ESG Updates – The Bank of England Climate Biennial Exploratory Scenario

The Bank of England (BoE) has published the results of the Climate Biennial Exploratory Scenario (CBES), which explores the financial risks posed by climate change for the largest banks and insurers operating in the UK. In line with the findings of other central bank stress tests across the globe, the CBES found that while the financial system might be adequately capitalised to absorb the shocks of climate change scenarios, the sector would suffer losses across each scenario, with the greatest quantifiable losses suffered in a No Action and Late Action scenario. This reaffirms the BoE’s drive to an early and orderly transition to a net-zero economy.

  • In June 2021 the BoE launched the CBES, seeking to explore and better understand the financial risks posed by climate change to the UK financial system, and to ensure that real change is effected to help with systemic resilience.
  • Following the submission of participants’ initial responses in October 2021, we looked at the CBES in the context of other central bank initiatives and stress tests across the globe, to understand the scope of the CBES as part of our November 2021 Global Banking Review, which focussed heavily on the issues facing financial institutions in connection with Climate Change.
  • Just over six months later the BoE has published the results of the CBES, and we consider here what it has learnt, where will the focus fall, and what will come next?

Summary of key findings – Banks

The climate risks captured in the CBES scenarios are likely to create a drag on the profitability of both UK banks and insurers. Loss projections varied across participating firms and the three different climate scenarios but equated to an annual drag on profits of around 10-15% on average. Projections suggested (unsurprisingly) that the overall costs will be lowest in scenarios with early, well-managed actions to transition to a net-zero economy.

However, the CBES found that there was substantial uncertainty as to the magnitude of climate risks. The figures identified in the BoE report were heavily caveated to allow for various acknowledged limitations, with this, its first CBES, including:

  • The banks’ projections were focused on credit risk, and did not yet fully take into account possible impacts resulting from market risk;
  • The data used to populate responses from firms was incomplete and inconsistent in its approach – for example, loss estimates on the same corporate customers differed substantially in participating firms’ responses;
  • The ‘No Action’ scenario would likely incur losses past the time horizon selected for the CBES projections, and as such projections for this scenario were likely partial; and
  • The BoE acknowledged the limitations of the fixed balance sheet approach adopted for the CBES.

Despite these, and other limitations, the CBES included a number of interesting observations for market participants:

Quantitative findings – calculating the risk

  • Projected climate risk impacts were highest for banks’ wholesale and mortgage exposures, and projected climate-related consumer credit losses were relatively low.
  • Institutions which relied upon third-party modelling and data without sufficient internal capability to challenge and scrutinise often gave rise to materially lower loss projections than those institutions which had invested in and developed their own internal models. The development of internal models was more established in the insurance than the banking sector.
  • Limitations caused by data gaps and inconsistent data provision from third parties such as clients and counterparties were again noted. In particular, the lack of available data regarding corporates’ current value chain emissions and future transition plans was a common issue affecting firms. The BoE also recommends that banks act to encourage remediation of data limitations and gaps to help firms meet the PRA’s supervisory expectations, as set out in SS3/19. Firms’ efforts in this area will be supported by initiatives currently in train to resolve some of these data gaps.

Qualitative findings – planning ahead

  • Responses to the qualitative secondary part of the CBES, which focused on transition planning, suggested that some banks, in particular, were not considering their transition plans holistically: they were failing to take into account the likelihood of similar management actions from competitors or adjusting for different macro scenarios.
  • Transition plans suggest that banks intend to divest from energy-intensive sectors. The BoE sounded a note of caution in relation to these suggestions and to the idea that capital requirements could be used to target investment towards “green” sectors and away from energy-intensive sectors. The BoE noted the systemic risk inherent in depriving energy-intensive sectors from the funding they would need to transition towards net-zero, and also the economic repercussions of mass divestment from providing finance to carbon-intensive sectors ahead of the expansion of renewable energy supply.
  • Capital adequacy remains at the forefront of the BoE’s mind, but in the context of developing (along with other central banks) Solvency II to better accommodate the nuances of climate change risk, rather than using the BoE’s prudential regulation as a pseudo-governmental arm seeking to drive policy change.
  • While participating firms were making good progress in some aspects of climate risk management, they all had more work to do to improve their climate risk management capabilities.

Climate Litigation Risk 

As part of the CBES, the BoE engaged with members of the London Insurance Market to understand the extent to which existing policies would cover climate-related litigation. Following the trend of increasing climate-related litigation (particularly in the United States, which is ahead of many European jurisdictions in this regard), the BoE wanted to look at the impact of this development in the contentious landscape. The BoE identified seven ‘types’ of climate-related litigation, these are set out in full below:

  • Direct causal contribution: a corporate is found liable for its representative contribution to manmade climate change.
  • Violation of fundamental rights resulting in cessation or reduction of operations: a corporate is prevented from practising carbon-intensive activities that violate fundamental human and dignity rights, this has a significant impact on financial revenues.
  • Greenwashing: a corporate is found to be misleading customers (e.g. false advertising, mislabelling as ‘environmentally friendly’, underreporting disclosures) and must pay out compensation to customers/investors.
  • Misreading the transition: a corporate is sued on the basis that it continued to sell a carbon-intensive product while in knowledge it would become redundant due to government net-zero policy, they must refund and compensate customers.
  • Indirect casual contribution (related to exposure to Utilities sector only): utilities are sued for their indirect contribution to climate change which amplifies physical risks due to inadequate or negligent preparation.
  • Directors’ breach of fiduciary duties (related to cover against asset managers only): investors of an asset manager allege that the entity’s directors have understated the physical and/or transition risk to their assets in their disclosures. Investors seek payment for damages from the directors’ breach of fiduciary duty.
  • Indirect causal contribution (financing): a case is brought against financiers of carbon-intensive activities, as they have contributed indirectly to manmade climate change through financing activities of carbon majors.

                                                  Taken from Table 1 of Box C of the CBES Results

Following engagement with members of the insurance market, the BoE identified that (in aggregate) just under half of the D&O insurance policies currently in place would cover these types of litigation risk; while approximately a quarter of the professional indemnity policies would cover climate related litigation. The respondents noted that this figure may not reflect coverage of the defendant’s own legal costs, which could often be high, particularly where the claims were investor-led.

While the focus of these questions was on the impact to the insurance industry of the developing trend, the analysis should focus the minds of banks and asset managers: have they sufficiently considered their litigation risk? Have they considered whether their policy coverage is adequate? As we move forward, have they budgeted for the increasing cost of Profin and D&O insurance which may arise from developing trends in this area?

What next

  • The BoE’s work on climate scenario analysis, including that done as part of the CBES, provides a key tool supporting firms and policymakers as they navigate uncertainty over future climate policy and climate change, enabling assessment against a range of possible outcomes.
  • As set out in the PRA’s October 2021 Climate Change Adaptation Report, the PRA and the BoE are undertaking further analysis to determine whether changes need to be made to the design, use, or calibration of the regulatory capital frameworks.
  • To support this work on the capital framework, the BoE will host a research conference on the interaction between climate change and capital in Q4 2022, and has already put out a ‘Call for Papers’. The BoE will publish follow-up material on the use of capital, including on the role of any future scenario exercises, informed by the conference and the findings of the CBES.
  • While no future CBES has been announced, it is clear that more work is needed before the BoE and market participants understand the stress that they may soon be under as a result of climate risks.
Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750
Eleanor Dole Sheaf
Eleanor Dole Sheaf
Associate
+44 20 7466 7612

How to navigate the Autonomy judgment: guidance for corporate issuers defending Section 90A / Schedule 10A FSMA shareholder claims

The High Court has handed down its long-awaited judgment in the US$5 billion civil fraud action brought by the Hewlett Packard group in connection with its acquisition of the UK software company Autonomy Corporation Limited in 2012: ACL Netherlands BV & Ors v Lynch & Ors [2022] EWHC 1178 (Ch).

