TCFD alignment studies from the FCA and FRC

Scope

At the end of July 2022, both the Financial Conduct Authority (FCA) and the Financial Reporting Council (FCA) published reviews of TCFD reports by listed companies.  The FCA’s report covers all calendar year-end reports published to date by premium listed companies, with a group of 31 of these from a broad spread of sectors covered in more detail.  The FRC’s report covers a smaller list of 25 companies weighted toward the sectors most affected by climate change and toward larger companies.

Compliance levels

The listing rules require companies to report, on a comply or explain basis, whether they have reported in accordance with the TCFD framework and, where not, why not and when they might do so.  Superficially both studies showed high levels of compliance in terms of self-reported compliance, although both studies noted that, when companies’ self-reported compliance was investigated more closely, there were significant omissions from the TCFD’s list of recommended disclosures.

While the FCA appears to consider compliance to be a work in progress, and has been willing to tolerate initially lower levels, it is clear that more is expected in future years both to implement the original recommendations and to enhance disclosures to reflect the TCFD’s updated 2021 guidance, which is effective for 31 December 2022 year-ends and later.  The FCA also note that they consider that their Listing Principle 1, requiring listed companies to have appropriate procedures, systems and controls, should cover systems to produce TCFD data.

Structure

The quality of disclosures is analysed under the TCFD’s four pillars of governance, and the eleven subheadings given in the TCFD’s 2017 guidance for all sectors, with additional commentary on the completeness of compliance statements, some analysis of net zero plans and some commentary on consistency of financial statements with narrative disclosures in the front-end.   Of the four pillars, on a self-reported basis, governance showed the highest level of compliance and strategy the lowest, in particular scenario analysis.

Both studies noted better compliance in larger companies, those most affected by climate issues and those in highly regulated industries.  The typical length of a TCFD statement is 4-5 pages but a few much longer statements push up the mean length to 11 pages.  In 84% of cases, the statement of compliance is in the strategic report and in most cases the data underlying the report is also there.

The FRC’s document covers both the front and back-end of the annual report.  Our comments here are, for reasons of conciseness, not exhaustive and refer only to the front; narrative, portion of the annual report and do not cover comments on disclosure of judgements and estimates and consistency of front and back-end (save in passing).  The FCA does note, however, that there are a number of companies where low-carbon activities feature significantly in the narrative but have remarkably little visibility in the financial statements’ disclosure.

Statements of consistency with TCFD guidelines

The FRC wants clarity here; what areas in the TCFD guidance have not been complied with, why not, and when they will be complied with.  It notes that, where a company has given a statement noting less than full compliance with the TCFD guidelines, it should take care not to refer to compliance without qualification elsewhere in the annual report. The FCA note that they found a number of cases in which companies claimed compliance with the framework, but the underlying disclosures were not consistent with this.  The FCA notes that it is considering action here.

Where the data required by the TCFD framework is provided by cross-reference to other parts of the annual report, the FRC note that cross-references should be specific enough to identify particular pieces of information and its precise location.

Governance

The regulators note that this is an area with which they would expect all companies to comply with.   Compliance with the first part of the requirements here; describing the board’s oversight, was largely good, albeit with some companies neglecting to note the frequency with which the board looked at climate-related matters and few indicating impact of climate on major capex or investment/divestment decisions.  Compliance with the second part of the governance requirement; describing management’s role in assessing and managing climate related risks and opportunities, was rather lower, with a number of companies claiming consistency but only half mostly or partially consistent under the FCA’s analysis and not all companies giving specific accountable individuals in the area.

Strategy

The FCA notes that it may be difficult for companies to build the capabilities to describe resilience through scenario analysis, particularly on a quantitative basis, but expects companies which currently do not make these disclosures to set out the reasons why not and the steps taken and expected timescale to be able to do so in future.

The level of detail given in the first two parts of the strategy disclosure (identification and impact of climate-related risks and opportunities) was also criticised by the FCA for limited reference to useful lives of companies’ assets and description of the processes used to determine which risks could have a material impact on the organisation. 

The FRC notes that, though most of the companies in their sample undertook a scenario analysis, there was limited detail of scenarios and quantification was rare.  In addition, the FRC clearly felt there often needed to be more granular disclosure linking risks and opportunities to geographies or specific businesses. 

Risk Management

Although companies generally identified climate-related risks, both the FCA and the FRC note shortcomings in disclosure of the processes for identifying, assessing and manging climate-related risks.

Metrics and Targets

The TCFD’s guidance lists ten recommended disclosures under metrics and targets.  Virtually all companies provided some climate-related metrics and a large proportion quantified these.  The most common metrics were the scope 1 and 2 emissions required by the energy and carbon reporting regulations.  Fewer provided scope 3 emissions, which the 2021 update to the TCFD regulations now specifically exhort companies to consider.  The FCA suggests that 2/3 of their sample do so, but we suspect that a large proportion of this is companies reporting on fuel use and travel by employees on business travel.  Most companies provided comparative information for metrics, though there were suggestions that longer periods could be covered here and a significant proportion of the FRC’s sample gave some link to remuneration.

There was much less disclosure of internal and external carbon pricing and few companies provided metrics covering opportunities as well as risks. 

While efficiency ratios were given, fewer companies explained why these ratios had been chosen and explanations for movements in either absolute figures or efficiency ratios were not universally provided.

The FRC noted that, while most companies in their sample seemed to have taken into account the TCFD’s guidance for all sectors, fewer seemed to have considered the section specific guidance, and linkage of metrics to specific risks and opportunities could be improved.

Net Zero commitments

Many companies provided “net zero” targets, but the scope of these was not always clear.  Definitions of what net zero meant and the level of use of offsets were not always sufficient, and there was insufficient provision of interim milestones for longer-term targets.  The FRC also notes that investors would like more detailed and comparable information here with clarity on terms such as “Paris-aligned”, explanations of assumptions involved in achievement of targets, such as the emergence of new technology and better understanding of capex plans’ contribution to achievement of targets.

Conclusion

The number of UK companies providing disclosure under the TCFD framework has increased very substantially, as might be expected given the new regulations.  Despite these being mandatory requirements, however, it is clear that there has been substantial forbearance by the FCA and FRC in enforcement of the new regulations. 

While it is evident from their comments that the regulators recognise that infrastructure required to produce the full suite of information required by TCFD is not yet mature and that many companies will still not yet be able to comply with all requirements, it is clear that expectations from the regulators, and also from investors, continue to increase and that rapid improvement and better explanations and timetables for full compliance are expected, even if full compliance cannot be achieved.  We look forward to continuing rapid development in this field and continued evolution managing the difficult balancing act between available resource, comparable data and relevance in the future.