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October 28, 2021

ESG Update: UK Government Releases Roadmap to Sustainable Investing

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ESG UPDATE: UK GOVERNMENT RELEASES ROADMAP TO SUSTAINABLE INVESTING

The “Greening Finance” Roadmap outlines plans for new sustainability-related disclosures and implements a “Green Taxonomy” to evaluate corporate environmental behaviour and counter greenwashing.

“Greening Finance: A Roadmap to Sustainable Investing” (Roadmap) sets out the Government’s ambition to make the U.K. a world leader in attracting green investment. The Roadmap focuses on the first step to deliver on this ambition: ensuring that reliable information exists to enable financial decisions to factor in, and be assessed by, objective environmental and sustainability criteria.

The ultimate objective is to establish a globally consistent reporting standard for environmental sustainability that will help investors and consumers better judge the sustainability characteristics of products and firms, consistent with the U.K.’s Sustainability Disclosure Requirements (SDRs). This U.K. initiative parallels similar work which is ongoing in the E.U., particularly with regards to the development and use of a new Green Taxonomy (see below).

The Roadmap builds on the U.K. Government’s 2019 Green Finance Strategy paper, and focuses on three principal areas:

  • The SDRs;
  • A U.K. Green Taxonomy, defining what it means for corporate activity and products to be “green”; and
  • Responsible investor stewardship in relation to the U.K.’s sustainability commitments.

Sustainability Disclosure Requirements

The Roadmap explains that the SDR regime will bring together existing sustainability-related disclosure requirements under one integrated framework, building on current global standards and recognised best practice.

In November 2020, the Chancellor, Rishi Sunak, announced that the U.K. intends to make disclosure requirements recommended by the Task Force on Climate-Related Financial Disclosures (TCFD) mandatory across the U.K. economy by 2025. U.K. regulators have already taken steps towards implementing TCFD recommendations, which the SDRs will build on. For example:

  • In December 2020, the Financial Conduct Authority (FCA) announced premium listing rule changes mandating TCFD disclosures with a “comply or explain” approach (similar to existing U.K. Corporate Governance Code reporting requirements). The disclosure requirements require a statement in annual financial reports for periods starting on or after 1 January 2021. The first financial reports to include the required statement would therefore be published in 2022.
  • In June 2021, the FCA announced that it would be consulting on proposals to extend the same premium listing TCFD reporting requirements to standard listed equity and potentially other issuers and to impose TCFD reporting on asset managers, life insurers and pension providers.
  • In March 2021, the Department for Business, Energy and Industrial Strategy launched a consultation on extending climate-related disclosures to a wide range of corporates (including limited liability partnerships).
  • On 1 October 2021, regulations requiring trustees of certain occupational pension schemes to embed climate change risk into their governance, strategy and risk management process, came into force. The U.K. Government is proposing amending these to introduce a requirement that trustees select and calculate a portfolio alignment metric for the assets of their scheme to be included in the TCFD reports they will be required to produce under the new regulations.

Now, following their implementation, the SDR reporting requirements will apply to corporates (i.e. U.K. registered financial services companies and listed entities), asset managers and asset owners and investment products. While relevant regulators and government departments will, subject to consultation processes, determine the precise scope, timing and reporting detail of the disclosure requirements, as well as other statutory requirements, it is expected that the regime will broadly cover the following types of disclosure:

  • Corporate disclosure: SDR corporate disclosures will require the in-scope corporates to:
  • report under new international standards set out by the International Sustainability Standards Board, a new board to be established by the IFRS Foundation to develop a global baseline reporting standard for sustainability; and
  • report their Taxonomy-alignment using the grading system under the U.K. Green Taxonomy criteria (discussed further below).
  • Asset manager and asset owner disclosure: asset managers and asset owners will be required to disclose how they take sustainability into account when making their investment decisions.
  • Investment product disclosure: providers of investment products will be required to report on the products’ sustainability impact and relevant financial risks and opportunities through a new sustainable investment labelling regime, to be developed by the FCA and HM Treasury. A discussion paper is expected to be published later this year.

The Roadmap notes that a growing number of organisations are publishing transition plans to support their commitments to reach net zero emissions. The SDRs will require disclosures on transition plans and certain firms will be required to publish transition plans that align with the U.K. Government’s net zero commitment, or provide an explanation as to why they have not done so. While there is not currently an agreed standardised transition plan template in place, guidance is being developed by groups such as the TCFD as well as the Glasgow Financial Alliance for Net Zero (GFANZ) which aims to change this. As standard transition plans emerge, the U.K. Government and regulators will look to incorporate these into U.K. regulation and update disclosure requirements as appropriate.

Indicative timing guidelines provided in the Roadmap suggest that there will likely be a staggered approach to new mandatory reporting, starting with “economically significant” companies within one to two years from receiving royal assent for the required primary legislation.

UK Green Taxonomy

The Roadmap notes that a growing number of financial products are marketed as supporting climate or environmental objectives, but without an accepted definition or standard of what economic activities should count as being environmentally sustainable it is difficult for companies, investors and consumers to understand clearly the environmental impact of their investment decisions. This also gives rise to the risk of “greenwashing”—misleading or exaggerated environmental or sustainability claims—which the U.K. Government seeks to eliminate. The U.K. Green Taxonomy (Taxonomy) will set out criteria that specific economic activities must meet to be considered environmentally sustainable and therefore “Taxonomy-aligned.”

The Taxonomy has six environmental objectives, each of which will be underpinned by a set of detailed technical screening criteria (TSC). The environmental objectives are:

  • Climate change mitigation;
  • Climate change adaption;
  • Sustainable use and protection of water and marine resources;
  • Transition to a circular economy;
  • Pollution prevention and control; and
  • Protection and restoration of biodiversity and ecosystems.