The judgment follows a previously published Summary of Conclusions, in which the High Court confirmed that the claimants “substantially succeeded” in their claims against two former Autonomy executives (see this post on our Civil Fraud and Asset Tracing Notes blog, which sets out the background facts to the dispute and summarises the outcome).

The successful claims were brought under s.90A of the Financial Services and Markets Act 2000 (FSMA), common law misrepresentation and deceit, and the Misrepresentation Act 1967, as well as claims for breach of the defendants’ management duties.

The 1657-page judgment is significant, not only because the case is one of the longest and most complex in English legal history, but also because it is the first s.90A FSMA case to come to trial in this jurisdiction.

As a reminder, s.90A (and its successor, Schedule 10A FSMA) is the statutory regime imposing civil liability for inaccurate statements in information disclosed by listed issuers to the market. It imposes liability on the issuers of securities for misleading statements or omissions in certain publications, but only in circumstances where a person discharging managerial responsibilities at the issuer (a PDMR) knew that, or was reckless as to whether, the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact. The issuer is liable to pay compensation to anyone who has acquired securities in reliance on the information contained in the publication, for any losses suffered as a result of the untrue or misleading statement or omission, but only where the reliance was reasonable.

In recent years, there has been a noticeable uptick in securities litigation in the UK, in particular in claims brought under s.90A/Sch 10A FSMA. The purpose of this blog post is to distil the key legal takeaways on s.90A FSMA arising from the judgment, which may be relevant to such claims.

Scope of s.90A / Sch 10A FSMA

The court accepted the defendants’ “general admonition” that the court should not interpret and apply s.90A/Sch 10A FSMA in a way which exposes public companies and their shareholders to unreasonably wide liability.

It emphasised that, in considering the scope of these provisions (and in particular in considering the nature of reliance which must be shown and the measure of damages), the history of the s.90A regime is relevant. The court highlighted the following background to the provisions of FSMA, in particular:

  • Prior to s.90A, English law did not provide any remedy (statutory or under the common law) for investors acquiring shares on the basis of inaccuracies in a company’s financial statements (in contrast to the long-established statutory scheme of liability for misstatements contained in prospectuses). The rationale for the different treatment of liability for misstatements in prospectuses and those in other disclosures was because an untrue statement in a prospectus can lead to payments being made to the company on a false basis, but the same cannot be said of an untrue statement contained in an annual report, for example.
  • The ultimate catalyst for the introduction of a scheme of liability was the Transparency Directive (Council Directive 2004/1209/EC), which included enhanced disclosure obligations and the requirement for a disclosure statement. This gave rise to concerns that the English law’s restrictive approach to issuer liability would be disturbed and that issuers (and directors and auditors) might be made liable for merely negligent errors contained in narrative reports or financial statements.
  • The regime for issuer liability was introduced in this jurisdiction in a piecemeal fashion, recognising the historical tendency against liability. The government was aware that the scheme would involve a balance between: (a) the desire to encourage proper disclosure and affording recourse to a defrauded investor in its absence; and (b) the need to protect existing and longer-term investors who, subject to any claim against relevant directors (who may not be good for the money), may indirectly bear the brunt of any award against the issuer.
  • The original s.90A provisions introduced by the government were subsequently extended with effect from 1 October 2010 as follows: (a) to issuers with securities admitted to trading on a greater variety of trading facilities; (b) to relevant information disclosed by an issuer through a UK recognised information service; (c) to permit sellers, as well as buyers, of securities to recover losses incurred through reliance on fraudulent misstatements or omissions; and (d) to permit recovery for losses resulting from dishonest delay in disclosure. However, liability continued to be based on fraud and no change was suggested or made to the limitations that: (i) liability is restricted to issuers; and (ii) liability can only be established through imputation of knowledge or recklessness on the part of PDMRs of the issuer. Further, no specific provisions to determine the basis for the assessment of damages were introduced.

Two-stage test for liability under s.90A /Sch 10A FSMA

The court confirmed that the provisions of s.90A / Sch 10A FSMA make clear that there is an objective and a subjective test, both of which must be satisfied to establish liability:

  • Objective test: the relevant information must be demonstrated to be “untrue or misleading” or the omissions a matter “required to be included”.
  • Subjective test: a PDMR must know that the statement was untrue or misleading, or know such omission to be a “dishonest concealment of a material fact” (referred to in the judgment as “guilty knowledge”).

Each of these tests is considered separately below.

The objective test (untrue or misleading statement or omission)

The court said that the objective meaning of the impugned statement, is “the meaning which would be ascribed to it by the intended readership, having regard to the circumstances at that time”, endorsing the guidance provided in Raiffeisen Zentralbank Osterreich AG v The Royal Bank of Scotland plc [2010] EWHC 1392 (Comm).

The court gave some further guidance as to how to establish the objective meaning of a statement for the purpose of a s.90A/Sch 10A FSMA claim, including the following:

  • The content of the published information covered by s.90A/Sch 10A will often be governed by certain accounting standards, provisions and rules, which involve the exercise of accounting judgement where there may be a range of permissible views. The court confirmed that a statement is not to be regarded as false or misleading where it can be justified by reference to that range of views.
  • Where the meaning of a statement is open to two or more legitimate interpretations, it is not the function of the court to determine the more likely meaning. Unless it is shown that the ambiguity was artful or contrived by the defendant, the claim may not satisfy the objective test.
  • The claimant must prove that they understood the statement in the sense ascribed to it by the court.

The subjective test (guilty knowledge)

As in the common law of deceit, it must be proven that a PDMR “knew the statement to be untrue or misleading or was reckless as to whether it was untrue or misleading”; or alternatively, that they knew that the omission of matters required to be included was the dishonest concealment of a material fact. The court noted that for both s.90A and Sch 10A, the language used shows that there is a requirement for actual knowledge.

The court clarified several key legal questions as to what will amount to “guilty knowledge” for the purpose of the subjective test, including the following:

  • Timing of knowledge. In the context of an allegedly untrue/misleading statement, a party will be liable only if the facts rendering the statement untrue were present in the mind of the PDMR at the moment the statement was made. In the case of an omission, the PDMR must have applied their mind to the omission at the time the information was published and appreciated that a material fact was being concealed (i.e. that it was required to be included, but was being deliberately left out).
  • Recklessness. In the context of s.90A/Sch 10A FSMA, recklessness bears the meaning laid down in Derry v Peek (1889) 14 App. Cas. 337, i.e. not caring about the truth of the statement, such as to lack an honest belief in its truth.
  • Dishonesty
    • Even on the civil burden of proof, there is a general presumption of innocent incompetence over dishonest design and fraud, and the more serious the allegation, the more cogent the evidence required to prove dishonesty.
    • For deliberate concealment by omission, dishonesty has a special definition under Sch 10A (although s.90A contained no such special definition), which represents a statutory codification of the common law test for dishonesty laid down in R v Ghosh [1982] 1 QB 1053 (although in a common law context, that test has been revised by Ivey v Genting Casinos (UK) Ltd [2018] AC 391). Under the Sch 10A definition, a person’s conduct is regarded as dishonest only if:

“(a) it is regarded as dishonest by persons who regularly trade on the securities market in question, and (b) the person was aware (or must be taken to have been aware) that it was so regarded.”

