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Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021

Volume 816: debated on Tuesday 30 November 2021

Considered in Grand Committee

Moved by

That the Grand Committee do consider the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021.

Relevant document: 19th Report from the Secondary Legislation Scrutiny Committee

My Lords, I beg to move that these draft regulations, which were laid before the House on 28 October 2021, be approved. These regulations will amend the Companies Act 2006 to require certain publicly quoted and large private companies to include disclosures in their annual reports of climate change-related risks and opportunities material to them, aligned with the international framework of the Task Force on Climate-related Financial Disclosures; I shall refer to it as the TCFD in future.

This TCFD SI will help to deliver on the Government’s commitment to make climate-related financial disclosures mandatory across the economy by 2025, with a significant portion of those mandatory requirements in place by 2023. This commitment was set out in the Government’s paper, A Roadmap towards Mandatory Climate-Related Disclosures, published in November last year. The Government have made it clear that we view action to address climate change as a priority. Internationally, we are taking a leading role to promote action through our presidency of the Conference of the Parties to the UN Framework Convention on Climate Change— or COP.

Domestically, we are working to ensure that the UK achieves net-zero greenhouse gas emissions by 2050. The Government have published our net-zero strategy, setting out the measures to transition to a green and sustainable future. Transparency from businesses about climate risks and opportunities is key to delivering our net-zero ambition. Without an accurate assessment of climate risk by companies, it will be impossible for them to assess what action is needed to address this. That is why this instrument will require the UK’s largest companies to assess, disclose and take actions to manage climate-related risks and opportunities. This information should be a key part of all investment decisions and be taken into account in the strategy of every business.

Some large UK companies are, of course, already reporting on climate risks. However, to date, these disclosures have been variable in quality and quantity. This inconsistency makes it incredibly difficult for investors to compare investment opportunities and risks across companies, let alone across different markets. Many organisations are also not making the fuller disclosures needed to inform business risk and investment decisions.

The Government have already introduced regulations to require climate disclosures from occupational pension schemes through the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021, which were approved by both Houses and entered into force on 1 October this year. The Financial Conduct Authority has introduced TCFD-aligned disclosures for premium listed companies and recently conducted a consultation on extending this to standard listed companies.

Let me take a moment to talk through what these regulations actually do. The instrument will require companies in scope to assess and make specific climate-related disclosures in respect of governance, strategy, risk management, and metrics and targets. These headings broadly reflect the TCFD’s four-pillar approach to reporting. These requirements will apply to all PIEs—public interest entities—and companies traded on the Alternative Investment Market of the London Stock Exchange with over 500 employees. They will also apply to private companies with over 500 employees and over £500 million of turnover. The disclosure requirements will commence for accounting periods starting on or after 6 April 2022. My department will prepare non-binding guidance to help companies that fall into scope. This will provide additional information to help companies understand the requirements and improve disclosures.

The Government consulted on the policy in these regulations between March and May this year. The consultation generated 137 responses from a range of companies, financial institutions, civil society organisations, trade associations and accountancy firms. Officials also participated in three online events to try to engage wider audiences. Overall, the policy proposals received wide support.

The consultation led to two policy changes in response to the feedback that was received. First, to simplify reporting for those companies that are also subject to FCA rules, the regulations’ wording is now more closely aligned to that of the climate-related financial disclosures within the TCFD’s framework. Secondly, respondents to the consultation called for companies to be required to analyse their risks against specific climate-change scenarios. As such, these regulations include the requirement for companies to assess their climate risks against different scenarios and report this on a qualitative basis.

The draft regulations will require climate disclosures in the annual reports from just over 1,300 of the largest companies in the United Kingdom. Companies are of course at different stages of their journey towards net zero and producing robust climate-related disclosures. Our guidance will help companies in that journey and signpost some further sources of information, which can be drawn on according to their particular needs. In parallel, we also encourage the market-led evolution of good practices on disclosures.

The Government want to ensure that companies and investors can make the most of the opportunities created as we transition the economy to net zero and sustainability. To do this, we need companies to understand the risks and opportunities and to report transparently on them. I therefore commend these regulations to the House.

My Lords, I understand and welcome the principle of the regulations—to ensure that large companies state what they are doing about climate risks and opportunities—but I have one concern. Companies’ financial statements are becoming ever fuller of environmental, social and governance information. There is a danger that, in doing this, we render the accounts more difficult to follow. It becomes hard to see the wood from the trees.

We have only to look at US listed company financial statements to see how that can go. You have to wade through hundreds of pages of risk and other ESG analysis. Most of it consists of standard-form, boilerplate statements that do not change year to year and, in reality, add little or nothing to the understanding of the reader. Indeed, it can make the accounts almost unreadable and very hard to make an informed decision about the position of the company.

