The Financial Reporting Council will consider how investors are addressing the climate challenge in the stewardship of their investments and in their response to systemic and market risks, as it starts a review of how companies report and how auditors assess climate risk disclosures. 

 

The Financial Reporting Council announced last week that it would look at investors’ way of dealing with climate risk as part of stewardship when it monitors the first reports under the new Stewardship Code, which will be issued from the beginning of 2021. 

 

The statement came as the FRC also said it would start “a major review of how companies and auditors assess and report on the impact of climate change”, to look at where improvements can be made. The review will be internally led but, “where appropriate”, the FRC said it will engage with external parties. It expects the review to be completed in the autumn. 

 

Investors must play their part fully as well as companies, said the FRC, “challenging management, upskilling their people, and following the FRC’s strengthened Stewardship Code”. 

 

The regulator’s CEO, Sir Jon Thompson, said: “Not only do boards of UK companies have a responsibility to report their impact on the environment and the risks of climate change to their business, but investors expect them to operate sustainably.” 

 

 

The government already expects large asset owners and listed companies to disclose in line with the TCFD recommendations by 2022, and the Pensions Regulator, via a working group with industry participation, will publish guidance on addressing and managing climate risk next month. In the meantime, the government has put an amendment in the Pension Schemes Bill to require climate risk management and reporting from pension funds. 

 

The FRC’s review therefore appears to be a further piece in the puzzle of climate risk regulation in the finance sector, ahead of the UK hosting the UN’s next climate conference, COP26, in Glasgow this autumn. 

 

But could the pace and volume of new laws, regulations and guidelines on climate be disorientating for trustees?  

 

Alan Pickering, president of professional trustee firm Bestrustees,  said he has seen trustees get confused by what he termed “a plethora of initiatives emerging from government departments and thought leaders”. 

 

Pickering said there was “a need to stop and take stock at some stage, to make sure we aren’t creating such a fog of initiatives as to create a lack of vision”. 

 

Such vision, for trustees, comes from thinking through what they have to or can do in the context of investing pension fund assets, he noted, adding that good governance would in effect mean that applying environmental, social and governance factors “should become the norm”. 

 

Nonetheless, “trustees can’t be the advance vanguard of anybody’s ecological strategy. We have a role to play but there is a limit to how much you can expect trustees to do,” he warned. 

 

 

While some trustees might initially feel overwhelmed by the intense focus on climate that is suddenly required of them, others in the industry have welcomed the FRC’s review.  

 

Caroline Escott, policy lead investment & stewardship at the Pensions and Lifetime Savings Association, said the PLSA is committed to supporting schemes in the adoption of ESG matters, but that “the ability of investors to make good decisions is only as good as the information that they receive, and we therefore fully support this very timely initiative from the FRC". 
 

Good corporate behaviour, she added, must include a discussion of climate change in terms of strategic, financial and operational factors, integrated reporting – with larger companies using the TCFD framework – and transparency on the underlying assumptions on balance sheet valuations and earnings.  

 

“We look forward to working closely with the FRC and others in the industry to ensure the full length of the investment chain is incentivised to operate in the long-term interests of savers,” said Escott. 

 

 

Campaign groups have also responded positively to the announcement but noted it was overdue. ClientEarth lawyer Daniel Wiseman said: “Oversight of climate risk by the FRC and FCA has historically been poor, even in the face of glaring climate reporting failures we have flagged to both regulators. Climate change poses critical risks to companies, and systemic risks to the wider economy, and regulators have been asleep at the wheel on both counts. This long overdue review must lead to strong enforcement action.” 

  

Wiseman also said the fact the FRC will look at how investors like pension funds are addressing climate change as part of their stewardship, in his view, means the FRC expects those who sign up the new UK Stewardship Code must directly address climate change matters, and will need to look at them “not just as a risk at the portfolio level in traditional risk and return ways, but really looking at it more strategically, as a systemic risk". 

 

The TCFD provides a framework, but this is already several years old, he noted, arguing that it is now just the baseline standard for investors: “What we’re seeing is investors rapidly going beyond that in their expectations. We are seeing investors asking not just for risk disclosure and scenario analysis but for disclosure of Paris-aligned business strategies.” 

 

He therefore believes that the next step the regulators will look at will be to do the same, looking at the extent to which the whole investment chain from companies to pension funds are aligning their activities with the objectives of the Paris agreement, which aims to limit the global temperature increase to well below 2 degrees Celsius and pursue efforts to limit the increase to 1.5 degrees. 

 

ShareAction also lent its support to the FRC review, with UK policy officer David O’Sullivan saying: “We need better quality disclosures from companies, and a more meaningful dialogue between them and pension schemes on climate risk and we look forward to supporting the FRC on this vital work.”