    • Any advice given to the company and its directors from professionals will be relevant to the question of dishonesty (see below).
  • Impact of advice given by professionals on the subjective test
    • The court emphasised that, where a PDMR receives guidance from the company’s auditors that a certain fact does not need to be included in the company’s published information, then the omission of that fact on the basis of the advice is unlikely to amount to a dishonest concealment of a material fact (even if the disclosure was in fact required).
    • Similarly, where a PDMR has been advised by auditors that a particular statement included in the accounts was a fair description (as required by the relevant accountancy standards), it may be unlikely that the PDMR had knowledge that the statement was untrue/misleading or was reckless as to its truth (unless the auditor was misled).
    • However, in the court’s view, directors are likely to be (and should be) in a better position than an auditor to assess the likely impact on their shareholders of what is reported, and (for example) to assess what shareholders will make of possibly ambiguous statements. Accordingly, the court said “on matters within the directors’ proper province, the view of the company’s auditors cannot be regarded as a litmus test nor a ‘safe harbour’: auditors may prompt but they cannot keep the directors’ conscience”.
    • Accordingly, narrative “front-end” reports and presentations of business activities cannot be delegated by directors, as their purpose/objective is to reflect the directors’ (not the auditors’) view of the business and require directors to provide an accurate account according to their own conscience and understanding.
  • Subjective test to be applied in respect of each false statement. The court confirmed that liability is only engaged in respect of statements known to be untrue. If a company’s annual report contains ten misstatements, each of them relied on by a person acquiring the company, but it can only be shown that a PDMR knew about one of those misstatements, the company will only be liable in respect of that one, not the other nine.

Reliance

Reasonable reliance is another necessary precondition to liability under s.90A and Sch 10A, although the precise requirements of reliance are not defined in those provisions. In the Autonomy judgment, the court considered the question of reliance in further detail, providing the following guidance:

  • Reliance by whom? The court held that reliance must be by the person acquiring the securities, and not by some other person.
  • Individual statements vs published information. The court held that reliance must be upon a statement or omission, rather than, in some generalised sense, on a piece of published information (e.g. the annual report for a given year).
  • Express statements vs impression. The court suggested that statements and omissions may in combination create an impression which no single one imparts and, if that impression is false, that may found a claim (subject to the “awareness” requirement below).
  • Awareness requirement. The court held that, in order to demonstrate reliance upon a statement or omission, a claimant will have to demonstrate that they were consciously aware of the statement or omission in question, and that it induced them to enter into the transaction. The requirement for reliance upon a piece of information will not be satisfied if the claimant cannot demonstrate that they reviewed or considered the information: “it cannot have been intended to give an acquirer of shares a cause of action based on a misstatement that he never even looked at, merely because it is contained, for example, in an annual report, some other part of which he relied on”. Further, the relevant statement “must have been present to the claimant’s mind at the time he took the action on which he bases his claim”, i.e. made his investment decision.
  • Standard of reliance. The court held that a claimant must show that the fraudulent representation had an “impact on their mind” or an “influence on their judgement” in relation to the investment decision.
  • Presumption of inducement. The court held that the so-called “presumption of inducement” applies in the context of a FSMA claim to the same extent as it does in other cases of deceit. This is a presumption that the claimant was induced by a fraudulent misrepresentation to act in a certain way, which will assist the claimant when proving reliance. The presumption is an inference of fact which is rebuttable on the facts. In addition, for the purposes of s.90A and Sch 10A, any reliance must be “reasonable”, and that reasonableness requirement mitigates the effect of the presumption by introducing an additional test for the claimant to satisfy. The court also made clear that the presumption of inducement is subject to the “awareness” requirement above, i.e. the presumption of inducement will not arise if the claimant was not consciously aware of the representation.
  • When is reliance reasonable? The court held that “the test of reasonableness is not further defined, but is plainly to be applied by reference to the conditions at the time when the representee claimant relied on it. Circumstances, caveats or conditions which qualify the apparent reliability of the statement relied on by the claimant are all to be taken into account. The question of when reliance is reasonable is fact-sensitive.”

Loss in the context of FSMA claims

The court expressed its provisional view on some “novel and difficult issues” in the context of loss. In particular, it said that it is for the court to decide, and not for the defrauded party to make an election, as to whether “inflation” damages (i.e. if the truth had been known the claimant would have acquired the shares at a lower price) or “no transaction” damages (i.e. if the truth had been known, the claimant would not have purchased the shares in question) are available. The court will return to this question when addressing issues of quantum (the present judgment considered liability only).

Future use of s.90A / Sch 10A claims in M&A disputes

In the present case, the alleged liability of Autonomy under s.90A/Sch 10A was used as a stepping-stone to a claim against the defendants. This was described by the court as a “dog leg claim” because Autonomy (now under the control of HP) accepted full liability to its shareholder, and Autonomy sought to recover in turn from the defendants as PDMRs of Autonomy at the relevant time. The court said that there was no conceptual impediment to this, but that it was right to bear in mind that in interpreting the provisions and conditions of liability, the relevant question was whether the issuer itself should be liable.

This may open the door for future M&A disputes to be brought by way of a s.90A FSMA claim by disgruntled purchasers against the target company in order – ultimately – to pursue a claim against former directors of the target company (i.e. the vendors), based on breach of their duties owed to the target company.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187

SPACs in the City: the emerging litigation and regulatory risks in England & Wales

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on the litigation and regulatory risks for special purpose acquisition companies (SPACs) in England & Wales.

SPACs scorched the US stock markets last year, with the UK left out in the cold. While the recent crackdown by the Securities and Exchange Commission (SEC) is cooling investor interest in the US, the UK regulators are hoping that changes to the regulatory framework will bring some SPAC sunshine to this side of the Atlantic.

Given the limited number of London-listed SPACs to date, the litigation and regulatory risks for SPACs in the UK remain broadly untested. However, some cautionary tales are emerging from the US, where increasingly SPACs are the subject of litigation and regulatory scrutiny.

The article considers the changes to the UK’s regulatory framework applying to SPACs, before exploring some of the key anticipated regulatory and litigation risks for SPACs in this jurisdiction.

The article can be found here: SPACs in the City: the emerging litigation and regulatory risks in England & Wales. This article first appeared in the October 2021 edition of JIBFL.

