Defra publishes review on corporate reporting of emissions

Practical Law UK Legal Update 5-504-1309 (Approx. 8 pages)

Defra publishes review on corporate reporting of emissions

by PLC Environment

Background

The Climate Change Act 2008 (CCA 2008) requires the UK to achieve an 80% reduction in greenhouse gas (GHG) levels (below 1990 levels) by 2050. The government aims to meet this legally-binding target to cut GHG emissions by a system of five-yearly carbon budgets, with a key interim target of 34% reduction by 2020. Recently, there has been considerable speculation that the government will introduce mandatory reporting of GHG emissions by private and public sector organisations. Section 84 of the CCA 2008 requires, the Secretary of State to review (and report to Parliament on) the contribution that GHG reporting is making to the achievement of the UK's climate change objectives by 1 December 2010.

Section 85 of the CCA 2008 requires the Secretary of State, by 6 April 2012:

To make regulations under section 416(4) of the Companies Act 2006, requiring directors' reports to contain certain specified information about GHG emissions from activities for which the company is responsible; or
Lay a report before Parliament explaining why no such regulations have been made.

For more information about:

The requirements in the CCA 2008, see Practice note, Climate Change Act 2008: Duty on companies to report on greenhouse gas emissions?.
Mandatory environmental reporting for companies, see Practice note, Environmental reporting for companies: mandatory.
Voluntary environmental reporting for companies, see Practice note, Environmental reporting for companies: voluntary.

In September 2009, the Department of Environment, Food and Rural Affairs (Defra), in partnership with the Department of Energy and Climate Change (DECC), published voluntary guidance for businesses and other organisations on how to measure and report on their GHG emissions. The guidance was required to be published by section 83 of the CCA 2008 by 1 October 2009 (see Legal update, Government publishes guidance on corporate reporting under the Climate Change Act 2008).

On 8 January 2010, the environmental think-tank, the Aldersgate Group (AG), published an open letter to Lord Mandelson, then Business Secretary for the Department for Business, Innovation and Skills (BIS), calling on the government to introduce mandatory GHG reporting for all large UK companies as soon as possible. For more information, see Legal update, Aldersgate Group calls for mandatory GHG reporting for companies. The AG also published an open letter to Caroline Spelman, Defra's Secretary of State, on 26 November 2010 calling for the government to introduce mandatory carbon reporting for large firms under the CCA 2008 (see Businesses issue call for mandatory carbon reporting, BusinessGreen, 26 November 2010).

On 2 August 2010, BIS published a consultation on the future of narrative reporting (the non-financial information which is required by statute or regulation to be included in the annual report and accounts). The consultation was part of the government's commitment in the Coalition Agreement to "reinstate an operating and financial review to ensure that directors' social and environmental duties have to be covered in company reporting and investigate further ways of improving corporate accountability and transparency". The consultation closed on 19 October 2010 and BIS is due to report on the outcome of the consultation and its proposals to reform narrative reporting by the end of 2010 (see Legal update, Narrative reporting: BIS consultation).

Defra review on corporate reporting of GHG emissions

On 30 November 2010, Defra published its Review on the contribution that reporting of greenhouse gas emissions makes to the UK meeting its climate change objectives, a review of the current evidence (Review). The Review was presented to Parliament as required by section 84 of the CCA 2008.

The Review will inform the government's decision as to whether to introduce mandatory corporate reporting of GHG emissions. The review says that the government will announce how it intends to proceed with "promoting more widespread and consistent reporting of GHG emissions" in early 2011. This wording does not mention mandatory corporate reporting which may indicate that the government is drawing back from making corporate reporting on GHG emissions mandatory.

Aims of the Review

The aims of the Review were to understand:

Whether corporate reporting of GHG emissions leads to improved emissions management and the impact of such reporting.
Whether investors use GHG reports when deciding on investing in a company and the impact of the reports.
To what extent reporting can be used as a proxy for a company taking steps to understand and tackle its GHG emissions and whether this contributes to the UK moving towards a low-carbon economy.

Data used by the Review

The Review considered a wide body of evidence on the effects of GHG emissions reporting including the following key studies and reports:

