The U.K. government is subject to a legally-binding target to reduce greenhouse gas emissions by at least 100% relative to 1990 levels by 2050.1 The U.K. government has set out sector-specific goals to achieve this target in its net-zero strategy.
Financial and market regulators have indicated a strong focus on climate change issues. The Bank of England Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA), the Financial Reporting Council (FRC), and the Pensions Regulator (TPR) released a joint statement in 2019 setting out their position on climate change:
Climate change is one of the defining issues of our time. We recognise it presents far-reaching financial risks relevant to our mandates from both physical factors, such as extreme weather events, and transition risks that can arise from the process of adjustment to a carbon-neutral economy. Companies should consider the likely consequence of climate change on their business decisions, in addition to meeting their responsibility to consider the company’s impact on the environment.2
In October 2021, the FCA, PRA, TPR and FRC released a further joint statement on the publication of the Climate Change Adaptation Reports by the FRA, PRA and TPR under the Climate Change Act 2008.3 In these reports, the organisations each emphasised the risks posed by climate change to their regulatory objectives, and how they will integrate climate change considerations into their guidance and supervisory roles.4
In June 2021, the Bank of England announced its Climate Biennial Exploratory Scenario (CBES), a stress test to assess the resilience of the U.K. financial system and individual institutions.5 The results of the first CBES were published in May 2022; the Bank of England found that banks and insurers had taken some steps to integrate climate risk management into their processes, but that more remained to be done, and that if no changes were made to business models, climate impacts could cause an equivalent to a 10-15% drag on profits each year.6 A second round of the CBES was launched in February 2022.7
In November 2022, the Transition Plan Taskforce (TPT) released the Disclosure Framework for consultation.8 The Disclosure Framework aims to assist entities to disclose credible, useful, and consistent transition plans. This Disclosure Framework makes it mandatory for entities to disclose their transition plan. The TPT also released an Implementation Guidance to further elaborate the requirements under the Disclosure Framework.9
In February 2023, the Competition Markets Authority (CMA) issued draft guidance on potential exemptions to competition rules for companies collaborating on environmental sustainability.10
It is clear that U.K. regulators view climate change as a financially material risk. Well-advised boards should seek to incorporate climate risk into their decision-making.
Directors' Duties and Climate Change
Historically, company directors owed duties to their company under common law. However, in 2006, directors' duties were codified in the Companies Act 2006.11 Two relevant duties are the duty to promote the success of the company for the benefit of its members as a whole (section 172), and the duty to exercise reasonable care, skill, and diligence (section 174), the latter of which is not fiduciary in nature.12 The duty to promote the success of the company has been described as the ‘principal duty’,13 consistent with the primacy of the duty of loyalty at common law.14 Section 174 further informs the exercise of section 172 by directors by setting standards for the manner in which directors are expected to act and the knowledge, skill and experience they should hold.
Given the breadth and potential materiality of climate change-related risks, it seems increasingly likely that directors should consider these when fulfilling their duty under section 172.15 Discussing this in August 2019, Lord Sales, Justice of the U.K. Supreme Court, delivered a speech on directors’ duties in respect of climate change.16 Lord Sales recognised the links between directors’ duties and climate change, noting that general fiduciary and duty of care obligations may require directors to have regard to climate-related risks and to take action to reduce their contribution to climate change.
Additionally, in promoting the success of the company under section 172, directors are required to "have regard" to a non-exhaustive list of factors. This includes "the impact of the company's operations on the community and environment" (section 172(1)(d)) which captures consideration of climate change issues.
Therefore, when fulfilling their duty to promote the success of their company, directors should consider climate change risks both in light of the general duty under section 172 and the requirement to have regard to climate change issues. A well-counselled director should ensure that they consider climate-related issues in good faith as they carry out their role, using their own skill and judgment, and having regard to the likely long-term consequences of the decision being considered.
