Sep 26, 2024
This year has seen the rollout of some of the first climate statements required by the climate-related disclosures (CRD) regime under Part 7A of the Financial Markets Conduct Act 2013 (FMCA). Climate reporting entities (CREs) must produce their climate statements within four months of their balance dates (for managed investment scheme (MIS) managers the obligation applies to the balance dates of their qualifying registered schemes). The two public authorities in charge of the climate reporting regime are FMA and XRB.
Since the first climate statements have started coming out, the question of their usefulness has come to the fore. The FMA is clearly keen for these sorts of statements to be used, as in July 2024 it opened a consultation, which closed on 30 August 2024, on the topic of a proposed information sheet on references to climate statements in CREs’ disclosure documents. This consultation was concerned with what sorts of disclosures CREs should be required to make in the likes of a product disclosure statement (PDS), other material information (OMI), a statement of investment policies and objectives (SIPO), or an annual report. These disclosures are concerned with providing information on where related climate statements and climate-related investment policies can be located.
Previous to this consultation, FMA and XRB teamed up to produce conjointly a linked pair of documents in July 2024, namely Climate-related Disclosures Regime: What you need to know (CRD Regime), and Navigating climate statements Reader’s guide (Reader’s Guide). CRD Regime is quite high-level as an introductory document intended to be of benefit for “anyone interested in understanding the basics of the CRD regime, such as primary users of climate statements, and journalists and other intermediaries who use or communicate climate-related information” (CRD Regime, p. 2). Primary users are the true intended readership for climate statements and are defined within CRD Regime in relation to XRB’s Climate Standards as being “existing and potential investors, lenders and other creditors” (ibid.). In other words, entities with skin in the game if they lend to or invest in CREs.
In Section 3: About Climate Statements, CRD Regime devotes five pages to a potted summary which is a good place to start for those who do not feel especially knowledgeable on the subject. The section gives a concise description of what a climate statement is and, perhaps just as importantly, what it is not. CRD Regime advises readers to progress to Reader’s Guide if they “are interested in a more detailed explanation of the information disclosed in climate statements and what you can learn from it”. The two related documents form a hierarchy, with CRD Regime being basic entry level and Reader’s Guide more complex and instructive. Reader’s Guide reflects its audience in defining it as:
(Reader’s Guide, p. 3)
So why do primary users matter?
The message is clear across both FMA/XRB documents: CREs write climate statements for primary users as the end audience. Journalists and other interested parties may be nice to have mixed in with the crowd but are not critical participants. CRD Regime puts it this way:
In all cases, the [climate reporting] entity must think about how to apply the disclosure requirements to their own facts and circumstances, and how to provide that information in a way that it considers is useful for the decision making of its primary users …
CREs must also make materiality judgements as to what relevant and decision-useful information is provided to primary users in the context of the disclosures required …
All climate statements must be compliant with the Climate Standards and should enable primary users to assess the merits of how an entity is considering climate-related risks and climate-related opportunities, and then make decisions based on those assessments.
(CRD Regime, pp. 12-3)
Primary users make decisions about capital allocation that climate statements are intended to inform and influence. Depending on what its climate statements communicate to primary users, a CRE might expect to retain existing capital, attract more, or lose some or all of it. Obviously a lot rests on how primary users understand and interpret what climate statements communicate. Accordingly, FMA and XRB are concerned to ensure that primary users know how to use climate statements effectively in practice, which entails these regulators together achieving two essential outcomes:
In what follows, we will pick out some of the issues that primary users may need to confront in dealing with climate statements as described in Reader’s Guide. As a taste of things to come, Reader’s Guide includes a conspicuous disclaimer under the heading “Overarching considerations”:
Users must make their own judgements and assessments
This document contains some guidance and questions to consider when reading climate statements. However, each reader’s evaluations and judgements will depend on their individual profile, risk appetite and other relevant circumstances. The information in this document is intended to help readers understand the information disclosed in climate statements to assist with their own judgements.
(Reader’s Guide, p. 5)
Fair warning, then, that primary users may emerge not much the wiser from exposure to Reader’s Guide.