Karen Anderson
Karen Anderson
Partner
+44 20 7466 2404
Emma Deas
Emma Deas
Partner
+44 20 7466 2613
Sarah Hawes
Sarah Hawes
Head of Corporate Knowledge, UK
+44 20 7466 2953
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Eleanor Dole Sheaf
Eleanor Dole Sheaf
Associate
+44 20 7466 7612

COVID-19 market disclosures and managing the associated litigation risks

Herbert Smith Freehills have published an article in the Journal of International Banking Law and Regulation: COVID-19 market disclosures and managing the associated litigation risks.

Since the start of the pandemic many listed companies have sought to strengthen their balance sheet by raising additional capital from shareholders. This article considers the types of disclosures relating to COVID-19 that have been made to the market when doing so, the potential litigation risks that may be faced in the context of increased securities class actions activity in this jurisdiction, and how those risks may be appropriately managed.

The article can be found here: COVID-19 market disclosures and managing the associated litigation risks. This material was first published by Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ, in the September 2021 edition of JIBLR and is reproduced by agreement with the publishers.

Alternatively, please contact Nihar Lovell if you would like to request a copy of the full article.

Rupert Lewis
Rupert Lewis
Partner, Head of Banking Litigation
+44 20 7466 2517
Michael Jacobs
Michael Jacobs
Partner
+44 20 7466 2463
Daniel May
Daniel May
Senior Associate
+44 20 7466 7608
Sarah Ries-Coward
Sarah Ries-Coward
Senior Associate
+44 20 7466 2268

CJEU considers issuer liability for prospectuses marketed to both retail and qualified investors

The Court of Justice of the European Union (CJEU) has confirmed that qualified investors (as well as retail investors) can bring an action for damages on the basis of inaccuracies in a prospectus published to the public at large, as a matter of interpretation of Directive 2003/71/EC (the Prospectus Directive): Bankia SA v Unión Mutua Asistencial de Seguros [2021] EUECJ (C 910/19)The CJEU’s decision follows and confirms the opinion of the Advocate General (see our previous blog post: EU Advocate General considers interpretation of Prospectus Directive in relation to an issuer’s liability for a prospectus marketed to both retail and qualified investors).

The relevant provisions considered by the CJEU were Articles 3(2)(a) and 6 of the Prospectus Directive, which were implemented in UK law (before the UK left the EU) by virtue of s.90 of the Financial Services and Markets Act 2000 (FSMA). While the CJEU decision is unsurprising in the context of s.90 FSMA, the ruling provides helpful clarification on an important legislative framework that forms the bedrock of European securities litigation.

Although the UK is no longer a member of the EU, the CJEU decision may still be of relevance to the interpretation of s.90 FSMA claims, which represents “retained EU law” post-Brexit because it is derived from an EU Directive. In interpreting retained EU law, CJEU decisions post-dating the end of the transition period are not binding on UK courts, although the courts may have regard to them so far as relevant (see our litigation blog post on the practical implications of Brexit for disputes).

The CJEU decision is considered in more detail below.

Background

In 2011, the appellant Spanish bank (Bank) issued an offer of shares to the public, for the purpose of becoming listed on the Spanish stock exchange. The offer consisted of two tranches: one for retail investors and the other for qualified investors. A book-building period, in which potential qualified investors could submit subscription bids, took place between June and July 2011. As part of the subscription offer, the Bank contacted the respondent (UMAS), a mutual insurance entity and therefore a qualified investor. UMAS agreed to purchase 160,000 shares at a cost of EUR 600,000. The Bank’s annual financial statements were subsequently revised. This led to the shares losing almost all their value on the secondary market and being suspended from trading.

UMAS issued proceedings in the Spanish court against the Bank seeking to annul the share purchase order, on the grounds that the consent was vitiated by error; or alternatively for a declaration that the Bank was liable on the grounds that the prospectus was misleading. Having lost at first instance, the Bank appealed to the Spanish Provincial Court, which dismissed the action for annulment but upheld the alternative action for damages brought against the Bank on the grounds that the prospectus was inaccurate.

On the Bank’s appeal to the Spanish Supreme Court, the court held that neither the Prospectus Directive nor Spanish law expressly provided that it is possible for qualified investors to hold the issuer liable for an inaccurate prospectus where the offer made to the public to subscribe for securities is addressed to both retail and qualified investors.

The Spanish Supreme Court decided to stay the proceedings and referred two key questions to the CJEU for a preliminary ruling as to the interpretation of Article 6 of the Prospectus Directive.

Opinion of the Advocate General

The Advocate General’s opinion is considered in further detail in our banking litigation blog post.

In summary, the Advocate General concluded that Article 6 of the Prospectus Directive, in the light of Article 3(2)(a), must be interpreted as meaning that, where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors, although it is not necessary to publish such a document where the offer concerns exclusively such investors.

The Advocate General also concluded that a Member State has the discretion to provide in its legislation or regulations that awareness by a qualified investor of the true situation of the issuer should be taken into account, in the event of an action for damages being brought by a qualified investor on the grounds of an inaccurate prospectus (i.e. that Article 6(2) does not preclude this principle). However, this is subject to the condition that the principles of effectiveness and equivalence are observed.

CJEU decision

We consider below each of the issues addressed by the CJEU.

Issue 1: Inaccurate prospectus as the basis for a qualified investor’s action for damages

The CJEU agreed with the Advocate General that an investor who has participated in an offer of securities where a prospectus has been published, may legitimately rely on the information given in that prospectus, whether or not the prospectus was issued for that investor. On that basis, an investor is entitled to bring an action for damages on the grounds of that information, again whether or not the prospectus was issued for that investor. In reaching this conclusion, the CJEU made the following observations:

  • Context. Interpreting Article 6 of the Prospectus Directive, the court was required to take account of its context and the provisions of EU law as a whole. With this in mind, the CJEU noted that the Prospectus Directive does not identify the investors who may bring an action for damages, but merely identifies the potential defendants.
  • Objectives. Turning to the objectives pursued by the Prospectus Directive, which must also be taken into account in the process of interpretation, the CJEU focused on the objective of investor protection. It emphasised that the publication of a prospectus contributes to the implementation of safeguards designed to meet the objective of protecting the interests of actual and potential investors.
  • Language used. The CJEU noted that Article 3(2) lays down a series of exemptions from the general obligation to publish a prospectus, including an exemption from publishing a prospectus for securities offered exclusively to qualified investors. However, it could not be inferred from this that qualified investors are denied the opportunity to bring an action for damages. In the view of the CJEU, the distinction between retail investors and qualified investors at Article 3 of the Prospectus Directive did not cast doubt on its interpretation of Article 6.

Issue 2: Qualified investor’s awareness of the true situation of the issuer

The CJEU agreed with the Advocate General that Article 6(2) grants a broad discretion to Member States to lay down the rules for bringing an action for damages on the grounds of the information given in the prospectus. Accordingly, that provision must be interpreted as not precluding the qualified investor’s awareness of the true situation of the issuer being taken into consideration, in the event of an action in damages being brought by a qualified investor.

This point is illustrated by the legal framework in the UK, because the awareness of the true position of the issuer is expressly included in the list of potential defences to a s.90 FSMA claim, which appears at Schedule 10. A contrary ruling from the CJEU would, therefore, have contradicted the way in which the UK implemented the Prospectus Directive.

Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821
Sarah Hawes
Sarah Hawes
Head of Corporate Knowledge, UK
+44 20 7466 2953
Ceri Morgan
Ceri Morgan
Professional Support Consultant
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High Court determines that reliance issues in context of a s.90A FSMA claim should be heard at first trial

At a recent case management conference where a split trial was proposed by the parties in relation to a section 90A Financial Services and Markets Act 2000 (FSMA) claim, the High Court has held that reliance issues should be heard at the first trial rather than held over to the second trial: Allianz Global Investors GmbH & 76 Ors v RSA Insurance Group plc [2021] EWHC 570 (Ch).

Trial structure tends to be a key case management battleground in securities class actions. For strategic and practical reasons, claimants often seek to postpone issues involving reliance, causation and quantum (i.e. issues which concern the conduct of the claimants) to the second trial and render issues surrounding the issuer’s alleged liability the sole focus of the first trial (see our banking litigation blog post on The Tesco Litigation: lessons learned from split trial orders in the context of securities class actions for further details).

The judgment therefore provides noteworthy and helpful guidance to issuers faced with securities claims in advocating for a trial structure with a fairer allocation of the burden of preparing for trial. The court referred to various factors which influenced its decision that reliance issues should be heard at the first trial. In summary, the court was of the view that an early determination on reliance may increase the chance of a settlement, and that since questions concerning reliance are primarily factual, these should be determined as early as possible during the trial process, particularly where the claimants had issued proceedings deep into the limitation period.

There are two particular points of note from the judgment:

  1. the court acknowledged the claimants’ argument that the inclusion of reliance issues could lead to a longer first trial; however, the court found that this was not a telling factor in a claim of this size and significance, and that the claimants who had brought the claim “must be ready to take part in it fully” especially as litigation funding had been arranged; and
  2. the allocation of the litigation burden between the parties was one of the factors which had a bearing on the court’s decision. The court noted that the claimants who brought the claim “should be prepared to undertake substantial work in ensuring the expeditious progress of the proceedings to resolution”.

The additional implication of these points is that further securities class actions may be more costly or practically burdensome for claimants to pursue, as they may need to invest more time and costs in anticipation of being required to participate more fully throughout the proceedings from the outset.

We consider the court’s decision in more detail below.

Background

In late 2013, RSA Insurance Group plc (RSA) made public announcements in respect of certain misconduct and accounting irregularities which had occurred in its Irish subsidiary (RSA Ireland) during the period of 2009-2013. Following the 2013 market announcements, a reduction was observed in RSA’s share price.

A claimant group of institutional investors subsequently brought proceedings under section 90A and Schedule 10A FSMA against RSA on the basis that:

  • the misconduct within RSA Ireland meant RSA’s published information during 2009-2013 contained alleged false/misleading statements and/or omissions, and/or RSA had dishonestly delayed the publication of relevant information; and
  • they had suffered loss as a result of acquiring/continuing to hold RSA shares during 2009-2013 in reasonable reliance on the alleged false/misleading statements and/or omissions and/or dishonest delay of relevant information.

RSA denies the allegations and is robustly defending the s.90A FSMA claim being brought against it.

One of the main issues the parties asked the court to consider during the case’s first CMC was how the trial should be structured. It was common ground that there should be a split trial; however, the parties disagreed as to where that spilt should lie.

The parties framed the debate by reference to an agreed list of issues. It was agreed between the parties that issues relating to whether RSA is liable under section 90A FSMA (the RSA Issues) and issues relating to quantum should be heard in the first and second trial respectively. The dispute arose in relation to issues relating to reliance and causation which are issues which concern the actions of the claimants (the Claimant Issues) and in which trial such issues should be heard.

The claimants submitted that the first trial should deal solely with the RSA Issues only, leaving the reliance and causation issues to the second trial; whereas RSA submitted that in addition to the RSA Issues, the court should also determine issues of reliance in the first trial, and that as an alternative fall-back position, the court might also determine causation issues in the first trial.

Decision

The court found in favour of RSA and held that it was appropriate that issues of reliance should be included in the first trial for the reasons set out below:

  1. Settlement – The court noted that it was preferable, on balance, for more issues rather than fewer to be tried at the first trial, and that a determination on both the RSA Issues as well as the reliance issues at that juncture was more likely to bring about a settlement of the remaining issues.
  2. Timing for the determination of the reliance issues – The court was of the view that the timeline produced by RSA’s proposed split would lead to a faster determination of the factual issues concerning reliance. The potential difference between the parties’ suggested timelines amounted to approximately a year. The court was not persuaded by the claimants’ submission that such a difference was marginal and that a year or so of delay should be avoided if possible. The court agreed with RSA that the claimants had chosen to bring the claim late in the limitation period, and the more time which passed, the more difficult it would be for the parties and the court to establish what had happened on a true factual basis.
  3. First trial length – The court noted that there was some force in the claimants’ argument that their proposed spilt would lead to a shorter first trial. However, the court commented that in a case of this scale and importance, this ought not to be a particularly telling factor. The claimants who brought this claim “must be ready to take part in it fully”, even if it resulted in a longer first trial. The court further noted that it did not think a trial of 25-30 court days to be excessively onerous for parties who were as well funded as the claimants (who had secured litigation funding).
  4. Overlap between causation and reliance – Whilst the court recognised that there was some force in the claimants’ argument concerning the potential overlap between reliance and causation issues, and noted that in an ideal world it would be preferable to have a spilt trial structure which cleanly separated the Claimant Issues from the RSA Issues; however, the court did not deem such a division to be pragmatic in the present case. It further noted that it did not consider it likely for the potential overlap in reliance and causation evidence to lead to a serious risk of inconsistencies in the evidence or the court’s findings. The court acknowledged it may be unsatisfactory for the same witness to be called to provide evidence twice (once in the first trial for reliance, and another time in the second trial for causation); however, it was of the view that the process of taking causation evidence should be fairly short and self-contained in the second trial.
  5. Expert evidence – The court agreed with RSA that it was possible that no expert evidence would be required for issues of reliance. The proposition advanced by the claimants was that the price of securities on the London Stock Exchange was influenced by published information. The court’s initial view was that such an argument was self-evident and required no expert evidence. Nonetheless, the court noted that should expert evidence be required, it did not expect the process to be a long one.
  6. Possibility of appeals – Overall, the court noted that there was some force in RSA’s argument that if there were to be appeals following the first trial, it would be better for the appellate court to hear as many issues as possible at the same time. The court also regarded there to be a real risk that the determination of reliance issues could be further postponed, in the scenario where such issues are put off to the second trial and an appeal occurs after the first trial. As per the reasons above, the court deemed this to be unsatisfactory since reliance questions are essentially factual and should be dealt with sooner rather than later.
  7. Litigation burden – On the allocation of the litigation burden between the parties, the court agreed with RSA that the claimants’ proposed split effectively meant that the claimants’ burden would be postponed to the second trial and almost all the work for the first trial would rest solely with RSA. The court noted that both parties should be entitled to scrutinise each other’s case, and that there may be times where the litigation burden between the parties is lopsided by the nature of the litigation; however, that was not the case here – as such an imbalance would be created by the claimants’ proposals for a split trial. In its consideration, the court also underlined that the claimants, having brought the claim, “should be prepared to undertake substantial work in ensuring the expeditious progress of the proceedings to resolution”. This includes providing disclosure, preparing witness statements and being prepared to provide evidence at trial. The court was of the view that RSA’s proposal represented a fairer allocation of the litigation burden between the parties, which although not a determining factor by itself did however have some bearing.

