 2023 the International Sustainability Standards Board (ISSB) issued its first standards: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information; and IFRS S2 Climate-related Disclosures. IFRS S1 provides a set of disclosure requirements designed to enable companies to communicate to investors about the sustainability-related risks and opportunities they face over the short, medium and long term. IFRS S2 sets out specific climate-related disclosures and is designed to be used with IFRS S1. Both fully incorporate the recommendations of the TCFD.
The UK government has announced that it will be creating a mechanism for formal UK endorsement and adoption of these international standards. Once available for use in the UK, the Financial Conduct Authority (FCA) has also stated it intends to update the climate-related disclosure rules to reference the ISSB standards.
These two standards could apply as early as reporting periods starting 1 January 2024 if the UK adopts swiftly, meaning that firms who have been reporting to TCFD standards cannot assume that the disclosure that has been acceptable to date will meet these higher standards. The FCA has stated that the applying these standards will assist listed companies in improving the quality of reporting on sustainable matters.
The UK’s Transition Plan Taskforce has been consulting on a Disclosure Framework and Guidance to assist firms in the transition to net zero and is set to publish its Disclosure Framework and Guidance in the Autumn 2023. Also in the UK, the FCA is expected to publish their Sustainability Disclosure Regime and Investment Labelling policy statement in Q3 2023.
Firms need to ensure that they have the processes and resources to gather the necessary data and embed the disclosure requirements into their organisations polices, processes and procedures as well as their commercial relationships. These processes need to be kept under review and developed to enable firms to meet their increasing sustainability disclosure obligations.
Co-written by Sébastien Ferrière of Pinsent Masons.
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