No further action required
Given the enormous compliance machinery that has been assembled for the climate statement production line, it might be expected that such statements would necessarily involve CREs actually committing to actions calculated to adapt, mitigate and transition towards a zero carbon economy operating within the preferred Paris Accord lower-range average global temperature increase. Not so it seems. There is an important difference between making a climate statement and doing anything in accordance with it. Reader’s Guide reveals that there is a distinction to be drawn between mandatory compliance with climate standards and non-mandatory action:
The Climate Standards require disclosure of what an entity is doing, but do not require an entity to take any actions that are consistent with a transition to a low-emissions, climate-resilient future. For example:
However, the Climate Standards do require an entity to disclose information and be fully transparent about its action or inaction in relation to its CR&Os and impacts on its activities or investments.
It may come as a surprise to primary users that climate statements do not need to commit CREs to any particular course of action or mode of incentivisation. If a CRE discloses that it does not intend to make any adjustments at all in the face of climate change, then that could be fully compliant with Climate Standards, which are simply concerned with regulating disclosure and not actions arising therefrom. Presumably primary users would then have to draw their own conclusions about capital allocation in the face of such non-action disclosure, but at least, according Reader’s Guide, these users would be better informed than before.
Fraught with fundamental uncertainty
Reader’s Guide emphasizes that climate statements contain uncertain information. This characteristic is due to the fact that, unlike financial statements which record historical information, climate statements are concerned with future predictions. According to Reader’s Guide:
Climate statements include disclosures about the future, which is inherently uncertain. For example, scenario analysis, CR&Os, and anticipated financial impacts. What matters is the entity’s approach to navigating this uncertainty.
As a topic, climate change is particularly complex and dynamic, with future outcomes that are very difficult to predict. There is significant uncertainty about the scale, speed and magnitude of the physical and transition climate-related impacts that may play out in the future.
The use of uncertain data, and reasonable estimates based upon them, is also an essential part of preparing climate statements.
(Ibid.)
Reader’s Guide then goes on to explain that climate statements must disclose methods and assumptions behind their projections. Primary users are cautioned that, “Information should never be taken at face value without assessing how it was obtained, and the underlying assumptions, methods and level of uncertainty” (Ibid.). In case these users missed that point, Reader’s Guide rounds out the discussion of uncertainty by stating that:
Just because something has a number attached to it does not necessarily make it more certain or insightful. Qualitative information can have the same degree of certainty and usefulness as quantitative information.
(Ibid.)
It is unclear what comfort primary users should receive from the stated equivalence of quantitative and qualitative information, as both could be equally uncertain. Moreover, the burden is placed upon primary users, including retail investors, to become experts, or to hire expertise, on how to analyse and test information provided in climate statements for its origin, assumptions, methods, and uncertainty before arriving at their own degree of certainty of its usefulness. Little is to be taken at face value from climate statements, according to Reader’s Guide, which raises the question of what is to be taken from them at all. Climate statements assume the appearance of being elaborate guessing games that provide limited value to primary users.
Non-comparability
Reader’s Guide announces that “Climate statements of similar entities are likely to be different” (Ibid., p. 7) and lists reasons why this might be so for the entities involved:
These reasons add another layer of complexity for primary users as they may not necessarily be able to draw the same conclusions for capital allocation purposes when comparing the different climate statements issued by like entities. There is no common yardstick to apply, it would seem. In particular, materiality judgements made by CREs could be expected to be influential on primary users, and yet the Reader’s Guide states:
An entity is only required to disclose what is material for its primary users. What is considered material for one entity may not be considered material by another, even in similar circumstances. This is a critical element of the Climate Standards.
(Ibid.)
Reader’s Guide clarifies in a footnote that “Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that primary users make on the basis of an entity’s climate-related disclosures” (Ibid.).
The ability for similar CREs to reach different materiality judgements in selecting what to disclose in their climate statements is likely to create difficulties for primary users when making capital allocation decisions. It is also peculiar that Reader’s Guide should speak of an entity only being required to disclose what is material for its primary users, as that presupposes that the entity already knows who its primary users are and what is material to them. CREs may not know who the primary users of their climate statements are. They would seem to be expected to second-guess whom they are addressing through their climate statements when deciding what is material for inclusion to the benefit of primary users.
