FRC guidance on ESG reporting

On Friday 31 March, the FRC released a joint statement with the FCA welcoming the updated Green Finance Strategy and recognition of their role in respect of climate and environmental objectives. This comes as the FRC has expanded on their outlook in respect of ESG for 2023. The FRC has also published a 2023 Environmental Social and Governance Update, which builds on their 2021 Statement of Intent identifying challenges to the production, audit and assurance, distribution, consumption, supervision and regulation of ESG information.

We identify here some of the key guidance for the accountancy sector produced over the last year and further developments expected from the FRC following their ESG update. It is clear from the FRC's continued proactive engagement in this area that this will be an important area of focus for the FRC, and those responsible for preparing and reviewing financial statements should expect ESG reporting and TCFD disclosures to be closely scrutinised.

Helpful ESG guidance from 2022

In the last year, the FRC has progressed several projects, as reported in the Updated Statement of Intent, and produced a number of guides, best practice examples and thematic reports in respect of ESG reporting and disclosure. The FRC's Annual Enforcement Review of July 2022 also focussed on climate risk as an area of interest for the enforcement team, in particular: 

• (i) understanding the impact on financial statements of the judgements made by management in relation to environmental issues
• (ii) the ISA 720 risk (considering whether there are any material inconsistencies between the financial statements and the other information or the auditor’s knowledge obtained in the audit)
• (iii) the ISA 250 risk (considering whether the company has complied with environmental legislation).

The FRC's thematic review considered the disclosures of 25 large companies impacted by climate change and required to make TCFD disclosures in line with the FCA Listing Rule. Although the FRC noted significant improvements to the TCFD disclosures and climate reporting in the entities' financial statements, they also found that:

• Greater granularity was needed regarding the effect of climate change on the business sectors and geographies.
• The discussion of climate risks and opportunities needed to be more balanced and linked to other risk management and governance processes.
• The reasoning behind the decision to disclose climate-related information should be explained.
• The links between the effects of climate-related targets, commitments and other environmental scenarios and the impact on the valuation of assets and liabilities and narrative reporting should be made clear.

In respect of the accounts work regarding climate change reporting, the FRC have previously noted that: 

• The quality of support, training and resources provided to audit practice varied considerably across firms.

• Firms needed to do more to ensure their internal quality monitoring had appropriate regard for climate change considerations.
• Auditors needed to improve the consideration of climate-related risks at the planning and execution stages of the audit.
• Approaches to climate change differed in substance and granularity regarding references to climate-related reporting and the impacts of climate change.

Appendix 2 of the Thematic Review of TCFD disclosures outlines further the FRC's expectations across listing rule requirements, TCFD recommendations, narrative reporting, and financial statements for climate change and ESG reporting. This may be helpful guidance to teams going forward. 

The FRC note on "What makes a good annual report and accounts" also contains several suggestions for companies to improve climate-related reporting, which focuses on the quality of narrative statements and materiality assessment.

• Quality of data - The FRC encourages companies to disclose the sources of significant facts and claims made in the narrative reporting, where they are important to a user’s understanding. The FRC noted that, particularly in respect of ESG reporting, the quality of data is increasingly important, and that companies should:
  develop effective information systems to collect relevant and complete data
  introduce robust internal controls to maintain data and protect its integrity
  apply an accounting system that enables data to be retrieved and reported fully and faithfully.

Consideration should be given to both the effectiveness of the controls and the level of assurance required over such information to ensure the accuracy of the statements.

• Materiality - Climate-related disclosures according to the TCFD framework are subject to considerations of materiality. The FRC encourages companies to disclose the basis on which they have assessed the materiality of climate-related disclosures in order for the reader to properly consider the basis of the inclusion or omission of information.

Developments throughout 2023

Building on the guidance produced last year, the FRC has announced that in 2023, their areas of focus will include:

• IAASB and IESBA standard setting - The FRC will continue projects with the International Audit and Assurance Standards Board (IAASB) and International Ethics Standards Board for accountants (IESBA) to develop international ethical, independence and assurance standards consistent with ESG reporting and assurance.

• Another TCFD thematic review – the FRC will conduct a further thematic report which will include disclosures and climate reporting as part of its work to develop a framework for developing and reporting climate change. As part of this review, the FRC will also consider how adequately these companies’ address net zero commitments in their financial statements.

• An AQR focus on climate-related risk.

• Updated guidance for FRS 102 preparers - which will focus on the ESG matters that affect a company's financial position and the risks.
  

• Strategic report and materiality disclosures – the FRC will produce further guidance on the strategic report (in addition to their 2022 ESG updates) and are currently reviewing materiality to consider "enhancements to the materiality process" and the factors contributing to climate-related disclosures.