Given increasing public and investor focus on ESG disclosures and the growing recognition that managing ESG risks effectively can be effective in creating long-term value, there is significant and growing (internal and external) pressure on companies to make some form of ESG disclosure.  Some companies already view voluntary comprehensive ESG disclosure as a way of marking them out from their peers and competitors and thus creating investor value.

However, it is not only a recognition of its potential market value that has driven ESG disclosure, but also a determination on the part of regulators (including the FCA and the ESMA) to prevent ‘greenwashing’ – re-labelling of existing or ‘normal’ financial products to make them seem ‘green’.

ESG Disclosure in the EU

The EU Regulation on sustainability (environmental, social and governance) disclosures for certain financial services sector firms (the SFDR) came into application on 10 March 2021. The SFDR requires financial market participants and financial advisers to disclose certain ESG-related information in relation to the provision of their services and the marketing of financial products, using mandatory disclosure templates.

How does Brexit Affect ESG regulation in the UK?

Initial drafts of the Financial Miscellaneous Amendments (EU Exit) Regulations 2020, provided for parts of the SFDR to apply in the UK after departure from the EU.  However, in the end, the UK government elected not to implement the SFDR or the Taxonomy Regulation in UK legislation, opting instead to establish its own domestic green taxonomy and ESG disclosure regime.

In practice, many firms will continue to comply with the EU’s SFDR as a form of insurance pending the new UK taxonomy. Indeed, depending on their activity, some UK firms may still be subject to the requirements in the SFDR – for example, if they market certain financial products in the EU, or act under a delegation agreement with an EU fund manager.

The UK’s decision not to copy across the EU’s SFDR should be seen in the context of the UK’s wider ‘Global Britain’ strategy – characterized by a determination to move away from EU-centric policies towards a broader international approach.  This policy decision is reflected in the UK’s choice to apply instead the standards set by the Financial Stability Board’s Task Force for Climate-related Financial Disclosures (TCFD).  In addition, with COP26 high on its policy agenda, the Government also views ESG reporting as an opportunity to support the UK’s green economy.

The UK’s Legislative Maze

In November 2020, the Government announced its intention for the UK to become the first country in the world to fully mandate TCFD for companies and financial institutions. At the same time, the Joint Government and Regulator TCFD Taskforce published a roadmap for implementing mandatory disclosures. That roadmap set a timetable for cross-sector full disclosure reporting:

  • Pension schemes of over £5 billion, banks, insurance companies and building societies will be expected to comply with TCFD recommendations;
  • Smaller pension schemes, asset managers and life insurers will be subject to disclosure requirements from 2022;
  • Life insurers, FCO-regulated pension providers and other UK-authorised asset managers will be subject to disclosure requirements from 2023;
  • All other occupational pensions schemes and UK financial services firms will be subject to mandatory climate-related financial disclosures by 2025;
  • The UK will also implement its own green taxonomy (based on the EU Taxonomy).
  • The UK Government will provide an update on progress in the 2022 refresh of the Green Finance Strategy.

As the rollout progresses, it seems likely that some refinement will be required to the UK’s oversight structure.  Currently, the FCA, the PRA, the Department for Work & Pensions and BEIS all share some degree of oversight responsibility.

The FCA’s December 2020 Policy Statement (20/17) obliges all commercial companies with a premium listing to include a statement in their annual financial report of whether their disclosures are consistent with TCDF recommendations and to provide an explanation if they are not. These new rules will be implemented by Listing Rule 9.8 and the requirement applies to accounting periods that begin on or after 1 January 2021. The FCA also published a new Technical Note, clarifying existing ESG disclosure obligations.

The Pensions Act, which governs the specific timetable for implementation of the above roadmap received Royal Assent in February 2021.  One of its provisions is that the date for pension schemes of over £5 billion to comply with TCFD provisions is 1 October 2021.

The Consultation on the Regulations implementing the UK Government’s November announcement for occupational pension schemes closed on 10 March 2021.

The UK’s Green Taxonomy – Another Complexity?

The UK has not yet released any information on the content of its green taxonomy, but has established a Green Technical Advisory Group, which will analyse the EU Taxonomy Regulation’s metrics for technical screening standards with the aim of assessing their suitability for the UK market.  Although this leaves open the scope for the UK’s new system to align closely with the EU’s, it also opens up the opposite outcome.  Additional UK divergence from EU systems would create extra (and potentially burdensome) reporting requirements for firms and further complicate EU/UK regulatory alignment.

….Or a Competitive Advantage?

However, a UK taxonomy which was rigorous and robust could help set a new global high standard which would encourage other countries to introduce stretching green taxonomies.  For the UK, there is a potential competitive advantage in this approach.  Many financial services companies are keen to demonstrate their attachment to ESG as a USP (this trend in itself could create a new Ratings Market to ensure common standards are applied to ESG claims and to prevent ‘Greenwashing’).

In becoming the first country to mandate the TCFD’s standards, the UK is effectively making the case that, by setting the bar high, the UK will attract new financial service companies to the UK with the opportunity to burnish their green and wider ESG credentials under the highest global standards.  Such an objective is in keeping with the UK’s green agenda and fits well with its ambition for COP26.

Covington will continue to monitor developments in this area and would be delighted to help and advise clients as the UK’s taxonomy and ESG reporting requirements develop.