Reader’s Guide elaborates further on the non-comparability theme under the section heading Care should be taken with comparisons. In some detail it sets out why it might not be reliable to compare climate statements issued by similar CREs:
Given the reasons listed above as to why climate statements of similar entities are likely to be different, comparing information between climate statements of different entities should be done with caution. In some circumstances, it may be more useful to compare information provided by an entity with information it disclosed in previous reporting periods.
Reading climate statements requires a different approach to reading a set of financial statements. Most of the disclosed information in financial statements is historic and quantitative. In comparison, most of the information in climate statements is in narrative form and includes future-looking information, some of it is based on uncertain data, and different methods can be used for calculations (such as for GHG emissions). This means that comparability across different entities, particularly at an individual disclosure level, can be limited. For example, many different choices can be made in the process of calculating GHG emissions, which can have a large cumulative effect on single figure metrics (such as what is presented as scope 1, 2 or 3 GHG emissions). However, you will still be able to make some high-level comparisons between entities.
(Ibid., p. 8)
The passage of time will not necessarily enhance the reliability of climate statement comparison, because such reliable comparison is an enduring structural problem rather than a learning curve to be undergone. Reader’s Guide opines:
As climate-related reporting matures, standard practices are established, and common disclosure approaches evolve, comparability of climate statements may become easier for users. However, due to the subject matter, comparability is always likely to be challenging.
(Ibid.)
The above conclusion in Reader’s Guide adds another layer of permanent uncertainty to the interpretation of climate statements by primary users and by extension limits the certainty upon which such users can base their capital allocations.
Are primary users any the wiser?
The examples above selected from Reader’s Guide point to multiple layers of permanent uncertainty affecting the information that climate statements are based upon and the interpretation of these documents by primary users. There is also a disconnect evident between CREs deciding what is material to disclose to their known primary users (if any) and the wider universe of primary users who may be unknown to CREs but still want to use their climate statements to make rational capital allocation decisions. A likely wide gap exists between the skills and resources available to local and international banks and institutional investors as climate statement readers, on the one hand, and retail investors, on the other hand. It seems improbable that retail investors will be able to undertake many of the activities recommended for primary users in Reader’s Guide, which begs the question as to whether retail investors can reasonably be considered to be primary users.
By Reader’s Guide’s own admission, the passage of time and development of experience under the CRD regime will not likely eliminate key uncertainties. Perhaps the regime at best will at least enable CREs and primary users to identify what they do not know better than before through the common nexus of climate statements. Reader’s Guide and its associated CRD Regime contribute to achieving that much. The first round of climate statements that have emerged so far vary widely in length from just a few pages to over 100, with most running to a page count somewhere in the middle, indicating the CREs themselves have very different interpretations of what climate statements should include. Primary users will likely need the two guidances to help make sense of them, or at least find somewhere to start in the process.
Conclusion
“FMA and XRB’s CRD Regime and Reader’s Guide are essential reading for climate statement users,” said Matthew Band, General Manager of Trustees Corporate Supervision at Trustees Executors.
“Primary users, being the intended audience of climate statements, will benefit from reading about the challenges, in some cases permanent, that interpretation of climate statements will pose to rational capital allocation decisions.”
“Non-primary users will also gain some insights, such as journalists who will need to write about climate statements in order to analyse and explain them to the wider public, although that could be a challenge given all the caveats raised around uncertainty and comparability the two guidances raise.”
“The FMA is the frontline regulator for climate statements with responsibility for ensuring that these documents come up to scratch, which could take several annual iterations of issuance to achieve.”
“Supervisors do not have a role to play in assisting CREs to prepare their climate statements or make them fit for purpose to primary users.”
“Our role is concerned with helping our supervised CRE clients to comply with the applicable requirements of Part 7A of the FMCA.”
“It is going to be interesting to see how the first round of climate statements is received by primary users, supposing information about that comes to hand.”
“A survey of the reactions of primary users – including retail investors – to the usefulness for capital allocation purposes of these climate statements may prove enlightening.”
“Feedback from primary users to CREs about the value received from climate statements may help improve how the disclosure regime works out over time.”
“Possibly simple tools such as checklists or tables could be developed to assist retail investors with assessing and differentiating between climate statements so that these documents can be genuinely useful to the widest range of potential primary users.”
For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matthew Band at [email protected].