The FRC Lab sets out investor views on effectively communicating net zero commitments

As a growing number of UK companies commit to net zero targets, the UK Financial Reporting Council Lab (the Lab) has published a report designed to help companies with their corporate net zero disclosures and other greenhouse gas (GHG) emission reduction commitments. The report finds that companies face challenges in how they measure, manage, control and assure ESG data. Reporting is often too aspirational and high-level, and fails to provide users with sufficient information. Importantly, the report highlights that investors expect that the regulatory landscape for net zero reporting will continue to grow and evolve, and are calling for businesses to be clear and candid about how that might change the way they do business and transform their strategy and operations.

The report establishes that investors use net zero disclosures for: (i) comparing companies and their strategies and plans; (ii) understanding and comparing the GHG footprint of portfolios; (iii) assessing the credibility of plans and performance against commitments; and (iv) making decisions, such as whether to invest, divest, or provide financing. It also identifies three elements that investors seek to understand from companies’ disclosures: commitments, impacts, and performance.

1. Commitments

The Lab advises companies to be clearer about defining the nature and scope of the emissions included in their commitments, specifically with respect to the types of GHGs included. Carbon dioxide (CO2), for example, is only one of seven GHGs covered by the Kyoto Protocol, and ‘carbon neutral’ could mean commitments for CO2 alone, or carbon and carbon-equivalents, which would include all GHGs, converted into the equivalent CO2 impact.

The report also recommends clearly defining the scope of emissions in accordance with the GHG Protocol Corporate Standard, which distinguishes between direct emissions (Scope 1), emissions from energy used by the company (Scope 2) and up- and down-stream emissions from its supply chain (Scope 3).

Although investors value both absolute targets and intensity measures, the report calls for them to be clearly distinguished, and a transparent timeline provided. Further, companies with a more complex structure are recommended to specify which parts of their business are included and excluded from the commitment. Companies are also advised to provide information on any exclusions or limitations to the commitments, and to specify whether the commitment will be updated for a new approach or a more ambitious target at a later date.

The Lab’s overall approach in the report and its focus on ensuring that disclosures are as meaningful as possible align with the approach it took when reviewing Taskforce on Climate-related Financial Disclosures (TCFD) disclosures and climate in the financial statements (Lab TCFD Review) earlier this year. One of the observations that the Lab focused on in that case was the need for more granular and specific information and, for example, the need to include any key assumptions relevant to the TCFD analysis, as this would ensure that the information provided is as decision useful as possible.

2. Impacts

Reaching net zero GHG emissions may require material changes to operations and/or business strategy, and so investors seek to understand what management plans do and the extent to which their commitments change the operations and/or business strategy of the company. Investors also seek to understand how committing to reducing GHG emissions could lead to both risks and opportunities for a company. As a result, companies are advised to consider political, macro and microeconomic factors, whilst ensuring that estimates of future costs relating to net zero commitments for research and development, capital expenditure, and other green operating expenditure are provided.

3. Performance

The report finds that investors would prefer companies to set net zero targets aligned to the Science Based Targets initiative framework, which should be backed by interim targets set in the short and medium term, a point also raised in the Lab TCFD Review. Investors also value regular disclosures which articulate current performance against targets and the overall commitment, and if performance has been impacted by an event, investors value information setting out why that target has not been met or why progress has been slower than anticipated. Additional points outlined by the Lab TCFD Review include the need for companies ‘to clearly explain what ‘net zero’ or ‘carbon neutrality’ terms mean in the context of the company, ensuring that disclosures about such commitments are not misleading’. The Lab TCFD Review also suggests that companies should explain the role of offsets in the company’s strategy to net zero.

What’s next?

The report acknowledges that this is a rapidly evolving reporting environment, both in the UK and internationally. Recently, organisations have witnessed the development of the International Sustainability Standards Board’s disclosure standards, and notably, as reported in a previous blog post, the UK’s Transition Plan Taskforce’s consultation on how companies and financial institutions can develop “gold-standard” transition plans, with sector specific guidance due in 2023. Further, the UN’s report also sets out standards for transition plans for both corporates, cities and regions, and there are expectations that some governments (such as the UK) may increasingly mandate corporate net zero commitments.

In light of this, the report is useful in helping businesses understand investor expectations as with the development of new standards, regulations and practices in net zero reporting, investors anticipate that there will be a need to reimagine business operations and strategy, and they want detailed disclosures on how companies will navigate this changing regulatory landscape. This report is published alongside an example bank which provides practical tips through offering examples of current good practice – but the bar will continue to rise.