To help companies improve their reporting on net zero commitments, the FRC Lab have published its Net zero disclosures report (“the Report”), which provides companies with practical tips and questions to consider when preparing disclosures in their financial reports on net zero and other Greenhouse Gas (“GHG“) reduction commitments.
Governments across the globe continue to commit to legally binding net zero GHG emissions targets. The UK and EU, for instance, have committed to achieving net zero GHG emissions by 2050. Achieving these net zero targets will require transformative changes across an entire economy, which cannot occur without action from both public and private sector actors. Net zero targets have, therefore, become the ‘gold standard’ for company climate targets.
Companies that adopt net zero targets are increasingly required to disclose not only the targets themselves, but also supporting information, through mandatory disclosure regimes such as those aligned with the Taskforce on Climate-related Financial Disclosures (“TCFD“). For further information on the TCFD disclosure regime and the UK’s approach to the regime, please read our earlier blog posts here, here and here.
As noted in the UK Financial Reporting Council’s (“FRC“) Statement of Intent on Environmental, Social and Governance challenges, it remains the case that reporting on net zero targets is often too high-level, failing to provide stakeholders with sufficient information. Investors are increasingly calling for better information to be provided in financial statements, including information that connects a company’s net zero targets to relevant disclosures. Particularly in light of the growing scrutiny to which a company’s disclosures are subject, whether by regulatory bodies – such as the UK Financial Conduct Authority and the US Securities and Exchange Commission – or investors and other stakeholders, enforcement action and/or litigation becomes a real risk if the company’s reporting does not contain sufficiently accurate and verifiable information.
What does ‘net zero’ mean?
A commitment to achieving net zero GHG emissions is a commitment, by the public or private party, to actively reducing its GHG emissions, with offsetting of ‘residual’ GHG emissions as a last resort. This can be distinguished from a commitment to becoming ‘carbon neutral’, which means that the public or private actor commits to not increasing – but not necessarily reducing – its GHG emissions, often achieving this through using GHG emissions ‘offsets’.
A company’s net zero plan should, therefore, contain details regarding its GHG emission reduction targets and the steps it plans to take to achieve those targets.
Background to the Report
In an attempt to better appreciate the detail behind the net zero commitments made by companies, the FRC Lab spoke with investors, companies and other stakeholders in an attempt to understand: (1) how investors use disclosures around net zero commitments; (2) investor perspectives on current net zero reporting, including good practice and areas for improvement; and (3) reporting challenges and successes for companies with net zero commitments.
The views of a range of UK and international institutional investors, retail investors, analysts and companies were sought by the FRC Lab through a series of interviews, the findings of which formed the basis of the Report.
Elements to consider when reporting on net zero disclosures
Based on the FRC Lab’s discussions, the Report identified three elements that investors want to understand from companies’ disclosures on their net zero commitments:
- Commitments: information on the level of ambition, scope, nature and timing of a company’s net zero commitments, what is included and excluded from their commitments, and whether their commitments will be updated. In particular, investors want information on the types of GHGs emissions included, the scope of GHG emissions included, whether the relevant commitment pertains to absolute and/or intensity GHG emission reductions, the timelines for the commitments, and whether the commitments include plans to use offsets;
- Impacts: how a company’s net zero commitment impacts its strategy and business model, including information on transition plans, assumptions, uncertainties, and risks and opportunities. Investors also want to see estimates of potential future costs, where relevant, on capital expenditure, research and development, and other operating expenditure; and
- Performance: how performance is being measured in the short, medium, and long term. To measure performance accurately, investors want to know how high-quality data and accountability will be ensured, the actions company management are taking in response to changes, and consideration of whether any external assurance would be appropriate.
The Report notes that these elements are inherently interconnected, so that improving performance in relation to one element should help companies improve in relation to the other elements. For example, improvements to a company’s data gathering could help build a better understanding of the company’s GHG emissions amongst management, thereby enabling management to bring previously excluded GHG emissions into their net zero commitment.
An iterative approach to providing net zero disclosures
In addition to the above elements, the Report proposes a staged, iterative, approach for companies to take when providing net zero disclosures to investors, as well as a number of questions for companies to consider when devising such an approach:
- Define the commitment: What will the company reduce and over what period? Will offsets be used? What interim targets will the company set? How will the company communicate its targets internally?
- Assess the impact: How will the business model and strategy need to change? What resources does the company need? How will the company embed the commitments into its decision making?
- Measure progress: What internal targets and measures does the company need to have in place? Does the company have the requisite systems, controls and processes in place to measure and monitor progress? What internal review processes does the company need?
- Refine the approach: Does the company need to redefine any of its commitments? Does the company need any external review? How will the company share lessons with its wider workforce?
Following this iterative approach, and considering the above elements, will assist company management in making sufficiently accurate and verifiable disclosures in respect of their net zero commitments.