A review of the contribution of reporting GHG emissions reductions and associated costs and benefits by PricewaterhouseCoopers (PwC) and the Carbon Disclosure Project (CDP), (PwC/CDP Report). The PwC/CDP Report was commissioned by Defra for its Review. To collect evidence PwC and CDP conducted a review of relevant literature and a business survey to which 155 companies responded. They also conducted three focus group sessions and telephone interviews with 32 companies.
Investors, Climate Risk and Company Disclosures, a Climate Disclosure Standards Board (CDSB) report (CDSB Report) which looked at the factors that motivate the use of companies' carbon emissions reports in portfolio management, information sources investors use and the processing difficulties that they experience with that data and investor attitudes to regulation and public policy requiring environmental data to be used to guide portfolio allocation levels. Defra reviewed a preliminary report as the final CDSB Report is due to be published in January 2011. The CDSB Report was commissioned by Defra, the CDP and Aarhus University.
GHG management and reporting, a special report by the Institute for Environmental Management and Assessment (IEMA), (IEMA Report).
Environmental Disclosures, the third major review of environmental reporting in the statutory annual reports and annual accounts of FTSE All-Share companies by the Environment Agency (EA), (EA Report).
Transition to a low-carbon economy: public goals and corporate practices, a report by the Organisation for Economic Co-operation and Development (OECD), (OECD Report).
Company GHG emission reporting - a study on methods and initiatives, by environmental consultants, Environmental Resources Management (ERM), for the European Commission, Directorate General Environment.

Defra also conducted an in-house review of academic journals and information from investor groups and climate change lobby groups (the literature review) to understand the demand for and use of GHG emissions disclosures by investors and whether this information influences investment decisions. A list of the sources that contributed to this review are provided in Annex B to the Review.

Main findings of the Review

The main findings of the Review are:

Businesses are considering their environmental impacts at the highest level; the EA Report indicates that 62% of FTSE All-Share companies reported quantified figures on climate change or energy use in their 2009 annual reports and 22% are disclosing absolute figures in their total GHG emissions, showing improved performance since 2004.
The content of GHG reports tend to be qualitative (that is, verbal) but there are increased drivers to report more quantitative (that is, numerical) information.
The OECD, EA and ERM Reports and the literature review all highlighted the need for consistent reporting standards.
The PwC/CDP, IEMA and ERM Reports found an indirect link between reporting and managing emissions. However, reporting in isolation was not enough to drive emissions reductions. In particular, the ERM Report describes GHG reporting as a "tool" in the GHG management cycle and noted that GHG reporting has an important link to target setting (which in turn leads to GHG emissions reductions).
Emissions reductions and behavioural change are achieved though the combined influence of drivers including measuring and reporting GHG emissions, awareness and action.
While investors have a "significant and growing" interest in GHG emissions data (which is one of the major drivers for GHG reporting), in the majority of cases they are still not using environmental information when making investment decisions. Investors use GHG emissions data in relation to sectors significantly affected by climate change or where trustees have specifically asked for this information.
Investors are looking for robust quantitative information. The key barriers to making further use of environmental information for investment analysis are:
- an incomplete spread of company reporting;
- company reports that cannot be easily compared; and
- short-term investment behaviour.
The CDP's dataset is one of the most widely used on climate change disclosure. However, the Review says that even though the response rate to the CDP is generally considered to be high, the CDP is not a panacea for investors. This is because not all companies respond to the CDP's survey and of those that do, not all make their disclosures public. In 2010, 31% of FTSE 350 companies failed to respond to the CDP survey and only 54% of FTSE 350 companies reported their GHG emissions in their annual corporate report. Of those that did respond to the 2010 CDP survey, only 50% made their disclosure public. The statistics for the UK compare unfavourably to those for CDP's 2010 global survey where 73% of respondents reported their GHG emissions in their annual corporate reports and 65% made their disclosures public. UK businesses appear to be lagging behind the rest of the world in providing transparent and comprehensive GHG reporting to investors.
The Review notes that notwithstanding the increasing number of companies who are disclosing climate information, disclosures are not providing the information required to allow investors to properly assess the financial implications of climate change on their investments. In particular, disclosures tend to be based on historical information and does not consistently include projected GHG emissions, potential physical impacts and cost implications associated with climate change. Further, generic disclosures of climate change information do not put the responses in the overall context of the business. One report that was reviewed (R Sullivan, Climate change disclosure standards and initiatives: have the added value for investors? (2006)), argues that the multitude of reporting initiatives has lowered the overall standard of disclosures because they cater to a wider audience and not just investors so they lose sight of the information that is really important for investors. There are moves to tackle these issues such as the CDSB's forthcoming framework for disclosures of climate change information in mainstream reports which includes a requirement for forward-looking information.
The CDSB study found that 60% of respondents to the survey they conducted were dissatisfied with the information sources available on company environmental data (including carbon emissions date). Similar results were obtained on completeness and reliability of companies' environmental data.
The Review notes that an issue that emerges from the various reports reviewed is the quality of disclosures that are made and says that it is clear that a single, consistent and robust source of this data would be preferred. The International Auditing and Assurance Standards Board (IAASB) are currently working on an international standard on assurance engagements (ISAE) on GHG statements which will provide a standard against which to verify GHG reporting (see IAASB: Background Papers for St. Julians - Malta Meeting, September 2010). The Review also says that the literature reviewed reveals a demand from investors for mandating reporting in order to improve the quality and coverage of disclosures to a level which voluntary reporting alone is unlikely to achieve.
The PwC/CDP Report found that it was difficult to isolate the impact of GHG reporting from other related activities, in particular, measuring emissions and that it was difficult to quantify the costs and benefits associated with GHG reporting. Companies that responded to PwC/CDP's survey indicated a range of costs for external reporting of £25,000-£400,000 and the costs quoted for measuring GHG emissions were slightly higher than this. The majority of companies surveyed experienced reporting costs of less than £75,000. The PwC/CDP report showed that, based on quantifiable costs and benefits, 60% of those companies that responded to PwC/CDP's survey found there is a net cost of reporting. However, 53% of companies that were interviewed by PwC/CDP believe there is a net benefit to GHG reporting and the interviews indicated that the financial cost of reporting were not considered to be a material cost to the relevant businesses.
Additional benefits of reporting that were identified but difficult to quantify were:
- reputation, brand value and being seen as a market leader; and
- improved investor relations and being able to respond to shareholder requests.
The Review does not give a clear recommendation in favour of mandatory reporting. The PwC/CDP Report summary, in Annex A to the Review, includes a short discussion of the advantages and disadvantages of mandatory and voluntary reporting. The key points are:
- There is yet to be research that could present robust evidence for or against mandatory reporting. Much of the evidence is anecdotal and the viewpoints are those of selected groups of companies or individuals.
- Although those in favour of mandatory reporting argue that it helps deliver more comparable and consistent information and avoids selective reporting of good performance, the literature reviewed by PwC/CDP argues that mandatory reporting rules would have to be appropriate for all organisations. This may mean that the lowest common denominator regarding scope and innovation would have to be used. This seems a rather weak argument: a similar one could be made in relation to accounting standards but this issue would appear to have been overcome in that context.
- The form, structure and coverage of a reporting scheme is key. Companies were concerned that GHG reporting is complicated because the various mandatory and voluntary reporting standards that they have to, or are encouraged to follow, are inconsistent. There was unanimous agreement for clearer guidance and standards on GHG reporting which could cater for the differences in sectors and not apply a rigid standard across all industries.
- The coverage of a reporting standard needs to factor in the relationship between company size and emissions. While small companies are usually low emitters, the relationship between the size of a company and its emissions is less clear for large companies. A requirement for large companies to report on GHG emissions could place a heavy reporting burden on large companies that have low emissions. This would be more likely to be a net cost rather than a net benefit to such companies.
- The distinction between voluntary and mandatory schemes is blurring as some schemes, such as the CDP, are becoming quasi-mandatory.

