At a glance:

  • While firms’ net zero commitments to date have been voluntary, in the run-up to, and over the course of COP26, there has been a step change in regulatory expectations on net zero plans. Financial services firms will increasingly be required to develop and disclose transition plans and be supervised on the credibility of their plans.
  • The Task Force on Climate-related Financial Disclosures (TCFD) published guidance making it explicit that firms should disclose transition plans. This is likely to drive increased global disclosure and consistency.
  • The UK Government announced its intention to make the UK the “world’s first net zero aligned financial centre” and will move towards making publication of transition plans mandatory.
  • The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) plan increased supervision and stakeholder engagement with financial services firms in 2022, with the FCA focusing on the governance, content and disclosure of transition plans.
  • The EU had already taken steps in relation to the disclosure of transition plans, but Frank Elderson at the European Central Bank (ECB) has called for the EU to go further with a legally binding requirement for banks to adopt Paris-compatible transition plans. Recent EU proposals to implement Basel 3.1 also set out new supervisory powers in relation to the net zero transition.
  • While new rules and guidance will be rolled out over the next few years, firms can expect increased supervisory engagement on their transition plans from next year. Firms should act now to ensure that their transition plans will enable them to meet their public commitments and that their disclosures are complete and accurate. Doing so will enable firms to harness the opportunities arising from the transition to a more sustainable economy, meet their own goals, and meet the expectations of their stakeholders.

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At COP26 Finance Day on 3 November, over 450 global financial services firms as part of the Glasgow Financial Alliance for Net-Zero [i] committed to align over $130 trillion (representing 40% of the world’s financial assets) with the Paris Agreement climate goals [ii]. 

Over the next few years, as these and other firms aim to deliver on their net zero transition plans, the financial services sector will be transformed and, in turn, transform the economy at large. There will be considerable opportunities for firms in terms of the products and services they offer their clients. There has already been rapid growth in green and sustainable finance and investment markets, with further developments also arising in sustainability-linked lending [iii].

While firms’ net zero commitments to date have been voluntary, over the last few weeks there has been a step change in regulatory expectations on the net zero transition. Financial services firms will increasingly be required to disclose transition plans and be supervised on the credibility of their plans.

This blog reflects on the recent regulatory developments which set out this shift in regulatory and supervisory expectations. We have also written a blog looking at how Risk and Compliance functions can support the journey to net zero.

International 

From implicit to explicit

The TCFD published guidance last month [iv] which recommended that organisations which have made greenhouse gas (GHG) emissions reduction commitments, operate in jurisdictions which have made such commitments, or have agreed to meet investor expectations regarding GHG emissions reductions, disclose transition plans and report on their progress on an annual basis. The guidance defines transition plans as an aspect of an organisation’s overall business strategy that lays out a set of targets and actions supporting the firm’s transition to a low-carbon economy, including actions such as reducing GHG emissions. 

There has been widespread global take-up of TCFD disclosure standards and eight jurisdictions, including the UK, have TCFD-aligned reporting requirements [v]. While the TCFD noted that its recommendations implicitly cover the key aspects of transition plans, this explicit guidance is likely to drive increased global disclosure on plans and consistency among disclosures. 

 UK 

The world’s first net zero finance centre

Rishi Sunak, UK Chancellor of the Exchequer, announced that he is seeking to make the UK the “world’s first net zero aligned financial centre” and will move towards making publication of transition plans mandatory.

The UK is rolling out TCFD standards across the economy. Initially, asset managers, regulated asset owners and listed companies will be required to publish transition plans that consider the Government’s net zero commitment or provide an explanation if they have not done so. As standards for transition plans emerge, the Government and regulators will take steps to incorporate these into the UK’s Sustainability Disclosure Requirements (SDR) and strengthen requirements to encourage consistency in published plans and increased adoption by 2023 [vi]. 

The Government will also set up a high-level Transition Plan Taskforce to develop a “gold standard” for transition plans, which will report by the end of 2022, as well as publish next year a transition pathway for the financial sector setting out how the sector will transition to net zero by 2050 [vii].

Reporting against the future UK Taxonomy will form part of the SDR. Certain companies will be required to disclose which proportion of their activities or the assets they invest in are Taxonomy-aligned, although the UK Government notes that disclosure against the Taxonomy is not a replacement for robust science-based targets.

