COP26 Key Takeaways for Business and Accountants
Although not everyone views the COP26 Climate talks as a success, the UN Framework Convention on Climate Change (UNFCCC) Conference of the Parties (COP) is a crucial international mechanism for politicians and other key stakeholders to make progress in dealing with climate change. And progress is what happened in Glasgow in November.
Current country emissions reduction commitments (reflected in Nationally Determined Contributions or NDCs) are predicted to lead to a 68% chance of temperatures rising to 1.9°C-3.0°C, with a median value of 2.4°C. This is of course well over the 2015 Paris-Agreement to keep global warming “well below 2ºC”, with countries pursuing efforts to keep warming down to 1.5ºC.
With the 1.5ºC “carbon budget” quickly running out, the high expectations of COP26 to lead to commitments that are more likely to deliver on the 1.5-degree commitment did not materialize. However, agreements and discussions at COP26 will lead to an accelerated transition to decarbonized economies.
This is the COP where net zero commitments became mainstream. Governments and the finance sector firmed up actions to achieve net zero. We witnessed new country commitments including India, China and the US, new agreements for fossil fuel phase down and ending deforestation, and renewed commitments to increase the flow of money to developing economies. Importantly, governments agreed to increase their NDC pledges by 2022 instead of the middle of the decade.
The finance sector committed to portfolio transition commitment Glasgow Financial Alliance for Net Zero. Accessing financial capital will become dependent on achieving emissions reduction and related sustainability goals and a having a climate transition roadmap.
If it was not clear already, PwC’s 2021 global investor survey shows investors stating that reducing greenhouse gas emissions should be the top ESG priority for business. And for climate change to be managed effectively, investors expect climate risks and opportunities to be a core part of a company’s strategy.
More is expected of business as a result of COP26 particularly in terms of turning net zero commitments into plans and actions. A spotlight on greenwashing and misleading reporting will also mean that boards and CEOs will be turning to their CFOs and accountants to ensure an integrated and connected approach to sustainability in strategy and resource allocation, and greater accountability and transparency. Auditors also need to be alert to climate-related events or conditions that may contribute to the susceptibility of certain accounts and disclosures in a company’s financial statements to be misstated.
Keeping Up with Expectations on Enhanced Reporting and Disclosure
At COP26, the launch of the new International Sustainability Standards Board (ISSB) was announced with IFAC’s full support. This a significant and much needed achievement in the journey to establish global Standards for investor-focused sustainability disclosure.
Other events put the spotlight on investor expectations on enhancing transparency through financial reporting particularly based on International Financial Reporting (IFRS) Standards and the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD).
IFAC partnered with the CDSB on an event at COP26 on Accounting for Climate to highlight recommendations for improving reporting of climate change information given that investors and other stakeholders now consider climate change to be a material issue that can have financial consequences for many companies. IFAC has also issued a statement to its members, Corporate Reporting: Climate Change Information and the Reporting Cycle, to address this issue.
On the back of its research report, Flying Blind, The glaring absence of climate risks in financial reporting, Carbon Tracker ran a COP26 event in collaboration with Ceres, IIGCC and PRI which specifically explored the expectations of accounting for material climate-related issues in financial statements. The expectations for “Paris-Aligned Accounts”, which some asset owners and managers argue is necessary to shift capital flows to investments that will bring about the Paris Agreement, are set out in IIGCC’s report, Investor Expectations for Paris-Aligned Accounts.
The need for greater accountability and transparency of climate risks and opportunities is not contentious. However, it is important for accountants in business and auditors to be aware of how climate-related matters are relevant in relation to strategy and business models, and the material disclosures that should be disclosed and where to disclose them if they are to be considered decision-useful for investors.
A significant challenge in current reporting practices is a perceived lack of consistency between a company’s management (“narrative”) reporting on what a company is doing about climate change including its targets, and the assumptions and estimates used in the financial statements. The need for consistency also applies to the estimates used in financial reporting and those used in other separate reports such as sustainability or TCFD reports.
This is particularly an issue for certain industries where financial risk and opportunity largely arise from the need to retire and replace carbon-intensive assets on an accelerated basis. Climate change could impact disclosure, recognition or derecognition of assets and liabilities and the measurement of such assets and liabilities. For example, where a company has announced a net zero commitment, and has planned to retire infrastructure or capital assets and replace them with options that allow their climate targets to be met, estimates about the assets’ useful lives and residual values are likely to need adjusting.
Accountants and auditors need to ask the question: will there be accounting implications of a company’s emissions reduction targets, and plans to mitigate and adapt to climate change? The impact on the recognition and measurement of items in the financial statements, and possible need for additional disclosures, needs to be considered from the perspective of both individual assets, and the ongoing viability of an existing business model and the company’s ability to continue as a going concern.
Given the uncertainty around the timing and nature of events and assumptions such as around commodity prices, demand for products and services and changes to carbon prices, forecasting and forward-looking information becomes an important aspect of disclosure in financial statements as it currently is for fair value measurement and impairment testing. Scenario and sensitivity analysis are the basis for providing understanding and transparency on the timing and the likelihood of climate impacts that are needed for both planning and to understand the consequences for financial position and performance. Accountants need to then ensure that material transition and physical climate risks are considered in financial reporting.
This can be a challenging task depending on the facts and circumstances facing a specific company, and the way different climate-related scenarios may impact it -- including the time horizon for the climate-related risks. Climate risks may exist, but the impact on current-period financial statements may not be considered material. However, with climate being a high-profile issue this reporting season, this is an area that companies, and their accountants, cannot afford to ignore, or get wrong.
Accounting for climate guidance on how climate-related matters should be integrated into financial reporting based on IFRS Standards is available on the CDSB website. This guidance considers disclosure and examples in the context of the different types of estimation and measurement approaches used in different accounting standards.
For a discussion on what individual accountants can do right now to accelerate adapting for climate change, watch Accounting for our planet, IFAC's joint event with PAFA, ACCA and CA ANZ.