The application of these duties with respect to climate change is the subject of ongoing litigation. In March 2022, the U.K. NGO ClientEarth announced that it had issued a pre-action letter to the board of Shell plc, indicating its intention to bring a derivative claim against the board alleging that the directors had breached their duties to act in the best interests of the company and with due skill, care and diligence in failing to develop and implement a climate strategy that aligns with the Paris Agreement goals, increasing its risk of stranded assets and having to make write-downs.17 In February 2023, ClientEarth filed the derivative action claim against Shell plc further alleging that the board of directors breached its duties by failing to adequately consider climate risk in its transition plan.18 In May 2023, the High Court initially refused ClientEarth permission to continue this case based on the evidence and case argued on the papers.19 In this judgment, the Court focused on the “well-established principle that it is for directors themselves to determine (acting in good faith) how best to promote the success of a company for the benefit of its members as a whole”, and held that the actions of the board did not fall outside the range of reasonable responses to climate change risk. ClientEarth has now been granted an oral hearing to argue that it should be granted permission to continue its claim.20
Directors' Disclosure Obligations and Climate Change
Climate-related disclosures are also required to be integrated into disclosures on which directors are required to sign off, including Strategic Reports, the section 172 statement, and the financial statements.
The Strategic Report must include information about environmental matters, including the impact of the company's business on the environment, with additional disclosures in this regard being required following implementation of the EU Non-Financial Reporting Directive in the U.K. The Strategic Report must also include a section 172 statement on how the board has complied with its duty to promote the success of the company, including by having regard to the impacts of the company on the environment. The FRC published guidance in July 2018 on companies’ annual Strategic Reports, advising companies to report on climate-related risk where “material”.21
Certain listed companies have been required to produce disclosures aligned with the TCFD recommendations since January 2021. In December 2020, the FCA implemented amendments to the listing rules to implement TCFD disclosure reporting for premium-listed companies on the London Stock Exchange (other than investment companies) on a comply or explain basis for financial years starting on or after 1 January 2021.22
In December 2021, the FCA published rules expanding the scope of these requirements to include standard-listed companies and asset managers, life insurers and FCA-regulated pension providers.23 These rules apply from 1 January 2022 (although asset managers and asset owners will have a phased implementation, with the rules initially applying to the largest firms and coming into effect for smaller firms one year later).
In January 2022, the U.K. government published regulations requiring large U.K. incorporated companies to disclose climate-related information. The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 (the Climate Disclosure Regulations) amends sections 414C, 414CA and 414 CB of the Companies Act 2006 to require listed companies and those with a turnover greater than £500 million to provide a non-financial and sustainability information statement in their Strategic Report, and applies to disclosures made in financial years beginning on or after 6 April 2022.24 This statement must include climate-related information including: the actual and potential climate-related risks and opportunities arising in connection with their operations, and the time periods over which these are assessed; the impacts of climate-related risks and opportunities on their business model; their governance arrangements in assessing and managing climate-related risks and opportunities; their process for identifying these risks and opportunities; and an analysis of the resilience of the company’s business model under different climate scenarios. The Department for Business, Energy and Industrial Strategy (BEIS) has produced guidance on complying with these requirements.25
The disclosures required under the Climate Disclosure Regulations are less extensive than those introduced under the FCA rules (see above),26 but the FCA rules are on a comply or explain basis rather than being fully mandatory. BEIS’ guidance on the Climate Disclosure Regulations also explains the overlap between the FCA rules and the Climate Disclosure Regulations, noting that UK-registered listed companies are likely to be subject to both sets of requirements. In such a case, BEIS notes that disclosure in a manner consistent with the TCFD recommendations and recommended disclosures in line with the FCA rules are likely to fulfil the requirements of the Climate Disclosure Regulations.27