Herbert Smith Freehills LLP acts for the defendant, RSA, in this matter. 

Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
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Karen Wu
Karen Wu
Associate
+44 20 7466 2369

EU Advocate General considers interpretation of Prospectus Directive in relation to an issuer’s liability for a prospectus marketed to both retail and qualified investors

The Advocate General (AG) of the Court of Justice of the European Union (CJEU) has handed down an unsurprising opinion on the interpretation of Directive 2003/71/EC (the Prospectus Directive), considering the liability of issuers to qualified investors in respect of inaccuracies in a prospectus: Bankia SA v UMAS (Case C-910/19) EU:C:2021:119 (11 February 2021), (Advocate General Richard de la Tour).

The referral was made by the Spanish Supreme Court on the interpretation of Article 3(2)(a) and Article 6 of the Prospective Directive, which (before its repeal – as discussed further below) provided the framework for a “single passport” for prospectuses throughout the EU. As an EU Directive, it required further implementation measures by EU Member States to be effective. In the UK, the relevant provisions considered by the AG are found at s.90 of the Financial Services and Markets Act 2000 (FSMA).

The context for the referral was the relatively commonplace scenario in a securities issuance, where an issuer publishes a prospectus to the public at large, and as a consequence it is received by qualified investors as well as retail investors (e.g. where there is a combined offer). The question for the AG was whether the issuer could be liable (under Article 6 of the Prospectus Directive) to qualified investors (as well as retail investors) for any inaccuracies in the prospectus in circumstances where, if the offer had been directed solely at qualified investors, the issuer would have been exempt from publishing the prospectus under Article 3(2)(a) of the Prospectus Directive. If the qualified investor is entitled to bring a claim in these circumstances, the AG was asked if the qualified investor’s awareness of the true situation of the issuer could be taken into consideration.

In response to these questions, the AG’s opinion (which is non-binding but influential on the CJEU) concluded as follows:

  1. Article 6 of the Prospectus Directive, in light of Article 3(2)(a), must be interpreted as meaning that where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors; although it is not necessary to publish such a document where the offer concerns exclusively such investors.
  2. Article 6(2) of the Prospectus Directive must be interpreted as not precluding, in the event of an action in damages being brought by a qualified investor on grounds of an inaccurate prospectus, that investor’s awareness of the true situation of the issuer being taken into consideration besides the inaccurate or incomplete terms of the prospectus, since such awareness may also be taken into account in similar actions for damages and taking it into account does not in practice have the effect of making it impossible or excessively difficult to bring that action, which is a matter for the referring court to determine.

From a UK perspective (and as prefaced above), this is an unsurprising outcome in the context of s.90 FSMA. In particular, because the second point (awareness of the true position of the issuer) is expressly included in the Schedule 10 defences to a s.90 claim.

Securities lawyers will immediately question the impact of the AG’s opinion in the light of the Prospectus Regulation (EU) 2017/1129 and Brexit.  Although the Prospectus Regulation repealed and replaced the Prospectus Directive (see our banking litigation blog post), the substance of the Articles considered by the AG have been carried forward into the equivalent Prospectus Regulation provisions.

As to Brexit, although the UK is no longer a member of the EU (following the end of the Brexit transition period on 31 December 2020), the AG’s opinion may still be of relevance to the interpretation of s.90 FSMA claims. S.90 FSMA represents “retained EU law” post-Brexit because it is derived from an EU Directive. In interpreting retained EU law, CJEU decisions post-dating the end of the transition period are not binding on UK courts, although the courts may have regard to them so far as relevant (see our litigation blog post on the practical implications of Brexit for disputes). As noted above, AG opinions are not binding in any event, but this will be the status of the CJEU decision when finally handed down.

The AG’s opinion is considered in more detail below.

Background

In 2011, the appellant Spanish bank (Bank) issued an offer of shares to the public, for the purpose of becoming listed on the Spanish stock exchange. The offer consisted of two tranches: one for retail investors and the other for qualified investors. A book-building period, in which potential qualified investors could submit subscription bids, took place between June and July 2011. As part of the subscription offer, the Bank contacted the respondent (UMAS), a mutual insurance entity and therefore a qualified investor. UMAS agreed to purchase 160,000 shares at a cost of EUR 600,000. The Bank’s annual financial statements were subsequently revised. This led to the shares losing almost all their value on the secondary market and being suspended from trading.

UMAS issued proceedings in the Spanish court against the Bank seeking to annul the share purchase order, on the grounds that the consent was vitiated by error; or alternatively for a declaration that the Bank was liable on the grounds that the prospectus was misleading. Having lost at first instance, the Bank appealed to the Spanish Provincial Court, which dismissed the action for annulment but upheld the alternative action for damages brought against the Bank on the grounds that the prospectus was inaccurate.

On the Bank’s appeal to the Spanish Supreme Court, the court held that neither the Prospectus Directive nor Spanish law expressly provided that it is possible for qualified investors to hold the issuer liable for an inaccurate prospectus where the offer made to the public to subscribe for securities is addressed to both retail and qualified investors.

The Spanish Supreme Court decided to stay the proceedings and referred two key questions to the ECJ for a preliminary ruling:

  • When an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued for the retail investors, is an action for damages arising from the prospectus available to both kinds of investor or only to retail investors?
  • In the event that an action for damages arising from the prospectus is also available to qualified investors, is it possible to assess the extent to which they were aware of the economic situation of the issuer of the offer of shares to the public for subscription otherwise than through the prospectus, on the basis of their legal and commercial relations with that issuer (e.g. being shareholders of the issuer or members of its management bodies etc)?

Decision

We consider below each of the issues addressed by the AG in his opinion.

Issue 1: Inaccurate prospectus as the basis for a qualified investor’s action for damages

The AG concluded that Article 6 of the Prospectus Directive, in the light of Article 3(2)(a), must be interpreted as meaning that, where an offer of shares to the public for subscription is directed at both retail and qualified investors, and a prospectus is issued, an action for damages arising from the prospectus may be brought by qualified investors, although it is not necessary to publish such a document where the offer concerns exclusively such investors.

In the AG’s view, this interpretation was supported by both a literal/systematic interpretation of the Prospectus Directive, and a teleological interpretation (paying attention to the aim and purpose of EU law).

Before considering each approach to interpretation below, and by way of reminder, Article 3(2)(a) of the Prospectus Directive contains an exemption from the obligation to publish a prospectus where the offer is limited to qualified investors. However, the publication of a prospectus is mandatory where there is a combined offer to the public (i.e. both non-qualified and qualified investors) (Article 3(1)); or in the event of an issue of shares for trading on a regulated market (Article 3(3)).

Literal/systematic interpretation

Considering first the linguistic interpretation of the words used, the AG noted that Article 6 establishes a principle of liability in respect of inaccurate/incomplete prospectuses, but does not provide for an exception to that principle based on the nature of the combined offer, whether it is offered solely to the public or is intended for trading on a regulated market.

