The FRC’s climate review and the responsibilities of auditors and the companies they audit

• United Kingdom

• Financial services disputes and investigations
• Litigation and dispute management
• Financial services

13-05-2020

On 7 May 2020 the FRC published a statement announcing that, following a temporary hiatus in some supervisory activity owing to the COVID-19 pandemic, its Audit Quality Review, Corporate Reporting and Professional Oversight teams would resume their full programme of supervisory work from 11 May 2020.  This is a clear signal to firms, auditors and professional bodies that as of now the FRC is maintaining business-as-usual.

This means that the FRC can be expected to continue its major review, first announced on 20 February 2020, of how companies and auditors assess and report on the impact of climate change.  The FRC’s review will consider how the quality of information can be improved to support informed decision-making by both investors and other stakeholders. 

To reflect the fact that climate change issues permeate the business landscape, the FRC will review a cross-sector sample of company reports and accounts to assess the quality of compliance with reporting requirements.  In undertaking the review, the FRC will evaluate:

1.    the quality of disclosures under the UK Corporate Governance Code regarding risk and long-term viability; and

2.    the adoption of reporting in line with the Task Force on Climate-related Financial Disclosures (TCFD) framework, which recommends disclosures across four key thematic areas: governance; strategy; risk management; and metrics and targets.  Although reporting in line with this framework is not currently compulsory, last year the FRC Financial Reporting Lab recommended that companies use this framework to report on climate-related issues.  Under its Green Finance Strategy, the UK Government expects all listed companies and large asset owners to disclose in line with the TCFD recommendations by 2022.  Further, on 6 March 2020, the FCA published proposals which will require all premium listed issuers to comply with the TCFD framework or explain why not.  The FCA’s consultation period has been extended to 1 October 2020, to allow firms to focus on supporting consumers through COVID-19.

The FRC will also review a sample of audits to assess whether auditors are ensuring that the impact of climate change risks are appropriately reflected in company reports and financial statements; focussing particularly on how auditors challenge management on climate change impacts.  In a subsequent podcast published on 13 March 2020, the FRC explained that auditors  need to undertake a detailed risk assessment of audited entities to consider how their business models and underlying assumptions are affected by climate change.  This  requires auditors to consider both direct impact of climate change such as flood risk, and also indirect impact such as legislation and changes in consumer behaviour.  Many of these issues require complex judgements, and accordingly the FRC’s review will also assess the resources and training available within audit firms to support such impact evaluations.

The FRC has stated an intention to publish its findings in the Autumn, in advance of the 2020 United Nations Climate Change Conference.  This was scheduled to commence on 9 November 2020 but has presently been postponed.

Finally, in its February announcement, the FRC stated that it would be considering how investors are addressing the climate challenge in the stewardship of their investments and in their response to systemic and market risks when it monitors the first reports under the UK Stewardship Code.  The new code came into effect on 1 January 2020 and requires signatories to take environmental, social and governance matters, including climate change, into account in investment decisions.  The first reports will be issued from 2021.

The FRC clearly considers that historically auditors have not paid enough attention to climate change risk and it is essential that this risk is fully considered at the planning stage of audits to ensure it is addressed appropriately. With the Brydon Report also considering issues relating to climate change risk and the impact on financial reporting, climate change is set to remain a key area of focus in respect of auditors and the companies they audit.

Useful links

FRC statement: Covid-19 Update 7 May 2020  

FRC statement: FRC assesses company and auditor responses to climate change

The UK Corporate Governance Code July 2018

Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures

FRC Financial Reporting Lab: Climate-related corporate reporting October 2019

Green Finance Strategy

UK Stewardship Code

FCA Consultation Paper (CP20/3): Proposals to enhance climate-related disclosures by listed issuers and clarification of existing disclosure obligations.

Brydon Report