Climate and sustainability – Q2 2023

With an increasing emphasis on sustainability, international and UK oversight bodies issued new publications that foreshadow the imminent introduction of new standards. A summary of these updates is provided below.

Launch of sustainability-related reporting standards

On June 26, 2023, the International Sustainability Standards Board (ISSB) launched its first two sustainability-related reporting standards IFRS S1 on General Requirements and IFRS S2 on Climate. These Standards lay out a global baseline for sustainability disclosures with the aim of addressing the needs of investors and other stakeholders for high-quality and comparable sustainability information that is decision-useful.

The reporting structure of IFRS S1 and IFRS S2 is aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). They, therefore, cover the following four reporting areas:

  • governance
  • strategy
  • management of impacts, risks, and opportunities
  • metrics and targets

The response to the adoption of these two Standards has varied globally; some jurisdictions have already announced their intentions to be early adopters (such as Mexico, Nigeria, and Zimbabwe), while others are yet to decide. 

In March 2023, the UK Government set out its plans on adopting the ISSB Standards as part of its revised Green Finance Strategy, and it is now in the process of setting up an appropriate endorsement mechanism. An endorsement decision is expected to take place within 12 months from now.

The Financial Conduct Authority (FCA), has published a statement highlighting that once the ISSB standards have been formally endorsed for adoption in the UK, they will update climate-related disclosure rules to reference the ISSB standards.

In Europe, the ISSB, the European Commission (EC) and the European Financial Reporting Advisory Group (EFRAG) – the EC’s technical advisor – have worked together to ensure, to the greatest extent possible, the interoperability of IFRS S1 and IFRS S2 with the European Sustainability Reporting Standards (ESRS).

Update on transition plans – NGFS report

The Network for Greening the Financial System (NGFS) published a report taking stock of emerging practices relating to climate transition plans and assessing the role of central banks and supervisors in relation to transition plans.

Following its previous report on ‘Capturing risk differentials from climate-related risks’ which stressed the importance of a forward-looking approach to assess climate-related risks, the NGFS took stock of the recent development of transition plans by corporates and financial institutions transition plans.

The NGFS also examined the relevance and extent to which financial institutions’ transition plans relate to micro-prudential authorities’ roles and mandates, and could be considered and used most effectively within their supervisory toolkit and in the overall prudential framework.

The NGFS has identified six key findings as well as steps to advance the work on the relevance of transition plans and planning to micro-prudential authorities:

  • While the potential of transition plans is widely recognised, there are multiple definitions of transition plans, reflecting their use for different purposes.
  • There is merit in distinguishing transition planning (understood as a process to design a transition strategy) from a transition plan (transparency to a specific audience).
  • Existing frameworks speak to a mix of objectives, audiences and concerns for transition plans but predominantly relate to climate-related corporate disclosures.
  • Transition plans could be a useful source of information for micro-prudential authorities to develop a forward-looking view of whether the risks resulting from an institution’s transition strategy are commensurate with its risk management framework.
  • There are some common elements to all transition plans which are relevant to assessing safety and soundness.
  • The role that micro-prudential authorities play needs to be situated in the context of the actions of other financial and non-financial regulators rather than acting in isolation.

The NGFS recognises that transition plans have the potential to provide much-needed forward-looking visibility on the real economy’s pathway to a net-zero future. According to NGFS, financial institutions will prepare their own transition plans as well as engage entities that they finance on their respective transition plans. The forward-looking information contained in transition plans will be key to enabling the financial sector to mobilise private finance in support of the transition.

What management should consider

A climate transition plan is an action plan that outlines how an organization will pivot its existing assets, operations, and entire business model towards a trajectory that aligns with the national net zero emission strategy by 2050 (in the UK the Government outlines its strategy in this document). The Transition Plan Taskforce (TPT) launched by HM Treasury is currently working on the final Framework and Guidance for private sector climate transition plans and is expected to publish its work later this summer. Financial services firms are advised to prepare for transition plan disclosures.

Understanding climate-related disclosures of UK financial institutions

Researchers from the Bank of England (BoE) have found that climate-related policy communications in the form of regulatory guidance on future mandatory disclosures are associated with a catch-up by firms previously disclosing less. According to their results, prior to regulatory interventions only a fraction of firms disclosed climate-related information in line with the TCFD recommendations and these were on average the larger firms. This gap in voluntary disclosures has created a case for regulatory interventions encouraging smaller firms to disclose too. The results further suggest that regulators setting clear timelines for mandatory disclosures can help to accelerate the trend in disclosures, which leads to convergence across firms.

What management should consider

Since 6 April 2022, the largest UK-registered companies and financial institutions must disclose climate-related financial information on a mandatory basis. Financial institutions with over 500 employees and £500 million in turnover fall within scope of the regulations. Management is advised to closely follow the developments in disclosure requirements.

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