I fear there is a danger that we may be starting to follow that trend, so I am very pleased that Part 3 of the regulations requires a review to be carried out, but that is not until 6 April 2027. I suspect that it will become clear much more quickly than that whether they are having the desired effect or are just adding more meaningless boilerplate to the accounts. I urge the Minister to keep that under constant review, rather than waiting until 2027, and to take action much more quickly if it becomes clear that the regulations are really not doing what is intended.

We shall see, my Lords. We debate these regulations on the back of the most important summit the UK has ever held—a summit which future generations will look back on as when we either met the moment or missed the opportunity. It is increasingly clear that progress at COP 26 was modest and, too often, action will come too late. The Climate Action Tracker has stated that Glasgow commitments mean that, rather than limiting warming to the target 1.5 degrees, we are on track for a devastating 2.4-degree rise.

This is the backdrop to which we debate these regulations, which I hope have not come too late, as they will play an essential part in reaching net zero by 2050, as well as ensuring businesses both mitigate the risks of climate change and seize opportunities.

Today’s instrument introduces new reporting obligations for certain UK registered companies, as the Minister explained, including certain listed companies and companies with more than 500 employees and a turnover of more than £500 million, which require them to report climate-related financial information as part of their strategic report. This is in line with the recommendations of the task force on climate-related financial disclosures—a framework which includes 11 recommendations forming, as we have heard, four pillars: governance, strategy, risk management, and metrics and targets.

Support has been coalescing around these recommendations. The TCFD’s latest annual status report states that the number of organisations endorsing the task force’s recommendations has increased to more than 2,600—an annual increase of 70%.

We should remember that, regardless of the serious impact on migration, security and hunger, climate chaos is also costly. The Intergovernmental Panel on Climate Change estimates $69 trillion in global financial losses by 2100 from a 2-degree warming scenario.

Getting to this point has taken a while, and climate delay has been a repeated issue with this Government. The task force on climate-related financial disclosures published its recommendations back in 2017. Then the UK Government’s green finance strategy set out an expectation that all listed companies and large asset owners should disclose in line with the TCFD’s recommendations back in 2019, but did not hold a consultation on the proposals until earlier this year. As we have heard, these new requirements are to come into force next April, 2022—five years after the task force on climate-related financial disclosures published its recommendations.

According to BEIS, regulatory action is necessary because the current voluntary approach

“is unlikely to be effective … current levels of disclosure across the economy are low and reporting quality varies significantly.”

If we look in detail at the impact assessment, this is clear. Looking at the central scenario for additional groups having to comply with reporting requirements, it reveals that only 34% of the 1,350 companies in scope have already aligned with governance, 24% with risk management and only 14% with scenario analysis. The impact assessment estimates that 1,350 companies are in scope of the regulations. Can the Minister tell us what percentage of the UK economy this covers?

The impact assessment states that

“When a UK group is in scope, all the subsidiaries (UK and overseas) belonging to the same UK group, would be expected to hold some degree of reporting burden.”

What does “some degree” mean? These regulations also focus on companies producing mandatory qualitative scenario analysis. The impact assessment states that the Government

“understand that while some companies might decide to go beyond these requirements … there will be some companies that lack the expertise, resources and capabilities to undertake quantitative scenario analysis by the time these regulations come into force.”

How many companies are predicted to produce quantitative analysis as well? What will be done to encourage both qualitative and quantitative analysis to be produced? When does the Minister expect quantification to be phased in?

It is regrettable that, first, we are unable to study the non-binding guidance alongside these regulations and, secondly, that the LLPs regulations have not been laid at the same time as this SI, due to their interlinking nature. The Secondary Legislation Scrutiny Committee flagged this SI as an instrument of interest:

“We note that the Department will produce guidance on the new reporting requirements which, according to the Impact Assessment, will be around 125 pages long. This suggests a considerable degree of complexity. In the absence of the actual guidance, it is difficult to form a view of the nature and extent of the new reporting requirements, and how robust the Department’s assessment of the impact on businesses is.”

Does the Minister agree that there will be a “considerable degree of complexity”? Why is the guidance not ready for today’s debate? In the consultation stage impact assessment, the Government had assumed that guidance would be about 75 pages long. Why has this increased by 50 pages according to the Secondary Legislation Scrutiny Committee’s report?

The Government state that the combined impact on business of these regulations and those which apply to LLPs is £145.3 million. The impact assessment states that costs result from companies needing

“to get familiar with BEIS Guidance, TCFD Guidance and other companies’ disclosures before producing their own report”,

as well as ongoing costs which include collecting and processing information, strategy and risk management. How are the Government communicating to and supporting businesses with this additional cost?

