A regular briefing for the alternative asset management industry.
Last week, while the EU continues to debate how far to roll back its sustainability disclosure requirements, the UK took the next, tentative step forward in developing its own rulebook. The UK is already ahead of the EU in mandating TCFD-style climate-related financial disclosures for many large UK companies and asset managers – including many large private companies. It is now edging closer to more general sustainability disclosure requirements and, more controversially, mandatory climate transition plans.
The UK hitched its wagon to emerging international sustainability standards some years ago, rejecting the EU's more prescriptive approach. Progress has at times been sluggish but – although delays have been frustrating, and the resulting disclosures will not be as comprehensive as some would like – the lesson from the EU is that piling on too much, too soon can come back to bite. Slow and steady might yet win this race.
Last week's long-awaited milestone was the UK government's consultation on bespoke Sustainability Reporting Standards (UK SRS) for corporate sustainability disclosures, published on 25 June. The UK proposes to endorse the International Sustainability Standards Board's (ISSB) first two standards – IFRS S1 (general disclosures) and IFRS S2 (climate-related disclosures, building on TCFD requirements) – with only very minor modifications.
Separate consultations also consider assurance standards for sustainability disclosures and climate transition plans. In the latter case, the government is seeking views on how to implement its manifesto commitment to require UK-regulated financial institutions and FTSE 100 companies to prepare credible transition plans in line with the 1.5°C goal of the Paris Agreement (a target that looks increasingly unattainable).
The Financial Conduct Authority (FCA) is expected to follow with its own consultations on sustainability disclosure requirements and transition planning for listed companies, and – once it has endorsed the UK SRS – the government will consider whether to require large private companies to use them.
The UK sustainability standards adopt the ISSB’s four-pillar approach – governance, strategy, risk management, and metrics and targets – mirroring the globally influential Task Force on Climate-Related Financial Disclosures' (TCFD) framework. IFRS S1 and S2, issued in June 2023, set a global baseline, and the UK government’s proposed modifications are modest. For example, entities may choose to, rather than being compelled to, consider SASB sector-specific disclosure topics, and early adopters may opt to report solely on climate issues (a “climate first” approach).
The UK government is clearly cognisant of the debate that is raging in the EU and is keen to maintain the competitiveness of its capital markets and avoid undue burdens. It claims that improved transparency could lower capital costs and bolster understanding of sustainability risks, although it requests further evidence on the costs incurred by businesses operating under expanded reporting regimes.
The consultation on the assurance of sustainability-related financial disclosures explores a framework in which assurance service providers, overseen by the Financial Reporting Council (FRC), might offer limited assurance for various sustainability reporting systems – including the UK SRS, the EU's European Sustainability Reporting Standards (ESRS), and other international regimes. The FRC is itself consulting on a UK version of the International Auditing and Assurance Standards Board’s ISSA 5000 standard, designed specifically for sustainability engagements. Of course, assurance is a double-edged sword: it can increase investor confidence in disclosures but can also add significantly to compliance costs. The government will be keen to balance these competing priorities.
The government has previously made clear that it intends to mandate climate transition plans, including for asset managers. This will be the most challenging part of its agenda – and alternative asset managers should focus hard on that aspect of the consultation package.
The government’s consultation outlines several possible approaches, notably a “comply or explain” option and a more assertive mandate requiring firms not only to disclose but also to implement transition plans. The government is also exploring how closely these plans should align with net zero targets by 2050, and whether interim targets or scenario analyses for 2°C and 4°C futures should be enforced. For now, however, the Government appears to be open-minded about the content of future requirements and respondents have an opportunity to shape them.
Mandatory transition plans for asset managers are especially tricky. If net zero targets for the portfolio are based on divestment or exclusion policies, there is limited evidence of real-world impact. On the other hand, stewardship – and the private market's famous "active ownership" model – clearly can support the transition. For example, a strategy may focus on investments in potentially redundant or harder-to-abate sectors, transforming business models to ensure longevity and financing business process upgrades. Similarly, investments may be in companies with higher operational emissions or impacts but which avoid future emissions, such as EV or renewable energy infrastructure.
