TerraLex Cross-Border Guide to Cross-Border Guide to ESG and Sustainable Finance

The Companies Act 2006 requires banking and insurance companies, companies listed on the Main Market or AIM and large private companies to include non-financial and sustainability information statements in their strategic reports. These must include climate-related financial disclosures and information relating to environmental matters (including the impact of the company's business on the environment), the company's employees, social matters, respect for human rights and anti-corruption and anti-bribery matters. The climate-related financial disclosures required reflect the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and include disclosures on climate change-related risks and opportunities; how climate change is addressed in corporate governance; the impacts on strategy; how climate-related risks and opportunities are managed; and the performance measures and targets applied in managing these issues. Separate Regulations impose similar requirements for TCFD-aligned disclosures on large, traded or banking LLPs. If any of the required elements are omitted from a corporation's disclosures, the corporation must provide a clear and reasoned explanation for this.

The FCA imposes further climate-related financial disclosure requirements on listed companies, asset managers, life insurers and FCA-regulated pension providers, including a requirement to disclose transition plans on a "comply or explain" basis.

The FCA's Listing Rules also require all companies admitted to the Main Market to disclose in their annual financial report whether they meet the FCA targets for gender and ethnic minority representation on the board of directors and, if they have not met the targets, why not. The targets are that at least 40% of the board are women, that at least one of the senior board positions (Chair, CEO, CFO and Senor Independent Director) is held by a woman and that at least one member of the board is from a non-white ethnic minority background.

Companies listed on the Main Market are required to report on their application of the UK Corporate Governance Code on a "comply or explain" basis. Companies listed on AIM must apply a recognised corporate governance code such as the UK Corporate Governance Code or the Quoted Companies Alliance Corporate Governance Code and report on their application of their chosen code on a "comply or explain" basis. In addition, certain large private companies must include a statement of corporate governance arrangements in their annual financial reports which must state which corporate governance code, if any, the company applied in the financial year; how the company applied any corporate governance code selected; whether the company departed from any corporate governance code selected and, if it departed from that code, the respects in which it did and its reasons for doing so.

Other ESG disclosure requirements are found in the Modern Slavery Act 2015, which includes reporting obligations in relation to modern slavery in supply chains for companies with a total turnover of £36 million or more, and the Equality Act 2020 (Gender Pay Gap Information) Regulations 2017, which requires employers with 250 or more employees to publish information on their gender pay gaps each year.

In addition, trustees of most occupational pension schemes are required to include in their statement of investment principles how they consider financially material factors (including ESG factors) when making investment decisions.

Large private companies are not required to comply with a corporate governance code, but if they do choose to comply with a corporate governance code (such as the UK Corporate Governance Code, Quoted Companies Alliance Corporate Governance Code or the Wates Corporate Governance Principles), they must then explain in their annual financial reports how they comply with the provisions of their chosen code or explain any non-compliance.

A number of entities choose to report in accordance with voluntary frameworks such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB).

To date, mandatory climate-related disclosures in the UK have reflected the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). However, a number of entities also voluntarily report in accordance with other frameworks such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB).

The UK government has indicated that, in the future, further disclosure obligations may be introduced in line with the new standards of the International Sustainability Standards Board (ISSB).

UK legislation and regulation provide for a number of environmental regimes, including the Environmental Permitting Regime, combining the pollution prevention and control regime and waste management licensing and industrial emissions, and regimes to deal with water; waste; contaminated land; conservation of nature, wildlife and habitats; environmental impact assessments; and climate change, in particular in relation to the UK's new net zero emissions by 2050 target.

Recent climate change regulations designed to help companies meet the UK government's statutory 2050 net zero target include:

• the Emissions Trading Scheme, which requires the amount of carbon dioxide emitted by installations in energy-intensive industries to be less than or equal to the amount of allowances that they hold
• the Climate Change Levy, which is a carbon tax levied on non-domestic consumers of certain energy supplies
• the Energy Savings Opportunity Scheme which requires larger companies and non-public sector organisations in the UK to carry out mandatory energy saving assessments, calculating their total energy saving consumption, carrying out energy audits and identifying where savings can be made.

Other recent environmental laws include provisions against using illegally harvested timber included in the Environment Act 2021, the UK Timber Regulations and the Forest Law Enforcement, Governance and Trade Regulations.

Under the Bribery Act 2010, organisations are required to assess their procedures and ensure that they are adequate to prevent bribery and corruption.

In addition, section 172 of the Companies Act 2006 imposes a duty on directors of a company to promote the success of the company for the benefit of its members as a whole having regard to the long-term consequences of decisions; the interests of the employees; the company's business relationships with suppliers, customers and others; the impact of the company's operations on the community and the environment; the desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the company.

