An increasing focus on how businesses report the impact of their operations on the environment and on wider social and corporate accountability considerations has seen Environmental, Social and Corporate Governance ("ESG") rising higher up the agenda of both UK regulators and investors for some time. This has been an area of special focus in the financial services sector over the summer. Our recent blog considered the consultations issued by the Financial Conduct Authority ("FCA") on 22 June 2021 on enhanced climate-related disclosures. Hot on the heels of the FCA's consultations, on 7 July 2021, the Financial Reporting Council ("FRC") published its Statement of Intent on Environmental, Social and Governance Challenges.
The FRC regulates auditors, accountants and actuaries; issues accounting, audit, assurance and actuarial standards and guidance; and sets the UK's Corporate Governance and Stewardship Codes. Its work is aimed at investors and others who rely on company reports and audits.
Its Statement of Intent is in response to the Government's publication of its Roadmap towards mandatory climate-related disclosures in November 2020, aligning the UK with the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD). The Statement of Intent also acknowledges the September 2020 consultation paper by the International Financial Reporting Standards (IRFS) Foundation setting out proposed constitutional changes to allow for the introduction of an International Sustainability Standards Board, in order to develop a global set of standards intended to drive high-quality consistent and comparable reporting.
Against this background, the FRC identifies the need for a rigorous framework on ESG reporting which aligns with financial reporting standards, in terms of which companies are required to give proper consideration of ESG issues in their annual reports, financial statements and audits.
Clarifying ESG standards and the quality of reporting
The Statement of Intent identifies six challenges which must be overcome if ESG reporting is to meet the demands of stakeholders and the market. Those challenges are:
- Production – Improving the quality of internal information will enhance decision making and lead to deeper insight for stakeholders but differing standards create challenges in how ESG data is measured, managed, controlled and assured
- Audit and assurance – There can be a lack of credibility in ESG information. Going forward, reported information must be robust and reliable. Material ESG issues affecting a company must be properly reflected in the published financial statements
- Distribution – ESG information must be accessible to interested parties
- Consumption – In order that stakeholders can use ESG information to make better decisions, it needs to be useful and useable. More work is needed to clarify standards and frameworks in order to improve consistency, comparability and useability
- Supervision – ESG performance and published data requires to be appropriately monitored and standards upheld to reflect the market's increasing expectations of more and better reporting on ESG issues
- Regulation – There is a need to achieve consistency in standards within the UK and internationally, to ensure that ESG frameworks are compatible, relevant and of equal quality. Greater coordination is needed to ensure that reporting standards are clear to businesses and respond to the demands of stakeholders and the wider market
Addressing the challenges
The FRC's stated ultimate objective is to achieve a consistent framework for ESG reporting, both within the UK and internationally. In working towards that goal, the FRC has set out various actions within each of the six stages of the reporting cycle:
- To provide guidance on the frameworks and methodologies used by businesses in deriving, measuring and controlling ESG data, including work to improve the quality of non-financial data by engaging with investors and stakeholders to ensure that ESG data meets their needs
- To consider the role of the UK Corporate Governance Code in ensuring boards are taking appropriate account of ESG issues in their consideration of the long-term success of the company
- To develop guidance to companies reporting under UK GAPP on how they can include consideration of climate-related issues in their financial statements
- To work with companies and information users to ensure that the developing framework for audit and assurance of ESG information meets their needs, including by considering ESG-related amendments within future revisions of the auditing and assurance standards
- To achieve an appropriate framework for ESG information to be made publicly available on a more consistent basis, where information is accessible and useable in a digital format
- To increase regulatory coherence by supporting global sustainability reporting standards and working with international regulators and governments to ensure global efficiency.
It will be clear that the FRC's Statement of Intent is driving at achieving clarity, consistency and accountability in corporate reporting of ESG issues. The FRC's overarching objective is to deliver a framework of ESG reporting which supports the growth of sustainable business. Higher standards of ESG information will improve investor decision-making and better hold corporates to account for the impact of their operations on the environment and the societies in which they operate. As the regulator for audit and corporate reporting in the UK, the FRC is uniquely placed to set and uphold the standards for ESG reporting in the UK. It is notable that the FRC's ultimate objective is to deliver a standard for "ESG information, and the frameworks and structures that surround it, [which] are as mature as those for financial information". It will be interesting to see whether the FRC ultimately achieves this objective, and also whether it does so in a manner which keeps pace with the demands and expectations of investors, stakeholders and society more broadly.
For information on ESG or other corporate governance issues, please don't hesitate to get in touch with a member of our Corporate Crime and Investigations team.