Ashurst Governance and Compliance Update Issue 17

1. EU Corporate Sustainability Due Diligence Directive: What will it mean for UK companies?

On 23 February, the European Commission adopted a proposal for a directive on corporate sustainability due diligence. Under the directive, 'in scope' companies would be required to:

• undertake due diligence across their value chains to identify the adverse impacts of their business;
• implement processes to mitigate those impacts;
• integrate sustainability and human rights considerations into their corporate governance and management systems. 

Before coming into force, the proposed directive will likely be amended through the EU legislative process and will need to be approved by the EU Parliment, which could potentially alter its scope. However, the introduction of mandatory supply chain diligence will require a significant change in behaviour for most in scope companies and the draft directive offers a good indication of steps that companies will be required to take in preparation. The intention is for these obligations to apply to relevant companies within two years of the directive entering into force, and for smaller companies in certain high-risk sectors within four years.

While the impact of this legislation is a few years away, it takes time to design and implement effective human rights and environmental due diligence processes, particularly in large international companies and companies with long or complex value chains. As such, we would encourage companies with a presence in the EU to consider if they are likely to fall within the scope of the directive and, if so, start preparing for the actions they are likely to have to take. For more detail, read our in-depth analysis here.

For those interested in the impact of the proposed directive on EU companies, please read Draft EU Directive on sustainability-related Due Diligence Obligations of Companies published by our Frankfurt-based Head of Corporate Governance, Florian Drinhausen, and Astrid Keinath.

2. FRC publishes briefing on Corporate Purpose and ESG

The Financial Reporting Council has published a briefing on 'Corporate Purpose and ESG' by way of a follow-up to its report on Creating Positive Culture – Opportunities and Challenges, published in December 2021, which we covered in Ashurst Governance & Compliance update, Issue 10.

The briefing draws attention to some of the key observations, best practice and examples of application identified in research conducted on the subject on the FRC's behalf.

The FRC's key observations regarding corporate purpose include:

• Purpose acts as an anchor and grounds business in times of volatility and uncertainty - it serves as a 'moral compass' and acts a navigational guide to ethical decision-making.
• Purpose unifies and drives delivery of strategic objectives and business performance using ethical conduct, culture and values as key enablers.
• Purpose requires activation and embedding across the value chain of a business through leadership action.
• Purpose requires higher levels of disclosure and transparency in reporting by setting the context and joining up across the organisation.

The FRC's key observations regarding ESG include:

• Culture, purpose and values are at the centre of workforce-related issues.
• If aligned with strategy and embedded across an organisation, ESG can help to strengthen the resilience and boost the competitiveness of a business as well as its access to capital.
• Focusing on those ESG issues that have the greatest impact on a company and their stakeholders will lead to more insightful reporting.
• Disclosure of ESG related risks and opportunities, as well as measurable targets and outcomes, lead to greater board accountability and helps investors to make informed decisions.

3. ISSB publishes exposure drafts of IFRS Sustainability Disclosure Standards

The International Sustainability Standards Board, which was established at COP 26 to develop a comprehensive global baseline of sustainability disclosures for the capital markets, has published a consultation on its first two proposed standards:

• IFRS S1 sets out general sustainability-related financial disclosure requirements. This standard would require disclosure of material information about all significant sustainability-related risks and opportunities to which a company is exposed. The disclosure would be made as a part of a company's general purpose financial reporting, meaning that the sustainability-related financial disclosures would be published at the same time as the financial statements; and
• IFRS S2 sets out climate-related disclosure requirements. This standard would require the provision material information about a company's significant climate-related risks and opportunities. It incorporates and adds to the recommendations of the Task Force on Climate-related Financial Disclosures.

Both standards are founded on the TCFD 'four pillar' methodology and, as such, would require a company to focus its disclosure on the governance, strategy, risk management, and metrics and targets it uses to measure, monitor and manage its significant sustainability or climate-related risks and opportunities.

The consultation on the drafts closes on 29 July 2022. The ISSB is seeking to issue the new standards in final form by the end of the year. It will be up to individual jurisdictions to decide whether and when companies will be required to comply with the final standards.

In the same area, Deloitte has published its observations on TCFD disclosures from the first 30 annual reports published by UK-premium listed companies with 31 December 2021 year-ends – i.e. those companies obliged to make such disclosures for the first time in accordance with the FCA's Listing Rules.

