Guest blog: ESG: cutting through the cacophony

First published in Society Matters, by Richard Small, Partner, Addleshaw Goddard LLP

First published in Society Matters, by Richard Small, Partner, Addleshaw Goddard LLP

Since the onset of the pandemic there has been a seemingly endless tsunami of ESG developments. But how to cut through the ESG cacophony? And what truly matters?

This article sets out eight key requirements and expectations currently relevant to building societies. A few of these are new but many are existing requirements that need to be re-evaluated in the context of ESG.

The eight key ESG considerations

First, building societies, as PRA regulated firms, are required to have a nominated senior manager responsible for identifying and managing the financial risks from climate change. The PRA expectations in relation to managing financial risks for climate change is set out in Supervisory Statement 3/19 and should have been met by the end of 2021.

Second, all PRA-regulated firms are required to develop and maintain an appropriate approach to the disclosure of climate-related financial risks. Firms can disclose material risks within their Pillar 3 disclosure as required under the UK Capital Requirements Regulation but may choose to disclose climate risks through a combination of audited financial statements, the annual report and Pillar 3 disclosures. The PRA has made it clear that "firms will be required to disclose material climate-related financial risks from the end of 2021."

Third, ESG-related claims by building societies must be clear, fair and not misleading so that consumers can make informed choices.

Fourth, under the PRA's General Organisational Requirements Part 2.1, building societies must have robust governance arrangements in place to identify, manage, monitor and report the risks it is or might be exposed to - this includes climate-related financial risks.

Fifth, under the PRA's Internal Capital Adequacy Assessment, firms are required to carry out scenario analysis, stress testing and capital planning to inform strategy setting, risk assessment and risk identification. These should now include ESG factors.

Sixth, under PRA Fundamental Rules 5 and 6 building societies must have effective risk strategies and risk management systems in place and organise and control their affairs responsibly and effectively. Whilst these rules are general in nature, they should now take into consideration ESG related scenarios.

Seventh, as both the government and the PRA have made it clear that the risk of climate-related losses could erode confidence in an institution or the financial system - building societies will be expected to take action to reduce the potential for physical and transition risks associated with climate change.

Eighth, some building societies are already publishing ESG policies disclosing practical matters relating to the environment including energy use, paper use, waste reduction and disposal, using electric vehicles, promoting sustainability, environmental awareness and engagements across employees, members suppliers and contractors. Building societies should be monitoring such developments to make sure that they are meeting their customers' expectations.

Looking forwards

In November 2020, the Department for Business, Energy & Industrial Strategy published a consultation on Improving home energy performance through lenders which suggested that lenders should meet a voluntary target portfolio average of EPC Band C by 2030. A policy statement is expected shortly.

Finally, on 6th April 2022, the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2021 will come into force. The regulations expand s414CB of the Companies Act 2006 to include "climate-related financial disclosures". This will be of relevance to those building societies who disclose against s414CB in their annual reports.

The views, opinions and positions expressed within guest blogs are those of the authors and do not necessarily represent those of the BSA.