Accounting for climate change

Finance and accounting functions may be an unlikely ally in an environmental fight, but a growing body of investors argues that unless companies make clear the potential impact on their earnings, investment in carbon-intensive activities will continue.

Wind turbines in Xinjiang, China
Wind turbines in Xinjiang, China. Image: Chris Lim from East Coast (东海岸), Singapore (新加坡), CC BY-NC-ND 2.0

“Accountants will save the world,” according to Peter Bakker, chief executive of the World Business Council for Sustainable Development. He may be right. Investors and consumers are looking for better disclosure about what companies are doing to manage environmental issues and mitigate climate change risks. With a century of experience under its belt, the accounting profession has the opportunity to help the fight against climate change. 

Victor Ng, regional vice-president for Asia, BlackLine, a company specialising in cloud-based financial automation, said that chief financial officers and finance teams are increasingly being roped in to help steer sustainability efforts and align internal stakeholders around a company’s environmental, social and governance (ESG) responsibilities, particularly as climate reporting continues to evolve. 

“Having to juggle between the changing requirements of the finance function and learning more about what’s required for sustainability accounting is still relatively new for finance teams,” Ng said during a panel discussion in August. 

This is particularly the case in Asia-Pacific, according to Tan Chee Wee, senior environmental and social specialist at the Asian Infrastructure Bank. The depth and sophistication of the understanding about how climate impacts business is “simply not at the level necessary to promote the required sense of urgency and change,” he said. 

“You need that high-level buy-in first. So if the boss, the CEO, has not woken up yet … professional accountants need to help hammer home the message with solid data and solid analysis,” said Tan.  

Mounting pressure to disclose 

Investors have made it clear that they want the companies they own to commit to a business model which is compatible to climate change. Investors managing more than US$2.5 trillion called on governments to compel companies and auditors to file financial accounts aligned with the world’s net zero emissions targets, in a letter in September. 

“Accounts that leave out material climate impacts misinform executives, shareholders and creditors and thus result in misdirected capital,” the investor group said.

Similarly, an open letter published last September by investor bodies representing US$100 trillion in assets urged companies to follow guidance from the International Accounting Standards Board (IASB), released in 2019. 

The IASB ‘opinion’, made clear that factoring climate risks into company accounts is already required within the existing rules, if relevant and material, even though most companies have yet to do so. United Nations (UN) climate envoy, Mark Carney has said the IASB conclusions also needed to be reflected in company profit and loss statements. 

Most of the world uses International Financial Reporting Standards (IFRS), which are established by the International Accounting Standards Board (IASB). 

The IFRS Foundation said at the COP26 climate conference on Wednesday that it would form the International Sustainability Standards Board (ISSB), which will be tasked with creating a single set of standards “to meet investors’ and information needs”. 

“The ISSB will focus on meeting the sustainability information needs of investors for assessing enterprise value and making investment decisions. Its standards will help investors understand how companies are responding to ESG issues, like climate, to inform capital allocation decisions,” said Erkki Liikanen, chair of the IFRS Foundation Trustees. “The standards will form a comprehensive global baseline of sustainability disclosures.”

Underpinned by the Principles for Responsible Investment (PRI), the Institutional Investors Group on Climate Change (IIGC), UN Environment Programme Finance Initiative and other investor-led organisations, have also said that companies needed to explain the key assumptions made with regard to climate risk and make sure they are compatible with the goals of the Paris climate agreement.

The industry-led Task Force on Climate-related Financial Disclosures (TCFD), has also made it clear that companies should be measuring the material risk of climate change and informing investors how it is likely to impact their bottom line. 

Such risks can range from physical dangers such as water levels rising and destroying factories, to new regulations putting a higher price on carbon emissions, for example, which could render products and services redundant or in need of new pricing, impacting profits and contingent liabilities.

BlackRock, the world’s largest asset manager, has backed the initiative, stating: “Financial reporting should reflect reasonable assumptions about the impact of climate change and the transition to a low carbon economy.” BlackRock goes on to point out that if companies do not include this in their accounts, it could be regarded as “misleading”. 

Retooling accountants 

Analysis by Ernst & Young, a professional services company and analysis firm, Oxford Analytica suggests that the next 12 months are likely to result in the most significant innovations in corporate accounting and reporting in decades. 

There is no shortage of sustainability standards, which in itself poses a challenge. The global standard-setting process for climate reporting and disclosure continues to evolve, but questions remain about which information should be subject to mandatory disclosure, what is considered material and whether or not climate reporting should be integrated into management reports or remain separate. 

Some of the world’s largest carbon emitters are still not doing it, despite mounting pressure to do so. A recent study by Carbon Tracker and the Climate Accounting Project, an informal team of accounting and finance experts drawn from the investor community and commissioned by the PRI, found more than 70 per cent of the world’s heaviest-emitting companies did not disclose the full risks in their 2020 disclosures, with 80 per cent of audits showing no evidence the risk had been assessed. 

Accounting and banking bodies agree that a connection between financial impact, credit risk, and reputational risk needs to be forged with the fundamentals of ESG. While the audit profession alone will not change the course of climate change, better accounting standards that accurately reflect what risks companies are taking have a crucial role in aiding the energy transition. 

“Getting stakeholder buy-in in the process will be essential, and consistently communicating sustainability’s impact on the company’s bottom line will be the way forward,” said Ng. 

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