Comment

CBI

While supportive of GHG reporting, the Confederation of British Industry (CBI) consider that any move to mandatory reporting should consider the existing suite of climate change policy measures that require some form of emissions reporting and ensure that the regulatory burden of reporting was minimised by making sure the various measures were aligned.

Rhian Kelly, Head of Climate Change at CBI, said:

"The CBI strongly supports emissions reporting because it helps businesses cut carbon effectively and demonstrate their commitment to green growth to investors. Many companies already report their emissions under a number of mandatory schemes, including the EU Emissions Trading Scheme, the Carbon Reduction Commitment and Climate Change Agreements. As ministers consider whether to make carbon reporting mandatory, it is important that the Government takes the opportunity to simplify and align existing regulations, and ensure that any changes fit with international practices."

See CBI press release, CBI Comments on Government's Carbon reporting paper, 30 November 2010.

Deloitte

The Review's findings are more positive about the current state of GHG reporting in the UK than those of a study of the GHG/carbon footprint reporting of 100 UK listed companies by Deloitte, Carbon Reporting to date; seeing the wood for the trees also published in November 2010. That report found a high degree of variation in carbon reporting practices and concluded that many companies, particularly those outside the top tier of FTSE companies could do better. The Deloitte report also found that:

"only a handful of companies....came within striking distance of complying with all of Defra's recommendations".

The Deloitte report concluded that:

"the wide variety of both formal and informal carbon reporting practices identified does not facilitate comparison between companies or industry sectors, making it difficult to evaluate the relative performance of companies in monitoring and reducing their carbon footprint; a primary goal of the government in publishing the Defra guidance."

WWF

The World Wildlife Fund for Nature (WWF) has responded that:

"The published report in fact only highlights the progress of voluntary carbon reporting, and the benefits that can have for the companies themselves. Which is fine as far as it goes – but it doesn’t go nearly far enough. It’s a wasted opportunity – especially as a lot of businesses already support the idea of mandatory carbon reporting because it will provide clarity for them and for investors. But the government’s failure to spell out the benefits – from helping individual companies reduce emissions to creating new jobs and developing a green economy – and the lack of a clear timetable for change, means more uncertainty for businesses and investors… at least until 2011 and quite possibly into 2012 and beyond. "

See Carbon reporting – what’s the government waiting for?, WWF, 3 December 2010.

Defra publishes review on corporate reporting of emissions | Practical Law