IFAC and the ACCA hosted our second annual Climate Week panel on how accountants can create value in a climate emergency. The panel discussion, which you can watch in-full here, focused on the accountant’s critical role in climate action. While building on conversations from last year, the big difference, of course, is dealing with this systemic risk in the context of the COVID-19 pandemic. Climate risk will be with us long after the threat of COVID-19 dissipates.
Climate risk has significant financial implications and threatens value creation at portfolio and company levels. It is also foundational to the sustainable finance agenda and to stabilizing the climate at less than two degrees, as outlined in the 2015 Paris Agreement. The Private Finance work for COP 26 has a clear objective to ensure that every professional financial decision takes climate change into account from a risk and value lens.
Consequently, professional accountants have a significant task in bringing relevant and reliable climate risk information and analysis to internal and external stakeholders. In his closing remarks, Mark Carney, COP 26 Finance Adviser and UN Special Envoy on Climate Action and Finance, highlighted that the accountancy profession is essential to the fight against climate change.
We know that the role of accountancy is quickly evolving but there is a way to go to bringing accountants into the climate equation in many organizations. For example, during the panel conversation, Royal NBA Board Member Esther van der Vleuten highlighted the recent survey of Royal NBA members’ involvement in climate action, which found that accountants’ recent engagement in climate issues is limited, although they do aspire to play a greater role.
Based on the insights of our expert Climate Week panelists, here are three key areas where accountants must focus their efforts.
Financial impact of climate risk
Jane Thostrup Jagd of Ørsted emphasized the importance of high-quality reporting and disclosures. By aligning the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) and IFRS, finance and accounting professionals can ensure that their company accounts for material climate factors and delivers the financial-related information to investors about profits and valuations that accurately and clearly reflect climate risks and events. Disclosures that are quantified or monetized and presented in user-friendly tables enhances the usability of disclosures for investors.
Importantly, the TCFD should not be perceived as another non-financial reporting framework. Climate-risk information that is integrated into financial reporting will be more useful to boards and management, as well as investors. Climate-related financial disclosures should be incorporated into existing financial reporting at least on an annual basis but often more frequently.
There are various touchpoints between IFRS and climate risks, including IAS 37 Provisions, Contingent Liabilities and Assets; IAS 36 Impairment of Assets; IFRS 9, Financial Instruments; and IFRS 7 Financial Instrument Disclosures. The IASB has provided some guidance on the inclusion of climate-related matters within the scope of IFRS. The Climate Disclosure Standards Board has established a Climate Accounting Standards project group to build on its earlier report on how companies can use financial accounting to deliver the TCFD recommendations. Their project group, involving Jane Thostrup Jagd and IFAC, is developing additional guidance on integrating climate-related matters in line with current accounting standards – which should be available at the end of the year.
Forward-looking climate risk information in the context of different scenarios
Climate risk insights and disclosures are more useful in the context of scenarios-based risk assessments. Scenario analysis enhances both risk management processes as well as climate risk reporting by looking at time horizons beyond the short term. Ultimately, they show how resilient strategies and business models are to physical and transition (policy and regulatory) risk associated with climate change, and what might be done to future-proof against climate change. They also allow investors to identify assets and markets that are more likely to become stranded over time.
The practical preparation and presentation of scenarios help to identify the specific and relevant factors that can impact financial results. Jane demonstrated an investor-friendly climate scenario reporting approach (slides available here) that captures how different factors related to both physical and transition risk could impact a company financially.
David Wei who leads BSR’s climate practice works with companies to conduct climate risk assessment and scenario analysis. He reflected on the importance of prospective climate analysis for both managers and investors, and the challenges in undertaking and reporting on scenarios, including:
- Dealing with the complex interrelationships between risks and uncertainty of timescales and events
- Connecting climate models and scenarios (e.g. IEA, The Intergovernmental Panel on Climate Change, The Network of Central Banks and Supervisors climate scenarios) to companies’ financial information and business models. Off-the-shelf scenarios exist for different temperature increases and the resulting energy and economic pathways. The more bespoke the scenarios a company develops to help improve management decisions and capital allocation, the less comparability there is for investors. However, scenarios provide the basis for evaluating the climate resilience of business strategies to different climate scenarios.
- The required information for analysis can be incomplete (e.g. parameters for certain technologies, local data for climate variables), and uncertain (e.g. development of policies, future carbon and commodity prices). In addition to looking at a two-degree warming scenario, which is the basis of the 2015 Paris Agreement, it is useful to consider the potential impacts of more extreme scenarios and the transition and physical risk trade-offs. For example, a 1.5-2-degree world (based on aggressive mitigation) would be subject to significant transition risk, and a four-degree world (based on business-as-usual) would involve significant physical risk.
- Sectoral and geographical scenarios provide more relevant analysis of risks. For example, those companies with long and complex supply chains, such as those reliant on agriculture or long-lived infrastructure, will typically face greater physical risk. Given that increasing temperatures, more severe droughts and rising sea levels will continue because of the time carbon dioxide stays in the atmosphere (even in the event of emissions ceasing tomorrow), physical climate risks are largely “locked in” and must be planned for.
Climate-related financial information that is relevant and useful
The main areas of focus for finance teams and accountants need to be twofold:
- Driving and mainstreaming climate risk assessments and analysis into corporate decision making at the highest levels; and
- Ensuring climate impacts are quantified and monetized where possible.
To enhance the quality of climate information, accountants need to help ensure it is subject to the same procedures, processes, and controls as financial information so it can be reliably used in accounting, reporting and capital allocation.
Global standards for non-financial information would help deliver comparability, consistency, reliability and assurability of climate reporting, and provide a pathway for mandatory climate-related financial disclosure. Mark Carney highlighted the importance of the take-up of mandatory climate-risk reporting based on the TCFD recommendations as a common framework. Mandatory reporting is on the agenda of governments and regulators in various countries (New Zealand has become the first to implement mandatory TCFD reporting).
A move to a global and uniform approach would also help accountants and the profession in improving the quality of climate-related reporting and assurance. Enhancing the quantity and quality of reporting is critical to help investors align their portfolios to net zero targets. Providers of financial capital, including investors and central banks, are also increasing their commitments to disclose in line with TCFD.
The bottom line is that we all need to up our game to ensure that the transition to low-carbon economies is achievable. Accountants need to help their organizations and clients to improve climate risk assessments, information, reporting and scenario analysis.
Eu-Lin Fang of PwC Singapore highlighted the importance of applying the accountant’s professional and technical skillset to climate action. With their professional standards and Code of Ethics as a foundation, the more than 3.5 million professional accountants worldwide have a platform and unique opportunity to elevate their voice and participation in climate action.
The next 13 months, culminating in the Global Climate Summit COP 26 in November 2021. will prove decisive in tackling climate change. The accountancy profession and professional accountancy organizations can and must be proactive participants by building the capacity of their membership, who support organisations across the globe in managing and reporting on climate risk.
Additional list of useful resources:
- Nick Anderson, IFRS Standards and Climate-Related Disclosures
- The European Corporate Reporting Lab of the European Financial Reporting Advisory Group guidance on How to Improve Climate-Reporting, A Summary of Good Practices and Beyond
- The IAASB has issued a staff alert on The Consideration of Climate-Related Risks in an Audit of Financial Statements
- The CFA Institute’s report on Climate Change Analysis in the Investment Process
- The TCFD Recommendations technical supplement on The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities
- UNEP Finance Initiative, Changing Course, A comprehensive investor guide to scenario-based methods for climate risk assessment, in response to the TCFD
- TCFD Learning Hub