In general, UK ESG rules do not have extraterritorial effect. However, if an overseas company is listed in the UK, it will be required to comply with the FCA's regulatory requirements, including the Listing Rules and the Disclosure and Transparency Rules.

In the UK, the Consumer Protection from Unfair Trading Regulations 2008 (CPRs) protect consumers from 'unfair commercial practices' carried out by traders. The CPRs prohibit traders from making misleading statements about the environmental impact of a product or service including through marketing materials and product packaging. In the business-to-business context, the Business Protection from Misleading Marketing Regulations 2008 prohibit any 'misleading advertising' made to other businesses i.e., any advertising likely to deceive another business and affect its economic behaviour, and any advertising that may injure a competitor (reg 3).

The main regulatory codes governing environmental claims are the Competition and Markets Authority's (CMA) Green Claims Code and the Advertising Standards Authority's (ASA) CAP Code (Rule 11). Both codes apply to B2C and B2B environmental claims, reflecting the position under existing UK consumer protection law. The ASA has also published guidance: 'The environment: misleading claims and social responsibility in advertising'. These all set out similar principles regarding making environmental claims i.e., they must be truthful, accurate, clear, and unambiguous. They must be substantiated and not omit important information. The full life cycle of the product or service must be considered, and any comparisons must be fair and meaningful.

Businesses are currently under an increased level of regulatory scrutiny regarding misleading environmental claims (known as 'greenwashing'). New proposals in the draft Digital Markets, Competition and Consumers Bill (published 26 April 2024) provide the CMA with greater enforcement powers including the ability for the CMA to fine companies making misleading environmental claims up to 10% of their global annual turnover for breaches of consumer protection law.

Under section 54 of the Modern Slavery Act (MSA), large businesses (i.e., with a turnover of £36 million or more) must produce a modern slavery and human trafficking statement each year. The statement must set out the steps they have taken to ensure that there is no modern slavery or human trafficking in its business or supply chains or confirm that no steps have been taken. In practice, this would require such businesses to include contractual clauses in their supply contracts requiring that the supplier manages and tracks its supply chain and takes steps to prevent modern slavery and human trafficking.

Under the Environment Act 2021, large businesses with a turnover over a specific threshold (not yet set by regulations) must implement due diligence systems to identify and obtain information regarding products linked to deforestation. In practice, businesses procuring these products would have to include obligations into their supply contracts to require suppliers to comply with, and contribute to, such due diligence systems.

Under section 994 of the Companies Act 2006, a shareholder of a company may petition a court for relief where the affairs of the company are being, or have been, conducted in a manner that is unfairly prejudicial to the interests of shareholders generally or a group of shareholders (including at least that shareholder) or if an actual or proposed act or omission of the company is or would be so prejudicial. If the court agrees that unfair prejudice has resulted from the conduct of the company's affairs, it may make an appropriate order, the most common order being for the shares of the petitioning shareholder to be bought by other shareholders or, more rarely, the company itself.

Where a wrong has been committed against a company by its directors and that company has suffered loss as a result of their actions, the proper claimant is the company itself and the ability to decide whether to sue or not is generally vested in the board of directors. However, where certain types of wrong (namely negligence, default, breach of duty or breach of trust) are committed by company directors, the court has a discretion in appropriate circumstances to permit shareholders to bring a claim in their own name on behalf of the company unless those wrongs have been ratified in accordance with a procedure set out in the Companies Act 2006.

Under section 994 of the Companies Act 2006, a shareholder of a company may petition a court for relief where the affairs of the company are being, or have been, conducted in a manner that is unfairly prejudicial to the interests of shareholders generally or a group of shareholders (including at least that shareholder) or if an actual or proposed act or omission of the company is or would be so prejudicial. If the court agrees that unfair prejudice has resulted from the conduct of the company's affairs, it may make an appropriate order, the most common order being for the shares of the petitioning shareholder to be bought by other shareholders or, more rarely, the company itself.

Where a wrong has been committed against a company by its directors and that company has suffered loss as a result of their actions, the proper claimant is the company itself and the ability to decide whether to sue or not is generally vested in the board of directors. However, where certain types of wrong (namely negligence, default, breach of duty or breach of trust) are committed by company directors, the court has a discretion in appropriate circumstances to permit shareholders to bring a claim in their own name on behalf of the company unless those wrongs have been ratified in accordance with a procedure set out in the Companies Act 2006.

ClientEarth attempted to bring a derivative claim in its recent legal action against the board of directors of Shell, alleging that the directors had breached their duties under sections 172 and 174 of the Companies Act 2006 by failing to act in a way that promotes Shell's success and to exercise reasonable care, skill and diligence by failing to manage Shell's climate risk. However, the court held that ClientEarth's application and evidence did not disclose a prima facie case for giving permission, endorsing the well-established principle that the court will not readily meddle in directors' decision making when weighing up many competing considerations and reaching a decision in good faith.

