How the UK’s new TCFD rules look set to reflect post-Brexit alliances and miss double materiality

The move is welcome but, behind the headlines, there is small print worth reading

This week's announcement by the UK Chancellor Rishi Sunak that the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) will be part of the law is a step in the right direction. 

It shows that integrating the climate question into the core of financial statements and company filings is a matter of survival for the financial services sector in general and the UK’s City of London in particular – eager to reinstate its clout in the countdown to Brexit.

It also allows the UK to co-host COP26 with some bits of the Paris Agreement’s homework done (or in progress, at least), and to show a similar level of climate ambition as the EU, arguably represented by Italy as COP co-organiser.  

But beyond the high-level, self-satisfying statements issued so far on the back of the announcement, there are some nuances worth acknowledging.

Firstly, there is a very positive outcome from the legislative roadmap set out by the ‘TCFD Taskforce’ – a coalition of the country’s financial regulators, led by the Treasury, dedicated to looking into climate disclosure. The policy reports it published this week are a must read. They outline an “indicative path towards mandatory TCFD-aligned disclosures”; new regulatory and legislative work affecting the whole economy during the next five years.    

An implicit consequence of this should be a more cautious use of the expression “TCFD-compliant”. Perhaps as a result of premature enthusiasm, many businesses and investors have moved their rhetoric from being “supportive” of the TCFD, to somehow ‘abiding’ by the framework. Even if well intended, such claims border on greenwashing, because what it really means to be ‘TCFD-compliant’ (and who can attest for it) is precisely what will be determined over the next five years in the UK.  

Michael Zimonyi, Policy & External Affairs Director at the Climate Disclosure Standards Board (CDSB) agrees, telling RI that “someone with the relevant authority” is needed when it comes to TCFD implementation. “There has been progress, but we are not there yet,” he says. 

Donato Calace, Innovation Vice-President at ESG risk management software firm Datamaran, tells RI that these policy developments clearly show how “the era of voluntary reporting is rapidly coming to an end”. 

“Regardless of the nuances and technical frictions across the different legislative actions, there is a unifying trend: the oversight and responsibility of these areas belong to the board,” he adds, claiming that both the shift toward mandatory reporting, and the emphasis on board oversight apply to broader ESG issues, not just climate and decarbonisation.

The UK Taskforce report states that TCFD disclosures will eventually require international standards to become “consistent, comparable and enforceable”, so UK players will continue to work with international organisations. Notably, it does not mention the EU among those international organisations, despite the bloc’s efforts to pursue its own mandatory sustainability standards as part of the revision of the Non-financial Reporting Directive (NFRD). The European Financial Reporting Advisory Group, mandated by the European Commission, is currently preparing advice on these EU standards. See related RI coverage here.

But none of this is acknowledged in the UK report. What is mentioned as the way forward was the IFRS Foundation’s proposal to create a global Sustainability Standards Board (see RI coverage here), which could take years to come to fruition compared with the more immediate timeline of the EU.  

The UK Taskforce does, however, insist that it “strongly supports” the alliance of voluntary standard-setting organisations, i.e. the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), CDSB, the International Integrated Reporting Council (IIRC) and CDP. Moves so far suggest they will help form the basis for the EU standards. See RI coverage here.

“If regulators want to get involved in climate change and sustainability reporting, they need to understand what will drive transformation and what will hinder it” – Durham University’s Carol Adams

As well as the report from the TCFD Taskforce this week, the UK regulator that sits at the middle of this whole discussion – the Financial Reporting Council (FRC) – published a slew of thought leadership reports under the banner of Climate Thematic Review 2020 and issued a statement urging UK public interest entities to report voluntarily against the TCFD using SASB metrics.

Acknowledging how political standard-setting often is, it would be naive to disregard the omissions and explicit references made in these reports this week. 

It could instead be argued that there looks to be two camps emerging: an Atlantic one, favouring standards from investor-focused SASB and the London-based IFRS Foundation (perhaps more in tune with the UK standing in the post-Brexit world); and a European one, which aims at standards informed by the principle of double materiality (i.e. which cover the impact of ESG in companies and vice versa, the impact of companies in society). 

These differing camps are not irreconcilable, but it is commonly understood that the use of either SASB or the more stakeholder-focused GRI standards alone does not satisfy the double materiality approach.   

Wolfgang Kuhn, Director of Financial Sector Strategy at NGO ShareAction, tells RI that the inclusion of considerations beyond financial materiality – those that actually address how companies impact the world – will be vital when developing disclosure requirements. 

“Unless investors have the objective to contribute to climate change mitigation, all the disclosure in the world won’t materially change the temperature path we are currently on,” he explains. 

So is the UK less interested in double materiality than its EU counterparts? ShareAction CEO Catherine Howarth says the subject is still very much alive in some corners of the UK, but acknowledges that – while it is codified in the new EU Sustainable Finance Disclosure Regulation – it “has yet to be hard wired into regulation in the UK”.

“In that sense the UK is trailing,” she says. “I hope it will catch up, because, unless it does, it’s hard to see how the UK funds industry will be granted equivalence by European regulators and, on that basis, get full access to clients in European markets from 1st January [2021].”

“US asset managers are typically running their European operations out of London and tend to take a more conservative position on these themes, which only reflects the more conservative thinking on fiduciary duties in the US. 

CDSB’s Zimonyi says the issue of double materiality is being addressed in some ways by the FRC’s recent proposal of a Public Interest Report (see RI coverage here), but Carol Adams, Professor of Accounting at Durham University Business School, says its desire to use “SASB’s limited set of financially material-based metrics to climate change reporting” is disappointing.   

According to Adams, this would undermine the broader thinking – including about physical climate risks – that the TCFD recommendations seek to encourage. “If accounting regulators want to get involved in climate change and sustainability reporting, they need to understand what will drive transformation and what will hinder it,” she tells RI. “There’s a whole stack of research on this.”

She also warns of the dangers of the UK ignoring the EU’s efforts, saying it risks further fragmentation in a world that has been promising to offer consolidation over recent years.  

“The IFRS Foundation says it will align with the EU and that there is a need to reduce the number of standards; but this will not happen if they pursue their investor only perspective to materiality.”