The AG contrasted the approach in other provisions of the Prospectus Directive, which do provide for exemptions from the obligation to publish a prospectus, based either on the person to whom the offer is addressed (Article 3(2)(a)), the number of shares or total offer issues (Article 3(2)), or on the nature of the shares issued (Article 4). However, those exemptions from the publication obligation do not prohibit voluntary publication of a prospectus by an issuer who will then benefit from the “single passport” if the shares are issued on a regulated market.

From a systematic perspective, the AG pointed out that the effect of the exemptions was to create circumstances in which qualified investors will receive a prospectus, even if they would not have received one if the offer had been directed solely at qualified investors. For example, where there is a combined offer (as in the present case) or where the prospectus is published voluntarily to benefit from the “single passport”.

The AG commented that the referring court appeared to start from the premise that, since the prospectus was intended solely to protect and inform retail investors, qualified investors could not rely on the inaccuracy of the prospectus in order to bring an action for damages. In the AG’s view, a literal and systematic interpretation of the Prospectus Directive cast doubt on the idea that a prospectus is produced merely in order to protect non-qualified investors.

Teleological interpretation (looking at the aim and purpose of EU law)

The AG said the interpretation of Article 6 of the Prospectus Directive must have regard to and balance two objectives: (i) the completion of a single securities market through the development of access to financial markets; and (ii) the protection of investors whilst taking account of the different requirements for the protection of the various categories of investors and their level of expertise.

Again, in the AG’s view, the presence of exemptions in Articles 3 and 4 versus the lack of any exemptions in Article 6, must lead to an interpretation that where a prospectus exists it must be possible to bring an action for damages on the basis of the inaccuracy of that prospectus irrespective of the type of investor.

The AG also commented that if it were accepted that each Member State could determine itself whether or not qualified investors may bring an action for damages in the event of an inaccurate prospectus, that would lead to possible distortions occurring among Member States that would undermine, disproportionately, the objective of completing the single securities market. A uniform interpretation of Article 6 is required, therefore, concerning persons who may bring proceedings against the issuer in connection with an offer.

Issue 2: Qualified investor’s awareness of the true situation of the issuer

The AG concluded that a Member State has the discretion to provide in its legislation or regulations that awareness by a qualified investor of the true situation of the issuer should be taken into account, in the event of an action for damages being brought by a qualified investor on the grounds of an inaccurate prospectus (i.e. that Article 6(2) does not preclude this principle). However, this is subject to the condition that the principles of effectiveness and equivalence are observed.

The AG said that the extent of liability for inaccuracies in a prospectus is a matter for Member States (in terms of whether to take account of the contributory fault of the investor and questions of causation). Accepting that Member States may factor in the awareness of a qualified investor in their legislation, the AG drew an analogy with the reasoning of the CJEU’s decision in Hirmann C‑174/12, EU:C:2013:856. In Hirmann, the court accepted that a Member State may limit the civil liability of the issuer by limiting the amount of compensation by reference to the date on which the share price is determined for the compensation (although again, the Member State must observe the principles of equivalence and effectiveness).

In terms of observing those principles of equivalence and effectiveness, the AG emphasised the need to take the investor’s awareness into consideration specifically in a given situation, which will require the courts of Member States to assess the evidence of such awareness and of the extent to which that awareness has been taken into consideration.

Harry Edwards
Harry Edwards
Partner
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Sarah Hawes
Sarah Hawes
Head of Corporate Knowledge, UK
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000

Climate-related disclosures for issuers: further steps towards mandatory requirements?

In November 2020, the UK Joint Government Regulator TCFD Taskforce published its “roadmap towards mandatory climate-related disclosures”, which set out a vision for the next five years. As an initial step towards fulfilling that vision, in January 2021, the new Listing Rule 9.8.6(8) (LR) came into force. The LR requires premium-listed issuers, in their periodic reporting, to publish disclosures in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations on a ‘comply or explain’ basis. However, the Financial Conduct Authority (FCA) has recognised that some issuers may need more time to deal with modelling, analytical, metric or data-based challenges.

This flexibility in the new LR’s compliance basis reflects the challenges and evolving experiences with working on data and metrics in the context of climate risk. Key stakeholders should now be redoubling their efforts to meet the challenges and with the promise of further TCFD guidance on data and metrics later this year and the recent launch of a Department for Business, Energy and Industrial Strategy (BEIS) consultation seeking views on proposals to mandate climate-related financial disclosures in line with the TCFD recommendations from 6 April 2022, the step to a mandatory climate-related disclosure regime may be closer than initially envisaged.

In light of the ever-evolving regulatory landscape, it is important issuers continue to monitor the impact of any changes to their disclosure requirements and to consider what, if any, litigation risks may arise (particularly, under s90 FSMA, s90A FSMA, or in common law or equity) in connection with their climate-related disclosures.

The key developments on data and metrics, as well as the key proposals from the BEIS consultation, are examined below. We also consider what these developments and proposals mean for issuers in terms of regulatory reporting requirements.

Climate Financial Risk Forum

Following its fifth quarterly meeting in November 2020, the Climate Financial Risk Forum (CFRF) noted the importance of progress in the development and understanding of climate data and metrics. In light of this, the CFRF announced that all of its working groups will focus on climate data and metrics in the next phase of work. This is a shift from the CFRF’s previous approach of allocating different focus areas to its working groups.

TCFD Financial Metrics Consultation

The TCFD has this month published a summary of the responses to its ‘Forward-looking Financial Metrics’ Consultation, which was conducted between October 2020 and January 2021. The consultation aimed to collect feedback on decision-useful, forward-looking metrics to be disclosed by financial institutions. The TCFD solicited feedback on specific metrics and views on the shift to, and usefulness of, forward-looking metrics more broadly.

46% of the 209 respondents were financial services firms from around the world, and over half of the respondents were EMEA based, with just over a quarter from North America.

These findings will inform the work on metrics and targets which the TCFD plans to tackle in 2021. The TCFD announced that it will publish broader, additional draft guidance for market review and consideration later this year.

BEIS Consultation

BEIS launched a consultation this month on mandating climate-related disclosures by publicly quoted companies, large private companies and LLPs. The consultation proposes that, for financial periods starting on or after 6 April 2022, certain UK companies with more than 500 employees (including premium-listed companies) be required to report climate-related financial disclosures in the non-financial information statement which forms part of the Strategic Report. Such disclosures are required to be in line with the four overarching pillars of the TCFD recommendations (Governance, Strategy, Risk Management, Metrics & Targets).

BEIS has stated that the proposed rules are intended to be complementary to the FCA’s requirement that premium-listed companies make disclosures in line with the four pillars and 11 recommended disclosures of the TCFD. BEIS proposes to introduce the new rules via secondary legislation which will amend the Companies Act 2006.

The Financial Reporting Council will be responsible for monitoring and enforcing the proposed rules, while the FCA will supervise and enforce disclosures within the scope of the LR.

The consultation is open until 5 May 2021.

Regulatory reporting requirements

The new TCFD guidance, once published, is likely to feed into the LR requirements. The new LR expressly refers to the TCFD Guidance on Risk Management Integration and Disclosure and the TCFD Guidance on Scenario Analysis for Non-Financial Companies published in October 2020. Additionally, the FCA’s Policy Statement dated December 2020, which accompanied the new LR, stated that the FCA would be considering how best to include references to any further TCFD guidance in the FCA Handbook Guidance. This is likely to be achieved through the use of the FCA Quarterly Consultation Papers.

