Responsible business, sustainable business, ethical trading, ESG (environmental, social, governance) - however you choose to term it - is moving up the boardroom agenda across sectors. And in turn, the topic is increasingly a focus for legislators and regulators.
No surprise then that in a 2019 report by Centrica Business Solutions, "being socially and environmentally responsible" and "complying with legislation and regulation" are the 3rd and 4th most important organisational priorities, ranked ahead of "being focussed on innovation".
Much has already been written about the business case for adopting an effective responsible business strategy. But there is increasingly a legal and regulatory dimension which can catch businesses unawares. In this Insight, we review the latest legal and policy developments at the UK and EU level. Where are regulators likely to be turning their attention next and what should you be focussing on now to stay ahead of your competitors?
The UK published its Green Finance Strategy in July 2019. The strategy has two objectives:
- to align private sector financial flows with clean, environmentally sustainable and resilient growth supported by government action; and
- to strengthen the competitiveness of the UK financial sector.
We can expect this to be an increasing area of focus for regulators. Two particular areas to watch are climate change risk reporting and standardising sustainable finance and impact investing.
Climate change risk reporting
Climate change is likely to result in physical risks (more frequent, severe weather events), transition risks as we move towards a greener economy (shifts in asset values, costs of doing business, new business models) and liability risk (who will be held responsible for losses arising out of physical or transition risks?). Well managed businesses will already be considering their exposure to these risks. Increasingly, businesses are being expected to report publicly and much more robustly on those climate risks facing their business.
The UKLA's Corporate Governance Code, which applies to quoted companies, and the Wates Principles, which applies to large private unquoted companies, already explicitly require boards to consider climate change related risks as part of good corporate governance.
Regulators have also been highlighting the need for appropriate disclosures for some time. In 2015, the Financial Stability Board (an international body that monitors and makes recommendations about the global financial system) set up the Taskforce on Climate-related Financial Disclosures, in response to a request from G20 Finance Ministers and Central Bank Governors. The Taskforce is industry-led effort, chaired by Michael Bloomberg, with 32 global expert members from the private sector. Its remit is to develop voluntary climate-related disclosures that could "promote more informed investment, credit, and insurance underwriting decisions." It released its final report and recommendations in June 2019.
Although set up as a voluntary system, the UK government has already announced that it expects all listed companies and large asset owners to be disclosing in line with the taskforce's recommendations by 2022.
Standardising sustainable finance and impact investing
One of the issues currently plaguing the sector is a lack of standardisation, which inhibits comparison, fairness and competition. At a UK level, the government will be addressing these issues as part of its Green Finance strategy. But ahead of that, at a EU level, the European Commission has proposed a package of reforms relating to sustainable finance intending to establish an EU framework that puts ESG considerations at the heart of the financial system.
The proposed legislation includes:
- a Taxonomy Regulation (to introduce an EU wide taxonomy of environmentally sustainable activities);
- a Disclosure Regulation (to impose new transparency and disclosure requirements on certain firms);
- a Low Carbon Benchmark Regulation (to introduce a new category of benchmarks); and
- legislation to require investment firms to ask their clients about their preferences concerning ESG and to take them into account when advising their clients.
This package is currently going through the EU legislative process and is also likely to shape any UK-only policy developments.
New corporate governance disclosures
A company's annual report and accounts has for many years been more than just a report of the company's financial position. Large UK companies and groups are already required to prepare an annual strategic report which includes analysis about the business using non-financial KPIs, including information relating to environmental and employee matters. And quoted companies have to provide much more detail: specifying the impact of the company's business on the environment; providing information about the company’s employees and social, community and human rights issues, and including a breakdown of the company's employees by gender.
These requirements have recently been supplemented by three new statements which will have to be published as part of a company's annual report and accounts:
- a "section 172 statement";
- a "Statement of employee engagement"; and
- a "Statement of engagement with customers and suppliers".
You can read more about the statements here.
These statements must be included in reports for financial years beginning on or after 1 January 2019, meaning that we should see the first reports during 2020. Businesses should be prepared to collect information throughout the financial year so that they are properly able to report on their activities at the end of the year.
The government is especially keen to use the annual reporting cycle as a vehicle for wider reporting requirements – believing that tying new reports to existing timetables makes adoption easier for business. So we expect more and more disclosures to be shoe-horned into a company's annual report and accounts.
One recent example is the streamlined energy and carbon reporting regime, which applies to quoted and large unquoted company for financial years beginning on or after 1 April 2019, and requires them to report on their annual energy use and carbon emissions as part of their director's report. Another is the reporting of CEO pay ratios, which we discuss below.
Although a crude measure, pay ratios have increasingly been seen as a proxy for how fairly an employer treats its employees. We have already seen the impact of gender pay gap reporting and how effective that was in driving the national conversation. Now businesses should brace themselves for two new reporting requirements:
CEO pay ratios
For financial years beginning on or after 1 January 2019, quoted companies with more than 250 UK employees will have to publish the pay ratios of their CEO's remuneration compared to average pay in the wider company workforce. We'll see the first reports with annual accounts and reports published in the first quarter of 2020 and, as with gender pay gap reporting, there is likely to be a great deal of publicity.
Even if your business is not within the reporting obligation, you may find your employees asking for this information and/or informally making comparisons with other businesses in your sector which are required to report.
Ethnicity pay reporting
With gender pay reporting now an annual requirement, attention has turned to the race pay gap. In January 2019, the government consulted on mandatory ethnicity pay reporting – similar to the current gender pay gap reporting obligation. Whilst not yet law, a new reporting obligation on this topic is highly likely to be introduced in the next two to three years.
Supply chain transparency
Responsible businesses have long understood the need to interrogate their supply chains – not least so that they are able to publish a "transparency in supply chains statement" on their website under the UK's Modern Slavery Act.
In a consultation published in July 2019, the government has proposed a series of measures to strengthen the Modern Slavery Act regime, including setting up a centralised reporting service and a single reporting deadline for the TISC statement – similar to what is required for gender pay gap reporting. This is with the express intention of enabling civil society, investors and consumers to track progress over time. Businesses should increasingly expect to be compared to their peers on this issue by their customers and during procurement processes (particularly for public contracts).
Osborne Clarke comment
The wealth of legal and regulatory requirements – not to mention voluntary, best practice and industry codes – can seem overwhelming. Most businesses want to do right by their customers, employees and wider community. The trick is understanding how that translates into standards, metrics and reporting requirements. To discuss how we can help you fit your responsible business practices in with the legal and regulatory landscape so that your programmes are efficient and effective, contact one of our experts listed below, or your usual Osborne Clarke contact.