Comply or explain why

Tough new mandatory reporting requirements on greenhouse gas emissions put the onus on companies to compile accurate data for the authorities, says Malcolm Dowden.

New regulations (Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013) require UK quoted companies to report on the greenhouse gas emissions for which they are responsible worldwide. The regulations are retrospective, applying to any company financial year ending on or after 30 September 2013. Consequently, many companies will have to report on emissions dating back to the beginning of their current financial year, some extending back to October 2012.
The regulations apply to companies incorporated in the UK, and whose equity share capital is listed on the main market of the London Stock Exchange, or listed in a European Economic Area State, or admitted for dealing on either the New York Stock Exchange or NASDAQ.
Companies must report annual emissions in tonnes of carbon dioxide equivalent from activities for which they are responsible, including the: combustion of fuel; operation of any facility; and purchase of electricity, heat, steam or cooling by the company for their own use.
The obligations relate to all six Kyoto gases. To arrive at a carbon dioxide equivalent figure, the company must apply conversion factors to gases other than carbon. The company must explain the methodology it uses to arrive at its reporting figures, and must use at least one “intensity ratio” to give a clear indication of how the level of emissions relates to the scale and diversity of its operations.
The underpinning principle is “comply or explain”. A company must explain any significant gaps in its report, justifying estimates and highlighting difficulties in obtaining, analysing or presenting reliable data.
Quoted companies must produce both a strategic report and a directors’ report. Emissions reporting is part of the directors’ report. However, it may also be necessary to reflect “material” greenhouse gas emissions within the strategic report. The test is whether information would explain the company’s environmental impacts “to the extent necessary for an understanding of the development, performance or position of the company’s business”.
The strategic report should allow potential investors to make properly informed decisions. Investor scrutiny also explains the requirement to publish successive years’ data against a company’s base year. For existing quoted companies, the base year is the financial year ending on or after 30 September 2013. For newly floated companies, it will be the year of flotation. The objective is to allow investors to understand both current emissions and the effectiveness of any management or reduction measures implemented over time. Equally, if a company’s emissions increase sharply then potential investors’ concerns might be soothed if the increase demonstrably stems from the acquisition or commencement of new business or project, rather than from poorly managed operations or ageing plant and equipment.
Each company must determine its own organisational boundaries for reporting purposes. A company must explain any decision to report in a way that:
•    omits emissions from operations covered by its consolidated financial statement;
•    extends to emissions not included within that statement.
The regulations’ global reach means that companies cannot exclude operations in other, possibly poorly regulated, countries. Given the “comply or explain” rationale, any exclusion of significant sources of emissions must be explained.
The regulations restrict a company’s ability to manipulate data by departing from its financial year, for example by imposing a commencement date for reporting that falls shortly after an emissions-intensive operation has ceased. If a period other than the company’s financial year is chosen, the majority of the emissions reporting year must still fall within the financial year.
Companies must decide for themselves whether specific emissions are within their control. Government guidance recommends a distinction between finance or capital leases, and operating leases. Under a finance or capital lease (for example, for major plant and equipment), the lessee has the risks and rewards and should report emissions associated with it. Under an operating lease (for instance, of commercial premises) the risks and rewards of ownership remain with the lessor. In that case, the lessee should be responsible for reporting emissions only if it uses the “operational control” approach to its reporting boundary.
In the case of commercial real estate:
•    If both landlord and tenant are quoted companies, then it is essential to decide which of them is responsible for reporting in respect of a building. The regulations seek to ensure that emissions are accurately captured, not double counted
•    If the landlord is a quoted company, but the tenant is not, then the landlord would have to explain any decision to exclude emissions from its report
•    If the tenant is a quoted company, but its landlord is not, then the tenant would have to explain any such decision.
Companies must also consider the relationship with other compliance-based regimes. For example, compliance with the CRC Energy Efficiency Scheme goes only part of the way towards compliance with the new regulations. CRC is concerned only with carbon emissions within the UK associated with energy consumption. The new regulations catch a far wider range of activities (including generation) and have global reach. They also require reporting on all six Kyoto gases rather than just carbon dioxide. Consequently, existing compliance measures may contribute towards, but cannot fulfil, the new obligations.
Enforcement is always a key feature of a regulatory regime, and there are a range of offences and sanctions. However, there is a steep learning curve and the Financial Reporting Conduct Committee has made it clear that it intends initially to work with companies to promote compliance rather than going directly to court and sanctions. Once the system has bedded in, though, the prospect of enforcement remains.

Malcolm Dowden, consultant at Charles Russell LLP