Government Roadmap to Sustainable Investing

The UK government has set out its ambition to make the UK the “best place in the world for green and sustainable investment” in Greening Finance: A Roadmap to Sustainable Investing (the Roadmap). This Roadmap is broken down into three phases:

1. Informing investors and consumers – ensuring decision-useful information on environmental sustainability is available to from corporates to financial market decision makers;

2. Acting on the information – mainstreaming this sustainability information into business and financial decisions; and

3. Shifting financial flows – ensuring that financial flows shift to align with the UK’s net zero commitment and wider environmental aims.

The Roadmap sets out the government’s strategy to achieve Phase 1 through new Sustainability Disclosure Requirements for companies, asset managers and asset owners and about investment products (SDR) which will (1) improve the quality of information available from different organisations; and (2) allow comparisons on how companies are impacted by sustainability factors.

“There is a clear need for an effective government-led sustainability disclosures regime which enables the flow of comparable and decision-useful information on how companies and financial flows impact – and are impacted by – climate, the environment and broader sustainability factors.”

The government will also introduce a new UK “Green Taxonomy” (which appears to be based largely on the EU Taxonomy), with the intention of giving investors a clear picture of how environmentally sustainable a company’s activities are.

This all forms part of the government’s move towards a net-zero economy by 2050 and builds on its Green Finance Strategy (published in 2019) and the UK’s move to make Task Force on Climate-Related Financial Disclosures (TCFD) -aligned disclosures mandatory by 2025.

This article focuses on the impact of the proposals on companies. See ESG: UK sets out its roadmap on sustainable finance for more information on the proposals for asset managers and asset owners.

Sustainability Disclosure Requirements

The SDR for companies (including those in the financial services sector) is expected to require them to make sustainability disclosures in accordance with new International Sustainability Standards Board (ISSB) reporting standards and to report on the environmental impact using the UK Green Taxonomy (see below). The ISSB standards will initially only cover climate-related matters but disclosure against voluntary standards on wider sustainability issues is encouraged.

On 3 November 2021, the IFRS Foundation announced that the ISSB had been established and also published prototype climate and general disclosure requirements developed by the Technical Readiness Working Group, a group formed by the IFRS Foundation Trustees to undertake preparatory work for the ISSB.

The government expects that the ISSB standards will build on the four pillars of the TCFD recommendations and the SDR will also adopt those pillars: Governance, Strategy, Risk Management and Metrics and Targets.

Disclosure requirements for corporates will focus on:

• Governance: around sustainability-related risks, opportunities and impacts (SROIs)
• Strategy: actual and potential implications of SROIs for the organisation’s businesses, strategy, and financial planning
• Risk Management: processes used to identify, assess, and manage SROIs
• Metrics and Targets:
  • used to assess and manage relevant SROIs;
  • performance against targets; and
  • taxonomy alignment and relevant supporting information.

Initially, the SDR will be mandatory for the most ‘economically significant’ companies and voluntary for other companies but will eventually move towards being mandatory for all companies (see Timeline below).

Whilst the Roadmap does not define which companies will be economically significant, the government may decide to choose the same companies that it has decided are economically significant for its new rules on mandatory climate-related reporting (see Climate-related disclosures to be mandatory for large companies for more information.)

Transition plans

Under the Roadmap, the government expects publication of transition plans by companies working towards net zero to become the norm across the economy. The SDR will require companies either to publish transition plans which align with the government’s net zero commitment; or to explain why they have not done so.

Standards for transition plans may emerge and as they do, the government and regulators are likely to follow them to ensure consistency and comparability across plans.

The government has published a further statement, confirming that it will require asset managers, regulated asset owners and listed companies to publish transition plans that consider the government’s net zero commitment or provide an explanation if they have not done so. It will also set up a high-level Transition Plan Taskforce to develop a ‘gold standard’ for transition plans and associated cutting edge metrics, which will report by the end of 2022.

UK Green Taxonomy

The Taxonomy will set out the criteria which specific economic activities must meet to be considered environmentally sustainable and so “Taxonomy-aligned”. As stated above, reporting against the Taxonomy will form part of the SDR disclosures and certain companies will be required to disclose which proportion of their activities align with the Taxonomy.

The Taxonomy aims to create clarity and consistency for investors; improve understanding of companies’ environmental impact; and provide a reference point for companies.

The Taxonomy, which draws on the EU Taxonomy, has six environmental objectives:

• Climate change mitigation: stabilisation of greenhouse gas emissions consistent with the Paris Agreement and net zero by 2050
• Climate change adaptation: reducing the risk of adverse impact of current or future climate change on an economic activity, people, nature or assets
• Sustainable use and protection of water and marine resources: contribution to the good environmental status of bodies of water or marine resources or preventing their deterioration
• Transition to a circular economy: maintaining the value of products, materials and resources for as long as possible, thereby reducing environmental impacts of their use
• Pollution prevention and control: including preventing and reducing emissions or adverse impacts on health, improving levels of air, water and soil quality
• Protection and restoration of biodiversity and ecosystems: protecting, conserving or restoring biodiversity or to achieving the good condition of ecosystems, or preventing their deterioration.

Each environmental objective will have a set of detailed standards, Technical Screening Criteria (TSC). There will be a TSC for each economic activity included in the Taxonomy, which identifies how that activity can make a substantial contribution to the environmental objective.

To be Taxonomy-aligned an activity must meet the following three tests:

• Make a substantial contribution to one of the six environmental objectives (listed above): the criteria for a “substantial contribution” are set out in the TSC for the particular activity.
• Do no significant harm to other objectives: again, this is defined in the TSC.
• Meet a set of minimum safeguards: these are minimum standards for doing business, constituting alignment with the OECD Guidelines for Multinational Enterprises, and the UN Guiding Principles on Business and Human Rights.

The Taxonomy will also allow for companies that are working towards meeting the environmental objectives as they will be able to show:

• Enabling Activities: which support the transition by making substantial contributions to environmental objectives in other sectors, but which are not yet sustainable themselves. The example given is the manufacture of components for wind turbines.
• Transitional activities: activities which cannot currently be carried out in alignment with net zero ambitions and therefore the Taxonomy will include a threshold for ‘best in sector’ levels for these activities.
• Investment: companies can report the proportion of their capital expenditure which is Taxonomy-aligned, allowing them to show that they are investing in producing green activities in the future.

Stewardship

The Roadmap also addresses stewardship – in short, the government expects asset managers and asset owners increasingly to engage in stewardship activities and integrate ESG considerations into decision making and actions, particularly as the SDR information should give them the information to do so. Companies can therefore expect to come under increasing pressure from investors to focus on sustainability.

Timeline

The government has not yet decided on the scope and timing requirements of the reporting requirements for companies. But the Roadmap shows that:

• By 2022 – consultation on SDR framework for companies expected
• Q1 2022 – Government expects to consult on the UK TSCs for the climate change mitigation, and climate change adaptation objectives, with legislation expected by end of 2022
• Between now and 2023 – SRD disclosures and Taxonomy will be mandatory for the most ‘economically significant’ companies and voluntary for other companies
• Q1 2023 - expects to consult on the TSCs and standards for the other four environmental objectives
• Between 2023 and 2024 – they will become mandatory for all companies.