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In 2022, the Competition and Markets Authority (CMA) published advice on how competition and consumer laws can help meet the UK's environmental goals. The CMA did not see sufficient evidence that competition law prevents firms from acting sustainably, noting that, for example, it is already possible for companies to work together to lessen the environmental impact of their sector, by pooling resources or expertise, without breaching competition rules. Overall, the CMA's view was that there is some flexibility under the current rules to take environmental benefits into account when considering exemptions for agreements that restrict competition, but the CMA has committed to bringing forward more detailed guidance in this area.

Currently, there is not one statutory framework, however a broader UK sustainable framework is being developed which will become binding to move towards the UK's net zero goal. The latest UK government policy in this regard is the 2023 Green Finance Strategy which sets out key objectives of the government in relation to sustainable finance, which include UK financial services growth and competitiveness, investment in the green economy and alignment of global financial flows with climate and nature objectives.

UK legislation and FCA regulations currently impose climate-related financial disclosure requirements on banking and insurance companies, companies listed on the main market and AIM, large private companies and LLPs, asset managers, life insurers and FCA-regulated pension providers.

The FCA Handbook contains an ESG sourcebook with rules in force since 1 January 2022. The ESG sourcebook sets out rules and guidance concerning a firm's approach to ESG matters and regarding the disclosure of climate-related financial information consistent with TCFD Recommendations and Recommended Disclosures.

Broadly, the key aspects of the forthcoming sustainable finance framework in the UK are as follows.

• The proposed UK Green Taxonomy which defines what is green or sustainable by setting out criteria that economic activities must meet to be considered environmentally sustainable. This will allow businesses and investors to identify which activities can be considered environmentally sustainable. Firms will be required to report in line with this taxonomy as part of the SDR regime. A consultation on the taxonomy will likely take place in autumn 2023.
• Climate transition plans: the UK government will implement mandatory requirements for certain companies to publish net zero transition plans showing how they will decarbonise up until 2050.
• Mandatory TCFD disclosures: The UK has committed to mandatory disclosures that align with the Task Force on Climate-related Financial Disclosures (TCFD) across the economy by 2025.
• Sustainability Disclosure Requirements (SDR) which will form an integrated disclosure framework encompassing three types of disclosure: corporate disclosure, asset manager and asset owner disclosure, and investment product disclosure. The Financial Conduct Authority has consulted on this in October 2022 (see CP22/20) and plans to publish final rules and a policy statement later in 2023.
• The FCA is undertaking various projects and has developed an ESG Strategy which covers five core themes of transparency, trust, tools, transition, and team. It has developed guiding principles on ESG and sustainable investment funds for fund managers. The FCA has also been looking at how ESG data and rating providers should be regulated.
• The Bank of England, which encompasses the Prudential Regulation Authority (PRA) has also taken action, e.g., through the Bank of England climate change strategy, stress tests, and a PRA supervisory statement and reports.

Broadly, the emphasis in the UK is on the main sustainable finance framework set out above (climate-related financial disclosure, proposed UK Green Taxonomy, climate transition plans, mandatory TCFD disclosures, Sustainability Disclosure Requirements (SDR), various FCA initiatives including in relation to listing and the ESG sourcebook, as well as action by the Bank of England and Prudential Regulation Authority (PRA)).

However, one example of voluntary disclosure is that the FCA has noted that firms may still wish to make disclosures against the Sustainable Finance Disclosure Regulation ((EU) 2019/2088), which is EU legislation that no longer applies to the UK after its exit from the EU. This may be for example to increase comparability with EU products. Generally, FCA rules do not prevent firms from providing disclosure against any other framework (in addition to the domestic Taskforce on Climate-related Financial Disclosures (TCFD) based framework).

Another example of voluntary disclosures are the voluntary principles published by the International Capital Market Association in relation to Sustainability-Linked Bonds, which are linked to specified ESG metrics.

The Financial Conduct Authority is currently exploring how to introduce rules for financial advisers that would confirm that they should take sustainability matters into account in their investment advice. In 2021, it published a policy statement on enhancing climate-related disclosures by asset managers, life insurers and FCA-regulated pension providers (PS21/24). Further, the FCA handbook (which firms must comply with) contains an ESG sourcebook in force since 1 January 2022. The ESG sourcebook sets out rules and guidance concerning a firm's approach to ESG matters and regarding the disclosure of climate-related financial information consistent with TCFD Recommendations and Recommended Disclosures.

The UK government has indicated that, in the future, further disclosure obligations may be introduced in line with the new standards of the International Sustainability Standards Board (ISSB). Further obligations may also be introduced to reflect the recommendations of the Task Force on Nature-related Financial Disclosures.