Climate change should already be in the company accounts
The world of climate reporting gives the financial crisis a run for its money on acronyms.
Coming together in the effort to standardise how the world should define and track corporate sustainability is a collection of interested parties including the CDSB, the TCFD, the IIRC and the SASB (the latter two of which are now known as the VRF). Others such as the GRI and the CDP are also involved.
You don’t really need to know what all these stand for, or what they’ve done to date. They all care about having consistent reporting concerning environmental, social and governance (ESG) issues and are working with the IFRS Foundation to set up an International Sustainability Standards Board, or the ISSB. That will be the sustainability standards setter alongside its accounting equivalent, the IASB.
That a project aimed at clarity manages to be quite so confusing in its genesis is less than ideal. But having a robust set of standards to track corporate emissions, water usage or other social or environmental factors is important, given that the world of ESG data and sustainable investing is a bit of a mess.
A separate, but related, question is to what extent consideration of climate change is already factored into accounts today, particularly the financial statements. Bottom line: it should be, but largely isn’t.
The international accounting body has gone out of its way to clarify this point. Yes, the International Financial Reporting Standards, or IFRS, does not explicitly mention climate-related issues. But the rule-setters said last November that climate matters should be reflected in financial statements where that information could reasonably be expected to influence the decisions made by users of the accounts.
One area of focus is the future cash flows expected when testing an asset for impairment, and the judgments and uncertainties surrounding that calculation. Others include valuation and risk around financial instruments, the value of inventories, or the residual value or useful lives of assets. Requirements to disclose any other material information covers, well, just about everything else.
This isn’t happening. “There is no clear evidence that companies consider their strategic goals or climate-related risks in the preparation of their financial accounts”, says Barbara Davidson at Carbon Tracker. She has been leading an analysis of accounts focused on Climate Action 100+ companies, the largest emitters globally, with a report due in August. Even groups that provide climate targets and talk about transition tend to have financial reporting that reflects “business as usual”, she says (although UK companies do better with the US bringing up the rear).
This isn’t just a question for fossil fuel companies such as BP and Shell, which have both announced writedowns of assets as the prospect of lower oil demand filters through to the numbers. The analysis for Unilever, which along with a selection of others has already been published, cites “some concerns” about accounting judgments and consistency with other reporting, and “significant concerns” in other areas such as the visibility of climate assumptions, and the consideration of climate factors in the audit. And Unilever is, rightly given its recent plans around climate and transition, considered something of a leader in the ESG stakes.
A recurrent complaint of investors is that statements made in so-called front-half reporting, such as the strategic review or management commentary, tend not to match up with the back half where the numbers are. (And a consistency check between the two is one job of the auditors).
In other words, the story being spun about commitments to net zero in the glossy-picture pages isn’t reflected in the numbers, footnotes and other wonky disclosure.
Climate should, surely, already be a focus for the audit. But it is notable, says Paul Lee, head of stewardship at investment consultant Redington and a contributor to the analysis, how few audit reports mention the use of experts in climate or carbon markets, even as audit firms trumpet their credentials to vet sustainability information more generally.
Yes, the world needs better, more consistent standards around sustainability. But that’s no reason to luxuriate in the status quo while those are developed. The impact of climate change should already be evident in the company accounts.