The issue

Until recently, companies were able to report profits as though climate change did not exist. 

In the oil sector, a newly discovered oil well could be valued as though the oil coming out of it will be sold at $80 a barrel through to 2050 and beyond. A thermal power plant or a fossil fuel engine factory could be valued as though its future was indefinite and unchallenged by climate concerns. In most cases investors did not know what climate assumptions underpinned a company’s profits.

In a bid to address this issue, investors have coalesced over the last two years via a campaign supported by organisations including the Principles for Responsible Investment (PRI), The Institutional Investors Group on Climate Change (IIGCC) and the United Nations Environment Programme Initiative (UNEPFI). They hope to persuade international accounting standard setters that these practices should change and that the application of standards need to be clarified so that climate is considered in drawing up accounts. 

Regulators and accountants come on board

Most of the world uses International Financial Reporting Standards (IFRS), which are established by the International Accounting Standards Board (IASB). These standards are long established, mandatory in 140 countries, and apply to all companies, not just publicly quoted ones. 

The USA, and some other territories, have their own standards; the US ones are established by the Financial Accounting Standards Board (FASB) on behalf of the Securities and Exchange Commission (SEC). Auditing Standards are established globally by the International Auditing and Assurance Standards Board (IAASB) – in the US, these are applied by the PCAOB.

In a letter on the climate reporting topic to the International Accounting Standards Board (IASB), The Global Public Policy Committee (GPPC), which convenes the Big Four accounting firms (Deloitte, EY, KPMG and PwC) and mid-tier firms BDO and Grant Thornton, committed to “playing their part” when it comes to assuring that climate risk is properly reflected in company financial statements. However, they added that: “management and those charged with governance have the primary responsibility for the judgements, estimates and disclosures in the annual report and financial statements.”

Addressing climate-change risks

An initial paper endorsed by the GPPC firms, titled IFRS Standards and Climate-Related Disclosures [i], was published by IASB member Nick Anderson, in November 2019. 

According to Anderson, even if not explicitly mentioned, climate-change risks could be addressed by current reporting standards. Listing some of them and offering practical examples, he argued that: “IFRS Standards could require companies to consider climate-related and other emerging risks when making materiality judgements about what to recognise in the financial statements, about measuring recognised assets and liabilities and about what to disclose.”

A second major paper, titled The Consideration of Climate-Related Risks in an Audit of Financial Statement [ii], was signed by the staff of the International Auditing and Assurance Standards Board (IAASB), an independent body that is supported by the International Federation of Accountants.

That paper said: “If climate change impacts the entity, the auditor needs to consider whether the financial statements appropriately reflect this in accordance with the applicable financial reporting framework […] Auditors also need to understand how climate-related risks relate to their responsibilities under professional standards, and applicable law and regulation.” 

The ICAEW, which is the largest professional body of accountants outside the USA, has also written about the need to consider climate [iii].

The question will be whether the accounting firms, and the companies they audit, are pushed to follow the new guidance. The opinion of policy makers will be key here on whether they require companies and auditors to deliver on the opinions expressed by the IASB and IAASB.   

What do investors say?

Under the new accounting guidance, companies can continue to use assumptions which are incompatible with sustainability, provided these are published. Key investor groups have insisted that not only do they want to see IFRS properly applied, they also want to know that the assumptions used are aligned with the Paris Agreement. 

Investors organised through the IIGCC have been pressuring companies to reconsider the way they draw up their accounts. They have had some success. BP’s decision to write down up to $17.5bn in assets in Q2, 2020 [iv],  and to cut future capex, noted that the projections it was making about future oil prices were unsustainable. 

Blackrock, the world’s largest asset manager, has given its support to the investor pressure. It said: “Financial reporting should reflect reasonable assumptions about the impact of climate change and the transition to a low carbon economy (that is one where global warming is well below two degrees Celsius, ideally 1.5 degrees, and is consistent with a global aspiration to reach Net Zero carbon emissions by 2050).” 

It pointed out that if companies do not include this in their accounts, “and therefore may be misleading, Blackrock would reflect [its] concerns about management’s assumptions in [its] votes on financial statements, approval of auditor, or election of directors.”

Climate accounting is also now becoming part of the Climate Action 100+ framework [v], investor-corporate engagement initiative.

PRI has asked its signatories to individually sign an investor statement [vi] to support its continued engagement with the audit industry, accounting bodies and regulators to support the implementation of the IASB opinion.

The follow up….and the US?

To help investors, the PRI, IIGCC and others have put in place a system to monitor whether companies and their auditors are following the rules. For the 2020 reporting season, Carbon Tracker, the environmental research group, and the PRI are monitoring the accounts of over 100 companies (including many in the USA) to discover the degree to which these interpretations have been observed. Individual company briefings are being made available to CA100+ investors and will be available on request to other investors who want to know whether a company has followed the rules, and if so, whether its financial model is compatible with a sustainable climate.

IFRS standards apply outside the USA. However, US accounting standards are based on similar principles to those of IFRS, and the new US administration has made climate and related reporting a priority. Logic suggests that preparers of US financial statements will likely follow a similar approach. Investor groups are preparing to ask the SEC to issue guidance similar to that given by the IASB. The IASB and the FASB can set standards and interpretations. But they have no power of enforcement. That must be done by their regulators and the investors approving accounts.

If companies do not respond, investors say they might consider whether it is appropriate to approve the accounts, the appointment of the auditor, or the elections of directors, including the finance director or the chair of the audit committee.

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