Key observations were that:

• 90 per cent of companies disclosed a clearly identified compliance statement in their annual report.
• All companies indicated consistency with TCFD with respect to their Governance and Risk Management disclosures, in line with the FCA’s expectations.

Of the 21 companies presenting their TCFD disclosures wholly in their annual report:

• 62 per cent stated that they have performed quantitative scenario analysis.
• 62 per cent stated that they had obtained independent external assurance over some or all metrics disclosed; all these companies gained assurance over at least Scope 1 and 2 emissions, with 52 per cent also having obtained assurance over Scope 3 emissions.
• All but one company disclosed a carbon reduction target, with the majority of these companies describing their target as 'net zero' or 'carbon neutral'.

4. ESMA publishes updated Q&A on ESG-linked APMs

The European Securities and Markets Authority has published an updated version of its Q&A document which deals with the use of alternative performance measures: this now includes two new questions on ESG-linked APMs.

By way of reminder, an APM is a measure of a company’s financial performance or position that is not defined by a financial reporting framework. The purpose of the Q&A document is to promote 'common supervisory approaches and practices' when applying ESMA's 2015 Guidelines on APMs, which itself seeks to promote the usefulness and transparency of APMs included in regulated information such as prospectuses and annual financial reports. The FRC has stated that it regards the Guidelines to be a codification of best practice and expects companies to follow it, notwithstanding the UK's withdrawal from the EU.

Specifically, the new Q&A:

• Confirm that the Guidelines do apply to ESG matters (e.g. green turnover; sustainable CAPEX), unless they are determined in accordance with EU legislation, e.g. the Taxonomy Regulation or the Sustainable Finance Disclosure Regulation (new Question 19).
• ESMA calls on issuers to use caution when presenting APMs using ESG labels as these may be misperceived by users as compliant with the Taxonomy Regulation or SFDR. Accordingly, ESMA recommends that issuers should be clear about whether a specific ESG financial measure is determined in accordance with the Taxonomy Regulation or SFDR (new Question 20).

5. BEIS publishes statutory review of payment practices

The Department for Business, Energy and Industrial Strategy has published a statutory review of reporting in accordance with the Payment Practices and Performance Regulations 2017 (Regulations).

By way of reminder, UK companies and LLPs considered to be 'large' for accounting purposes are required to report on their payment practices, policies and performance every six months in relation to contracts for goods, services or intangible property which have a sufficient connection to the UK. Reports produced must be submit to a central website. The policy objectives of the reporting requirement are twofold: first, to increase transparency and public scrutiny of large businesses’ payment practices and performance and, second, to give suppliers better information to make informed decisions about who to trade with, negotiate fairer terms, and challenge late payments.

BEIS has concluded that:

• The Regulations, along with the Prompt Payment Code (which sets standards and best practice in payment culture and the role of the Small Business Commissioner to hold non-compliant businesses to account) have driven improvements in payment practices.
• There is more to be done to increase awareness of the operation of the Regulations, not only to ensure that qualifying businesses are reporting their data, but also to ensure that it is better publicised and utilised by suppliers to determine whether to enter into contracts.
• It will undertake further consultation on the Regulations to decide whether to amend their expiry date beyond 6 April 2024 and also review the reporting guidance accordingly.
• As part of that further consultation it will take into account feedback received in response to its White Paper on 'Restoring trust in audit and corporate governance' as part of which it invited views on whether companies should be required to include a summary of their payment practices in their annual reports.

6. FRC publishes 3-Year Plan

The Financial Reporting Council has published a Three-Year Plan in which it sets out the FRC’s progress towards establishing the new Audit, Reporting and Governance Authority.

The Plan considers how, and when, the FRC will need to increase its capacity to adapt to its likely new powers and responsibilities. The Plan comprises a detailed breakdown of the FRC’s intended expenditure for 2022-23, alongside a summary of expected costs and headcount for the following two years.

7. FRC publishes new Audit Firm Governance Code

The Financial Reporting Council has published a revised Audit Firm Governance Code for the Big Four audit firms and firms that audit FTSE-350 companies and significant numbers of public interest entities or 'PIEs'.

The Code has been produced as a result of the findings of a monitoring programme undertaken by the FRC which identified scope to strengthen further its oversight and governance and to align the provisions of the Code with the operational separation of the Big Four firms.

The FRC has also announced a plan to take responsibility for the registration of auditors of PIEs from the relevant recognised supervisory bodies in order to enable it to 'become increasingly assertive in holding audit firms to account for the delivery of high-quality audits'.