On 18 October 2021, HM Treasury published a policy paper called "Greening Finance: A Roadmap to Sustainable Investing (the "Roadmap"), which represents Phase 1 of the UK government's 2019 Green Finance Strategy. It addresses the gap in environmental sustainability information available for stakeholders in the UK corporate and financial sectors. For more information on UK corporate climate-related reporting, please see our client alert. The UK government and regulators are working together to close this information gap for market participants by:
- introducing Sustainability Disclosure Requirements across the UK economy incrementally as new measures come into force;
- delivering an effective UK Green Taxonomy as a useful investment tool; and
- promoting responsible stewardship expectations for investors.
Although the Roadmap is generic in certain areas and much of the disclosure framework remains subject to consultation, it is very likely that the direction of future governmental policy will mandate climate disclosure and transition plans to achieve net-zero greenhouse gas emissions by 2050, therefore, UK market players should prepare accordingly.
Key findings from the Roadmap
1. Disclosure, Disclosure, Disclosure...
Central to the Roadmap are the new Sustainability Disclosure Requirements (SDR), bringing together new and existing sustainability reporting requirements into a unified framework designed to empower investors. At present, climate-related reporting consistent with the Task Force on Climate-related Financial Disclosures' (TCFD) recommendations is mandatory for only premium-listed companies and certain occupational pension schemes in the UK. The UK government's intention is that TCFD-aligned disclosures will be mandatory across the UK economy by 2025 through the implementation of SDR.
The SDR will comprise two components:
- a global baseline reporting standard for sustainability, yet to be developed by the International Sustainability Standards Board (ISSB); and
- the TCFD recommendations, based on its four-pillar structure of Strategy, Governance, Risk Management, and Metrics and Targets.
Once developed, the SDR will set out a single, standardised framework of three types of climate disclosures with certain similarities to the disclosure regime of EU's Sustainable Finance Disclosure Regulation and the proposed Corporate Sustainability Reporting Directive:
- Corporate disclosure for companies (including those in the financial services sector);
- Disclosure for asset managers and owners that deal with assets on behalf of clients, disclosing how sustainability is taken into account in decision-making processes; and
- Investment product disclosure for the creators of investment products to report on the sustainability impact of such products.
SDR will also require disclosures on transition plans to reach net zero emissions on a "disclose or explain why you have not done so" basis. Although there is no common standard for transition plans yet, the UK government aims to incorporate a standard into UK regulation and expects the publication of such plans to become the norm across the UK economy.
Implementation Timeline of SDR
Subject to consultations, the ISSB issuing its standards and other statutory requirements, SDR will gradually replace existing frameworks over the next two to three years, beginning with mandatory disclosures for "economically significant" corporates, followed by most other companies, large funds of at least £5 billion, asset managers and owners, and creators of investment products. The incremental approach is designed to allow time for information disclosed to filter into the investment decisions of stakeholders.
2. UK Green Taxonomy
The UK Green Taxonomy (the "UK Taxonomy") aims not only to create clarity and consistency for investors by improving their understanding of companies' environmental impact, but also to give companies a reference point and informative targets for their own performance. The UK Taxonomy sets out criteria that specific economic activities must meet in order to be considered sustainable, and therefore "UK Taxonomy-aligned". As part of SDR, the proportion of activities (or financial products) that are UK Taxonomy-aligned will be required to be disclosed by certain companies and providers of investment funds and products. Matching the sequenced approach of the SDR, disclosure requirements for investment products will not become mandatory until the corporate disclosure requirements have taken effect.
The proposed UK Taxonomy shares a number of similarities with the EU Green Taxonomy. For more information on the EU Green Taxonomy, please see our client alert. The UK Taxonomy has six environmental objectives: (i) climate change mitigation; (ii) climate change adaptation; (iii) sustainable use and protection of water and marine sources; (iv) transition to a circular economy; (v) pollution prevention and control and (vi) protection and restoration of biodiversity and ecosystems.
To be UK Taxonomy-aligned, an economic activity must: (i) make a substantial contribution to one of the six objectives (determined by satisfying certain Technical Screening Criteria (TSCs) that will be identified for each economic activity included in the UK Taxonomy); (ii) do no significant harm to the other objectives; and (iii) meet a set of minimum safeguards, such as aligning with OECD and UN guidelines. The UK government aims to draft TSCs for the environmental objectives of climate change mitigation and climate change adaptation in the first quarter of 2022 (with draft TSCs for the remaining objectives in the first quarter of 2023), which will underpin the assessment of whether an individual economic activity makes a "substantial contribution" to the relevant objective.
The UK Taxonomy also recognises "transitional" activities, which cannot yet align with net-zero ambitions and will instead be judged by best-in-sector emissions levels, and "Enabling Activities" which support the net-zero transition by enabling substantial contributions to environmental objectives in other sectors, but are not yet sustainable themselves. The Roadmap provides the example of wind turbine blade manufacturing.
3. Responsible Stewardship
The Roadmap also highlights the crucial role of the 2020 UK Stewardship Code (the "Code"), which sets out stewardship standards relating to the responsible allocation, management and oversight of capital. At present, becoming a signatory to the Code is voluntary, however, the UK government envisions that as more decision-relevant information becomes available under the SDR, the bar will be lowered for asset managers, asset owners and service providers to become signatories to the Code – and the expectation is that they will do so in the near-term. Currently, under the Financial Conduct Authority's COBS rules, only certain asset managers must disclose the nature of their commitment to the Code or, if they are not committed, their alternative investment strategy.
It should be noted that the UK government plans to assess the progress of stewardship in the pension and investment sectors against its expectations at the end of 2023. Therefore, organisations in these sectors should consider aligning their investment and business practices with the Code, alongside preparing a transition plan to net-zero.
What to expect next
The publication of the Roadmap comes at a crucial time with the UK's presidency of COP26, where one stated goal involves "unleashing the trillions in private finance". Rishi Sunak, in a speech at the COP26 Finance Day on 3 November 2021, emphasised the UK government's ambition "to rewire the entire global financial system for Net Zero" through better and more consistent climate data, mandatory sustainability disclosures and stronger global reporting standards. He pledged that the UK will become the first ever 'Net Zero Aligned Financial Centre'.
The Roadmap promises further consultation on and fleshing-out of the sustainability-related disclosure framework. In the near-term, we can expect discussion papers on a sustainable investment labelling regime for investment products, the broadening scope of mandatory disclosure requirements and the groundwork of UK Taxonomy-aligned activities. Greening the financial system will continue with Phase 2, which focusses on acting on information revealed by the SDR framework – meaning sustainability-related disclosures are here to stay – and Phase 3, which ensures a shift in financial flows across the UK economy to align with the UK's commitment to reach net zero by 2050. It is notable that goals have strong parallels to those of the EU, and plan to be achieved in a similar fashion.
Organisations within the scope of the SDR framework should consider the most effective and efficient way to implement best disclosure practices as soon as possible. It comes as no surprise that sustainability and environmental considerations have long been on the radar of investors and other stakeholders, therefore we may expect the uptake of sustainability-related disclosures long before the formal implementation of SDR.
James Quirke, London Trainee Solicitor, contributed to the drafting of this alert.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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