ESOS – An Update For Funds

M
Macfarlanes

Contributor

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The article outlines the Energy Savings Opportunity Scheme (ESOS) Phase 3, its requirements for large UK companies, and its impact on corporate groups, emphasizing compliance, action plans, and future net zero assessments.
United Kingdom Corporate/Commercial Law

The Energy Savings Opportunity Scheme (ESOS) is a mandatory energy assessment and energy-savings identification scheme for large organisations in the UK. 

It was established to help businesses improve their energy efficiency and reduce carbon emissions. The regulations have several implications for funds, particularly those with investments in large companies. 

Phase 3

ESOS was first introduced in 2014 to address the lack of data and improve the adoption of energy efficiency measures. ESOS is in phase 3 and each cycle is four years apart. The required audit provides energy efficiency recommendations and are signed off by a board member.

Organisations that qualify for ESOS should have notified the Environment Agency (the EA) by submitting a notification of compliance for phase 3 of ESOS by 5 June 2024. The EA noted they would grant forbearance until 6 August 2024.

Which companies qualified for ESOS phase 3?

An undertaking must take part in ESOS if, as of 31 December 2022, it was a "large undertaking" or was part of a corporate group which included another UK entity that met the criteria on that date. 

What is a large undertaking?

A UK company that either:

  • employs 250 or more people; or
  • has an annual turnover exceeding £44 million and an annual balance sheet total exceeding £38,000,000.

An overseas company with a UK registered establishment which has 250 or more UK employees (paying income tax in the UK).

In the case of a fund, why is ESOS more complex?

ESOS applies to undertakings which are part of a corporate group with any other entity that meets the ESOS thresholds. In practice, we tend to view different portfolio companies as separate group operations and they are largely independently managed from other portfolio companies owned by the same fund. However, this is not how the group is viewed for ESOS purposes. 

An assessment of the corporate structure of the group is necessary. This analysis can often be complex and may require a specialist corporate or funds lawyer to assess what constitutes the "group" for ESOS purposes, which is achieved by applying relevant criteria set out under the Companies Act 2006. 

A lack of understanding of what constitutes the "group" for ESOS purposes can result in a failure to comply and enforcement action from the EA.

By default, the highest UK parent acts as the responsible undertaking for ESOS (which can be a UK fund) – this means it will complete the ESOS assessment and notify the EA of compliance for itself and subsidiary undertakings, which could potentially include every portfolio company of that fund. The responsible undertaking is the organisation responsible for ensuring the group complies with the requirements of ESOS, however many funds favour the disaggregation approach, where they may agree with portfolio companies that each will comply with ESOS separately. A disaggregated entity must comply with ESOS irrespective of its own size. 

Changes - action plan, annual progress reports and net zero

The new requirements of the latest ESOS phase require an action plan to be prepared by 5 December 2024, however the EA will accept action plans until 5 March 2025 (accounting for some technical delays to the platform).

Progress reports in relation to the action plans will be required by 5 December 2025 and then 5 December 2026. Particular attention should be paid to ensuring that the action plans are achievable, and the progress reports are accurate, clear, well presented and not misleading, as they, or elements of them are expected to be made public. 

It is expected that, going forward, ESOS Phase 4 will also require a mandatory net zero assessment. The British Standards Institute (BSI) is developing an international standard for net zero assessments. The new standard will be launched by the BSI at COP30 in November 2025.

Conclusion 

It would be wise for a fund to refresh the analysis of their corporate group in anticipation of each new ESOS phase. More immediately, they will need to prepare their action plan (to the extent required), along with continuing to engage with portfolio companies if necessary to ensure awareness of their own obligations to do the same. On a longer-term basis, it will be beneficial to consider the implications of the future net zero assessment when further details are released. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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