Increased supervision and stakeholder engagement

The FCA intends to engage with stakeholders in the first half of 2022, with a view to promoting well designed, well governed, credible and effective net zero transition plans by listed companies and regulated firms. It will consider, for example, the governance of transition plans, including Board oversight, senior management responsibilities and objectives, and remuneration/incentive structures, as well as the content and disclosure of transition plans, building from TCFD guidance, which the FCA has proposed to integrate into its TCFD-aligned disclosure rules [viii].

The PRA will consider transition plans as part of the supervisory process for banks and insurers and will provide an update on how it intends to do so at a later date [ix]. 

EU 

Translating 2050 targets into milestones

Earlier this year, the EU took steps in relation to the disclosure of transition plans. The European Commission’s (EC) April 2021 proposal for a Corporate Sustainability Reporting Directive (CSRD) is expected to require in-scope companies (including financial institutions) to disclose their plans to ensure that their business model and strategy are compatible with the transition to a sustainable economy and with the Paris Agreement goals, although the disclosure content and timing are left to firms’ discretion. The CSRD is expected to apply to large undertakings from 2023 and to certain small and medium-sized undertakings from 2026.

The EC also plans to examine the extent to which more guidance could ensure voluntary pledges are credible and will monitor progress over time across the EU [x].  

More recently, there have been calls for the EU to go further. Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, spoke about translating 2050 targets into milestones and called for a legally binding requirement for banks to adopt Paris-compatible transition plans. He thought that transition plans should become the next addition to banks’ climate risk management practices, as they are a crucial element to ensure that banks manage all material risks [xi]. This has been picked up in the EC’s recent proposal for CRD6/CRR3 in implementing Basel 3.1.

Firms will also want to follow closely developments on the EU Taxonomy, such as the extension to transition financing. Certain banks and financial market participants will have to make disclosures in relation to taxonomy-alignment of their assets and financial products respectively.

Increased supervisory powers under EU implementation of Basel 3.1

In implementing Basel 3.1, the EC has proposed powers for supervisors to be able to force firms to change their business model, governance strategies or risk management if they are misaligned with broader ESG trends and EU objectives (such as net zero transition) [xii]. We anticipate that supervisors would be given these powers in around mid-2026 (18 months after entry into force).

Conclusion

In delivering on the sustainable finance agenda, prudential regulators have focused largely on climate risk management, while conduct regulators have focused on the promotion of green finance and on combatting greenwashing.

Firms have made net zero and other low-carbon commitments on a voluntary basis in order to meet their own ambitions and those of their investors, employees and customers.

But in the run-up to, and over the course of COP26, there has been a marked shift in regulatory expectations. Regulators will increasingly expect firms to support the net zero transition and the credibility of firms’ transition plans is set to come firmly within the regulatory purview.

While new rules and guidance will be rolled out over the next few years, firms can expect increased supervisory engagement on their transition plans from next year. Firms should act now to ensure that their transition plans will enable them to meet their public commitments and that their disclosures are complete and accurate. Doing so will enable firms to harness the opportunities arising from the transition to a more sustainable economy, meet their own goals, and meet the expectations of their stakeholders.


[i] The Glasgow Financial Alliance for Net-Zero is a forum which brings together the leading net-zero initiatives across the financial sector. GFANZ includes the Net-Zero Banking Alliance (NZBA), the Net-Zero Asset Owner Alliance (NZAOA), the Net-Zero Asset Manager Initiative (NZAMI), and the Net-Zero Insurance Alliance (NZIA).

[ii] GFANZ statement, November 2021.

[iii] For example, according to the Climate Bonds Initiative, cumulative green bond issuance to date is $1.436 tn (as at October 2021) and, according to the International Monetary Fund Global Financial Stability Report, October 2021, assets in sustainable investment funds have doubled over the past four years to about $3.6 tn.

[iv] Guidance on metrics, targets and transition plans, TCFD, October 2021; TCFD updated Annex: Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, October 2021.

[v] TCFD 2021 Status Report, October 2021.

[vi] Greening Finance: A Roadmap to Sustainable Investment, HM Treasury, October 2021.

[vii] Factsheet: Net Zero-aligned Financial Centre, HM Treasury, November 2021.

[viii] A strategy for positive change: our ESG priorities, FCA, November 2021.

[ix] Climate change adaption report, PRA, 2021.

[x] Annex to the European Commission Communication on a Strategy for Financing the Transition to a Sustainable Economy, July 2021.

[xi] Overcoming the tragedy of the horizon: requiring banks to translate 2050 targets into milestones, Frank Elderson, October 2021.

[xii] Implementing Basel 3.1 in the EU: Delay, Defer, Diverge – and more…, October 2021.