I would like some clarification from the Minister on enforcement. The impact assessment states that:

“We also expect there to be an additional ongoing cost of monitoring, supervision and enforcement to the Financial Reporting Council (FRC) as the appropriate regulating body for disclosures”,

but is the FRC properly resourced to take on this additional burden? Can the Minister explain how the Government will work closely with the Financial Conduct Authority and the Financial Reporting Council to ensure monitoring and enforcement frameworks operate in a coherent and complementary way? What happens if these companies fail to follow these obligations or publish substandard information? Will there be fines? The impact assessment states that “reporting quality varies significantly”, as the Minister said, so can these regulations ensure that this does not continue to be the case? A review before 6 April 2027 is welcome, but the impact assessment states that there will be “a light touch review” in 2023. What will this consist of?

I end by speaking about small and medium-sized enterprises. As the impact assessment states,

“Climate change poses significant risks to businesses,”

and we have to include SMEs within that statement. The cost implication of these risks means that SMEs can be even more exposed to the risks and to being squeezed out of the opportunities of climate change. Does the Minister see these obligations being extended to SMEs soon? The impact assessment states,

“disclosure can have cascade effects through the supply chain”.

Can the Minister confirm they are not just relying on trickle-down climate economics to see a change in reporting behaviour for SMEs? The cost implications for SMEs make it essential that the Government have a strategy to support them.

To conclude, these regulations are welcome, but they represent only a small part of the picture of how the Government need to help businesses respond to the risks and opportunities of climate change.

I thank both noble Lords. I know that they had some questions, which I will come on to shortly, but both their contributions emphasised how much support there is for these regulations. Although people have concerns about the detail, I think that we are at one in terms of general principles. That reflects the fairly broad support we have for introducing them.

The Government appreciate that these regulations will entail some additional costs to the UK’s largest companies, but we think that the legal targets we have make it essential for us to act if we are to achieve net-zero greenhouse gas emissions by 2050. The process of preparing the disclosures required by these regulations will help businesses to understand their climate-related risks and opportunities, and will bring a greater focus on how to manage them. The increased transparency will enable investors to make better-informed decisions about where to allocate capital in a consistent and climate-positive manner.

The proposals take account of business capabilities and business readiness. For instance, the introduction of qualitative scenario analysis allows companies to use this important tool to manage climate risks in a way that encourages capabilities to grow over time.

The noble Lord, Lord Vaux, raised the concern that annual reports and accounts are becoming more and more full of ESG information, such that it is sometimes hard to see the wood from the trees. He asked whether my department could commit to keeping the regulations under review in the interim. I can tell him that the Government will indeed review the effectiveness of these provisions. If we see that they are not working, we will certainly look at taking further measures. We will conduct a statutory review of the regulations after five years, as is normal.

In response to the noble Lord, Lord Lennie, I can tell him that we are publishing non-binding Q&A style guidance targeted to help companies making the disclosures. It provides clarification on the disclosures against each of these specific requirements. There is, in fact, already significant background material on how to disclose according to TCFD, which itself has recommendations and guidance available online. There is also, by way of background material, the existing guidance from the Financial Conduct Authority on the climate-disclosure provisions in the UK listing rules, and indeed from the Department for Work and Pensions on the disclosure requirements that exist for pension funds.

The department assumed to model costs that companies might read 125 pages for familiarisation before making the appropriate climate disclosures. We hope and anticipate that BEIS’s Q&A guidance on the regulations, which explains their legal requirements and desirable outcomes, will be well short of that page total. However, companies might want to consult wider background material and information to familiarise themselves with the disclosures. Accordingly, we made that assumption in our cost modelling to ensure that our impact assessment did not underestimate the true cost of these regulations to business. As I said, we appreciate that there will be a cost to implementing them.

On the point the noble Lord raised about monitoring and enforcement, the FRC will take on the monitoring of the climate-related disclosures alongside the other contents of the strategic report. The Government consulted earlier this year on reforms to the FRC. We will publish a response to that White Paper and our plans to create ARGA very shortly.

The responses to the consultation showed that many respondents considered that scenario analysis is important for meaningful climate disclosures. However, they also recognised that it is one of the most challenging and costly aspects of the TCFD to implement. We believe that requiring qualitative disclosures strikes an appropriate balance between, on the one hand, requiring companies to consider this important element in business planning, and, on the other, recognising that this is an emerging area of competence and one that will be new to many businesses and companies. So, although some companies are already doing quantitative scenario analysis to produce excellent disclosures, we did not believe that all companies within scope would be able to produce such analysis at this time; therefore, the regulations take a proportionate approach to enable businesses to grow their capabilities.

On extending the regime to SMEs, we will of course keep this matter under review once the largest companies in the UK have become familiar with the disclosure and capabilities in this area have increased. However, in my view, we need to be extremely careful before we impose undue burdens on SMEs in this country. We have a very good, vibrant and active SME sector that employs many hundreds of thousands of people; we do not want to overburden it with regulations.

The Government are intent on delivering a UK economy that is greener, more sustainable and more resilient. In my view, the implementation of the TCFD, aligned to disclosures across our economy, will support those aims. I therefore commend this draft instrument to the Committee.

Motion agreed.