The new LR is not a mandatory disclosure requirement and the new rules proposed by the BEIS consultation are yet to have legislative force. However, we are getting a clearer picture of the likely disclosure regime in the UK and in particular: the regulatory guidance around the compliance basis; the clear anticipated milestones this year relating to data and metrics guidance and best practice; and the forthcoming Consultation Paper by the FCA on the scope expansion (including compliance basis) of the new LR. That picture suggests the transition to mandatory climate-related disclosure requirements may well be a small step, rather than a giant leap.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750

Climate-related disclosures for issuers: FCA publishes final rules

The Financial Conduct Authority (FCA) has published a Policy Statement (PS20/17) and final rules and guidance in relation to climate-related financial disclosures for UK premium listed companies.

Companies will be required to include a statement in their annual financial report which sets out whether their disclosures are consistent with the Task Force on Climate-related Financial Disclosures (TCFD) June 2017 recommendations, and to explain if they have not done so. The rule will apply for accounting periods beginning on or after 1 January 2021.

As well as some additional guidance, the FCA has made only one material change to the rules consulted upon in March 2020 (CP20/03) with the final LR 9.8.6(8)(b)(ii)(C) R requiring non-compliant companies to set out details of how and when they plan to be able to make TCFD-aligned disclosures in the future.

With regard to monitoring compliance with the new listing rule, the FCA confirmed in its Policy Statement that it will provide further information on its supervisory approach to the new rule in a Primary Market Bulletin later in 2021.

In light of this latest regulatory development, issuers may also want to consider what, if any, litigation risks may arise in connection with climate-related disclosures (and indeed other sustainability-related disclosures which are made in response to these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) in which we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

For a more detailed analysis of the FCA’s Policy Statement, please see our Corporate Notes blog post.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750

Climate-related disclosures for issuers: next steps from UK financial regulators outlined

This month, there have been some significant regulatory announcements in relation to climate-related disclosures. These announcements are a result of the increasing focus on climate change and sustainability risks across governments, regulators and industry and a continued move towards corporate compliance with the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations.

While not launching new developments or heralding the unexpected, these announcements are noteworthy for issuers as they mark a change in tone from the UK regulators regarding climate-related disclosures. Previously, the Financial Conduct Authority (FCA) and Prudential Regulation Authority took a cooperative and directional view, in recognising that issuers’ capabilities were continuingly developing in some areas which might limit their ability to model and report scenarios in the manner recommended by the TCFD. With the latest announcements, it seems increasingly likely that there will now be a shift away from voluntary climate-related disclosures towards mandatory TCFD aligned disclosures across the UK economy.

Key announcements

Recent key announcements include:

  • HM Treasury publishing the Interim Report of the UK’s Joint Government-Regulator TCFD Taskforce (the Taskforce) on the implementation of the TCFD recommendations and a roadmap towards mandatory climate-related disclosures;
  • the Governor of the Bank of England’s (BoE) speech reaffirming what the BoE is doing to ensure that the UK financial system plays its part in tackling climate change;
  • the FCA’s speech on rising to the climate challenge; and
  • the Financial Reporting Council’s (FRC) publication of its Thematic Review on climate-related risk.

Summary of key announcements

These announcements highlight the UK’s financial regulators’ strategy for improving and developing climate-related disclosures. The key points from these announcements include:

Taskforce

  • The Taskforce’s Interim Report highlighted the UK government’s commitment to introduce mandatory climate-related financial reporting, with a “significant portion” in place by 2023, and mandatory requirements across the UK economy by 2025. The Interim Report considered regulatory steps around tackling climate change, and also identified proposed legislative changes from the Department for Business, Energy and Industrial Strategy (which is intending to consult in the first half of 2021 on changes to the Companies Act 2006 to insert requirements around the TCFD recommendations on compliant disclosures in the Strategic Report of companies’ Annual Reports and Accounts, including large private companies registered in the UK).
  • The Taskforce strongly supports the International Financial Reporting Standards Foundation’s proposal to create a new global Sustainability Standards Board on the basis that internationally agreed standards will help to achieve consistent and comparable reporting on environmental and, social and governance (ESG) matters.

BoE

  • The BoE reaffirmed its commitment to driving forward the business world’s response to tackling climate change and reiterated the importance of data and disclosure in firms’ attempts to manage climate risk.
  • The BoE announced that the delayed climate risk stress test (its biennial exploratory scenario dubbed “Climate BES”) for the financial services and insurance sectors would be carried out in June 2021.
  • While the Climate BES will not be used by the BoE to size firms’ capital buffers, the BoE has put down the marker that it expects firms to be assessing the impact of climate change on their capital position over the coming year and will be reviewing firms’ approaches in years to follow.
  • The BoE also directed financial firms and their clients to the TCFD recommendations to encourage focus and drive decision-making, pointing to the benefits that the BoE has itself felt from reporting this year in line with the TCFD recommendations.

FCA

  • The FCA confirmed that from 1 January 2021 new rules will be added to the Listing Rules requiring premium-listed commercial company issuers to report in line with the TCFD recommendations. As anticipated by last year’s Feedback Statement, the new rule will be introduced on a ‘comply or explain’ basis. The general expectation is that companies will comply, with expected allowances for modelling, analytical or data based challenges. It is expected that these allowances would be limited in scope. The Taskforce’s Interim Report notes that the FCA is considering providing guidance on the “limited circumstances” where firms could explain rather than comply. A full policy statement and confirmation of the final rules are expected before the end of 2020.
  • The FCA is also intending to consult on “TCFD-aligned disclosure” by asset managers and life insurers. These disclosures would be aimed at “clients” and “end-investors”, rather than shareholders in the firm itself. The consultation is intended for the first half of 2021 and is stated that “there will be interactions with related international initiatives, including those that derive from the EU’s Sustainable Finance Action Plan” (it should be noted that such standards cover much more than climate disclosures). Current indications are that these disclosure standards would come into force in 2022.
  • The FCA is co-chairing a workstream on disclosures under IOSCO’s Sustainable Finance Task Force, with the aim of developing more detailed climate and sustainability reporting standards and promoting consistency across industry.

FRC

  • The FRC emphasised that all entities (boards, companies, auditors, professional advisers, investors and regulators) needed to “do more” to integrate the impact of climate change into their decision making. One of the FRC’s ongoing workstreams is investigating developing investor expectations and better practice reporting under the TCFD recommendations.

Regulatory reporting requirements and litigation risks for issuers

The recent announcements are a reminder by the UK’s financial regulators that issuers must look beyond the current Covid-19 crisis to the oncoming climate emergency. It is clear that not engaging is not an option, even as the regulatory environment continues to change. Issuers and firms will therefore want to consider the impact of those disclosure requirements/suggestions across the board, from investor interactions to regulatory reporting to meeting supervisory expectations.

As the sands shift, issuers may also want to consider what, if any, litigation risk may arise in connection with climate-related disclosures (and indeed other sustainability related disclosures that are brought out from the shadows with these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) where we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nish Dissanayake
Nish Dissanayake
Partner
+44 20 7466 2365
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750