The Roadmap explains that the Green Technical Advisory Group, an independent body made up of a range of industry experts and academics, will initially focus on developing TSC for the first two objectives (climate change mitigation and climate change adaption), before turning to the remaining four objectives in 2023. The TSC for the first two objectives will be based on those of the E.U. Taxonomy, and the Roadmap states that legislation is expected by the end of 2022.

Certain corporates will have to report which of their activities are Taxonomy-aligned, and investment funds and investment products will have to do the same for their respective products. To be considered "Taxonomy-aligned" an activity must meet three tests:

  • Make a substantial contribution to one of the six environmental objectives (listed above);
  • Do no significant harm to the other objectives; and
  • Meet a set of minimum safeguards for doing business, which will be aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

Taxonomy-alignment will require companies to assess their current practices, as well as their future objectives:

  • Current practices: companies will be required to assess how their relevant business activities currently contribute towards relevant environmental objectives, based on reported data (rather than projections).
  • Future objectives: the Taxonomy will also take account of activities which may not currently make a positive contribution towards meeting environmental objectives but represent:
  • Transitional activities and investment: steps towards transitioning the business to meeting those commitments; or
  • Enabling activities: activities that provide a means of enabling environmental commitments to be met in other business sectors.

Responsible Investor Stewardship & Sustainable Investment

The Roadmap highlights the role that institutional investors, through their investment stewardship role, can play in encouraging a shift in capital allocation towards more sustainable economic activity, thereby helping in the greening of the U.K.’s economy.

The U.K. Government wants investors to make use of the improved sustainability data made available by SDR reporting to enhance their role as responsible stewards of capital, including by:

  • Providing leadership examples in the financial sector through engagement with sustainability initiatives such as GFANZ and the U.K. Stewardship Code 2020;
  • Actively monitoring, encouraging and challenging companies by using their rights and direct or indirect influence to promote long-term, sustainable value generation; and
  • Publishing by the end of 2022 “high-quality” transition plans detailing their pathway to net zero financed emissions.

The Roadmap notes that the U.K. Government will assess progress, including on the matters listed above, at the end of 2023.

Conclusion: A significant impact on the UK financial sector

The Roadmap makes clear the U.K. Government’s expectation and intention to see ESG reporting becoming core to business decision-making and investment, through an enhanced regime of mandatory SDRs.

The era of generalised and aspirational sustainability reporting is coming to an end and in its place we can expect to see a more informative and standardised reporting regime, aligned with developing global reporting standards. For corporates, this will involve so-called detailed double materiality sustainability review and reporting on their businesses, and for investment managers, an increased emphasis on disclosure of the sustainability impact of their stewardship activities.

Businesses will have to begin preparing for a more detailed and regulated approach to their ESG reporting, including developing their own transition plans and Taxonomy-aligned reviews of their various business activities.

Finally, in the debt and securities markets we have seen a dramatic increase in ESG-linked transactions over the last 12 months, commonly rewarding borrowers and issuers with cheaper financing if ESG key performance indicators are met. Market participants, while keen to engage, can be somewhat cautious of borrowers and issuers tapping into this trend without a genuine and meaningful commitment to the underlying cause, i.e. the “greenwashing” concern mentioned earlier. Over the past decade or so, documentation in the European leveraged finance market has moved significantly in favour of a more “permissive” approach where reporting and information disclosure requirements on borrowers and issuers have generally been relaxed. Better disclosure against established baseline standards and compliance with an internationally accepted taxonomy can only raise standards over the setting of those key performance indicators, while providing clarity, measurability and credibility to the ESG-element of any financing.

For assistance in preparing for this new wave of regulation, please contact any of the persons listed below.

Authors and Contributors

John Adams

Partner

Investment Funds

+44 20 7655 5740

+44 20 7655 5740

London

Simon Burrows

Partner

Mergers & Acquisitions

+44 20 7655 5696

+44 20 7655 5696

London

Phil Cheveley

Partner

Mergers & Acquisitions

+44 20 7655 5822

+44 20 7655 5822

London

Dan Feldman

Partner

Project Development and Finance

+971 2 410 8158

+971 2 410 8158

Abu Dhabi

Gary Hamp

Partner

Finance

+44 20 7655 5584

+44 20 7655 5584

London

Laurence Levy

Partner

Mergers & Acquisitions

+44 20 7655 5717

+44 20 7655 5717

London

Richard Porter

Partner

Mergers & Acquisitions

+44 20 7655 5069

+44 20 7655 5069

London

Paul Strecker

Partner

Mergers & Acquisitions

+44 20 7655 5047

+44 20 7655 5047

+852 2978 8038

+852 2978 8038

London

Nick Withers

Partner

Mergers & Acquisitions

+44 20 7655 5956

+44 20 7655 5956

London

Mehran Massih

Counsel

Real Estate

+44 20 7655 5603

+44 20 7655 5603

+1 212 848 7377

+1 212 848 7377

London

Michael Scargill

Counsel

Mergers & Acquisitions

+44 20 7655 5161

+44 20 7655 5161

London

Tim Waterson

Senior Associate

Finance

+44 20 7655 5909

+44 20 7655 5909

London

Frederick Lazell

Associate

Project Development and Finance

+44 20 7655 5968

+44 20 7655 5968

London

Gina Malone

Associate

Mergers & Acquisitions

+44 207 655 5079

+44 207 655 5079

London

Helen Walsh

Professional Support Lawyer

Finance

+44 20 7655 5107

+44 20 7655 5107

London