From 1 October 2021, occupational pension schemes have been required by new regulations to make TCFD-aligned disclosures, as well as put governance and management structures in place governance, strategy and risk management measures in respect of climate change-related risks.28 BEIS has noted that the Climate Disclosure Regulations are likely to inform the disclosures of pension schemes under these regulations.29
The FCA is also sharing views and expertise internationally through its co-chairing a workstream on disclosure as part of IOSCO’s Sustainable Finance Task Force.30
Climate-related issues may be required to be included in companies’ financial statements, on which the board is required to sign-off. The FRC has published thematic reviews on climate change reporting in November 2020 and July 2022 which identified that improvements were required.31 It supported the introduction of global standards on non-financial reporting, but, as an interim step, encouraged public interest entities to report against the TCFD’s recommended disclosures and the Sustainability Accounting Standards Board metrics for their sector. In November 2021, the FRC published a factsheet explaining how climate change-related matters may impact financial statements prepared under U.K. Generally Accepted Accounting Principles.32
Another potentially forthcoming development may be the incorporation of the International Sustainability Standards Board (ISSB)’s sustainability-related reporting standards, published in June 2023. The U.K. Government has stated that it will create a mechanism to assess, adopt and endorse the standards for use in the U.K.,33 and the FCA has stated that it intends to update its climate-related disclosure rules to reflect the ISSB standards.34 The ISSB standards incorporate the TCFD recommended disclosures, but expand on them in several ways. Importantly for boards, the ISSB standards require the disclosure of the identity of the body or individual responsible for oversight of climate-related risks and opportunities; how that body’s responsibilities are reflected in the company’s policies; how the body ensures that the appropriate skills and competencies are available to oversee strategies designed to respond to climate-related risks and opportunities; and whether dedicated controls and procedures are applied to management of climate-related risks and opportunities.
While governance around climate related risk has evolved over the last few years, governance of other environmental and social risks is now rapidly evolving. The UK is perhaps a frontrunner in its consideration of nature risks. The UK government commissioned the Dasgupta Review on The Economics of Biodiversity,35 endorsed and committed to address its findings, including through the incorporation of nature into national accounts, policy and finance frameworks and funding the TNFD framework.36 The proposed introduction of ISSB standards into the new UK Sustainability Requirement regime should include biodiversity-related disclosures.37 The CCLI has published a report on how companies in the UK and other jurisdictions may depend on biodiversity for the functioning of their business models.38Biodiversity risks may constitute material financial risks which boards are required to consider within the purview of directors’ duties.
There may be increasing regulatory focus on biodiversity risk. Biodiversity risk has been recognised by the British Institute and the Faculty of Actuaries,39 the UK Pensions Regulator,40 the Bank of England41 and the UK Financial Conduct Authority.42 The Financial Reporting Council listed biodiversity as an increasingly prominent theme for investors.43
In light of these policy and regulatory developments, directors may wish to begin considering biodiversity risk in order to ensure that they are fulfilling their legal duties and disclosure responsibilities.
Practical Implications for Directors
The focus on climate risk by U.K. regulators and the new disclosure requirements is likely to mean that directors of companies which are subject to these requirements will be required to consider climate change-related risks in order to properly fulfil their legal duties. In order to ensure high-standards of governance, well-counselled boards will:
- delegate climate risk identification and evaluation to a clearly-identified team in management which reports directly to the CEO and board;
- put on the agenda for the board within 3 or 6 months a process to start developing a climate transition roadmap to 2050 with transparent carbon neutrality or reduction targets, with clear interim targets to 2040, 2030, and within the current rolling multi-year strategic plan, and periodically thereafter report back to the board;
- delegate to the appropriate committee(s) of the board, such as risk, audit, legal and governance, scenarios/strategy, nominations/remuneration, or sustainability/corporate responsibility, the task of translating the long-term strategy into a clear decision-making process for each aspect that is relevant to each committee; and
- discuss with disclosure counsel, to develop an external engagement and communications plan and to oversee rigorous disclosure and accounting.
- Alex Cooper, Commonwealth Climate and Law Initiative