In this month’s ESG Market Alert, we cover:

• The EU Commission’s proposal for a directive on ESG-related due diligence obligations for EU and non-EU companies;
• A high level summary of the key ESG disclosure and reporting requirements for large/listed companies in England & Wales;
• What’s new in market practice: The Chancery Lane Project publishes a set of model climate clauses for use in commercial contracts and transactions; and
• Kicking off our 2022 corporate governance webinars with “ESG 101”.

The EU Commission published its proposal for a directive on ESG-related due diligence obligations for EU and non-EU companies

On 23 February 2022, the European Commission released its proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence (the "Proposed Directive"). This proposal lays down due diligence obligations for EU and non-EU companies, which extend to cover the business operations conducted by their subsidiaries as well as along their value chain. The Proposed Directive also includes provisions under which corporate liability may be incurred in the case of violations of such obligations.

The Proposed Directive provides that new due diligence rules will apply to the following EU and non-EU companies:

• Companies incorporated in a Member State which either have more than:
  • 500 employees and a net turnover in excess of EUR 150 million generated worldwide (“Group 1”); or
  • 250 employees and a net turnover in excess of EUR 40 million generated worldwide, if at least 50% of their net turnover is generated in a high-risk sector, such as the textile, food, and mining industries ( “Group 2”).

• Third-country companies active in the EU which:
  • generate a net turnover in excess of EUR 150 million in the EU (“Group 1”); or
  • generate a net turnover in excess of EUR 40 million in the EU, if at least 50% of their net worldwide turnover is generated in the above-mentioned high-risk sectors (“Group 2”).

The Proposed Directive provides that companies must:

• integrate due diligence into their corporate policies and have in place a due diligence policy that is to be updated annually;
• identify actual or potential adverse human rights and environmental impacts arising in the operations carried out throughout the entire value chain. Group 2 companies are only required to identify actual and potential severe adverse impacts relevant to their respective sector;
• prevent and mitigate potential adverse impacts, end or minimise actual adverse impacts;
• establish and maintain a complaint procedure;
• monitor the effectiveness of their due diligence policy and measures, with periodic assessments conducted at least every 12 months and whenever it is reasonable to believe that significant new risks of adverse impacts may arise; and
• publicly communicate on due diligence.

In addition, Group 1 companies are required to adopt a plan to “ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5°C in line with the Paris Agreement”.

Our full article on the proposed directive and the mandatory human rights and environmental due diligence obligations can be found here.

High level summary of the key ESG disclosure and reporting requirements for large/listed companies in England & Wales

Current disclosure and reporting requirements

Large companies (i.e. over £36 million turnover, £18 million balance sheet total, over 250 employees)

• Section 172(1) statement – requires a statement by the directors in their strategic report setting out how they discharged their duty to promote the success of the company for the benefit of shareholders. ESG elements to consider include setting out likely long-term consequences of decisions and the impact of the company’s operations on the community and environment.

• Streamlined Energy and Carbon Reporting (SECR) – requires additional disclosures in relation to emissions, energy consumption and efficiency for financial years commencing on, or after, 1 April 2019.

• Payment practices reporting – requires additional disclosures with respect to payment practices and performance of certain qualifying contracts (i.e. contracts between two (or more) businesses, if sufficiently linked to the UK for goods, services or intangible property and not for financial services). The primary purpose of these disclosures is to ensure transparency in the payment of suppliers and the timeliness of payments to small businesses in particular, which can be adversely affected by payment issues when dealing with larger companies in a supply chain due to their dominant position.

• Employee engagement statements (applies to companies with over 250 UK employees) – requires the directors report to include a statement summarising how the director's have engaged with employees and taken account of their interests during the course of the financial year.

• Statement of corporate governance arrangements (applies to companies with over 2,000 employees globally or over £200 million turnover or balance sheet total over £2 billion) – requires the directors’ report to disclose the corporate governance arrangements in relation to financial years beginning on, or after, 1 January 2019. This includes the corporate governance code (if any) applied during the financial year, an explanation of how the company applied the corporate governance code and the reasons for any departures from it. Private companies might choose to follow the “Wates Corporate Governance Principles for Large Private Companies”, which is a non-prescriptive corporate governance framework that provides companies with the flexibility of explaining how their corporate governance arrangements are applicable and relevant to their individual circumstances. Companies can also choose to apply other codes, including the UK Corporate Governance Code and the QCA Corporate Governance Code.

• Gender pay gap reporting (applies to companies with over 250 UK employees) – requires companies to report annually on their gender pay gap (i.e. the average (mean or median) earnings of men and women across the workforce) on a specified ‘snapshot date’.

• Modern slavery statement (applies to companies with over £36 million turnover) – requires the publication of an annual modern slavery and human trafficking statement setting out actions taken to ensure businesses and supply chains are slavery free or a statement that no steps have been taken.

Additional disclosure and reporting requirements for listed companies

• UK Corporate Governance Code (the “Code”) (applies to all companies with a premium listing) – reporting requirements include (among others):
  • a description of the company’s diversity policy;
  • a description of what engagement has taken place with the workforce to explain how executive remuneration aligns with wider company pay policy;
  • an explanation by the remuneration committee of the strategic rationale for executive directors' renumeration polices, structures and any performance metrics; and
  • confirmation in the annual report of the robust assessment of principal risks and emerging risks and a description of how those risks are being managed or mitigated, which in reality will need to take account of ESG implications.

• Listing Rule 9.8.6(8) (applies to all companies with a premium or standard listing) – requires premium and standard listed companies to publish, comply or explain disclosures in their annual reports in relation to the recommendations by the Task Force on Climate-related Financial Disclosures (“TCFD”). Broadly, the following disclosures are required under the recommendations by the TCFD:
  • the governance arrangements around climate-related risks and opportunities;
  • the impact of climate-related risks and opportunities on an organisation’s business, strategy and financial planning;
  • the principal climate-related risks and opportunities and how they are identified, assessed and managed; and
  • the organisation’s metrics and targets to assess and manage climate-related risks and realise climate-related opportunities.

• Disclosure Guidance and Transparency Rules (“DTRs”) (applies to all companies with a premium or standard listing) – the DTRs set out further rules, time frames and requirements on issuers in relation to annual financial reports, half-yearly financial reports and (in the case of issuers in the logging industry) reports on payments to governments.

Additional disclosure and reporting requirements for asset managers, insurers and FCA regulated pension providers

• Environmental, Social and Governance sourcebook in the FCA Handbook – applies TCFD disclosure requirements to asset managers, insurers and FCA regulated pension providers.

• The MIFIDPRU Remuneration Code (SYSC 19G) – the MIFIDPRU Remuneration Code sets out the minimum requirements with which MIFIDPRU investment firms must comply in relation to performance periods starting on or after 1 January 2022.

Upcoming additional requirements

• Compulsory TCFD-related Financial Disclosures – these regulations come into force on 6 April 2022 and apply to any Public Interest Entities, or other UK companies or LLPs with over 600 employees and a turnover of more than £500 million. All in-scope entities will have to make the disclosures required under the recommendations of the TCFD.

• UK Net Zero 2050 target – in 2019, the UK committed Net Zero 2050 to law in its amendment to the Climate Change Act 2008. The target will require the UK to bring all greenhouse gas emissions to net zero by 2050. Companies are expected to report on their own contribution (where they have committed) and progress to net zero.

• The Environment Act 2021 – the Environment Act 2021 is in force and forms part of the legal framework for environmental protection to ensure greater resilience, traceability and sustainability are built into the UK legal framework, particularly in relation to supply chains. Additional regulations will apply the Act to businesses with turnover above a yet to be specified threshold (drafts of which are expected by October 2022). These will introduce further due diligence requirements from businesses, and make it illegal for UK businesses to use key commodities if they have not been produced in compliance with laws protecting forests and other natural ecosystems.

What’s new in market practice?

The Chancery Lane Project (the “TCLP”) has, through a collaborative effort with organisations in the legal sector, including Hogan Lovells, developed 71 model clauses dealing with climate change/carbon-related issues across different practice areas. Each model clause aims to tackle a specific climate change issue and can be incorporated into commercial contracts and transaction documents. These can be found on TCLP’s website or viewed all in one place in their “playbook”.

[View source.]