- Accounting standards set guidance on reporting on climate risk that is not being followed by most companies or their auditors.
- Investors and proxy advisory firms could do a lot more to push companies and auditors to include climate risk in their financial reports, such as voting against accounts with inadequate disclosure.
- The ‘big four’ auditors admit they have a role to play and say they are ramping up education and resources on climate risk reporting.
The push for companies to report more sustainability-related data, particularly on climate, is gaining momentum as investors and regulators step up efforts to drive such disclosure. Yet one key section of the market is failing to play its part fully, even by its own admission: auditors.
This is a crucial issue, as data on levels of greenhouse gas emissions is sorely needed, because – as is often stressed – it is difficult to manage what you do not measure.
Indeed some investment experts say unaccounted-for climate factors in risk management could lead to the next big audit scandal to rival those that blew up around US energy group Enron in 2001 or British retail chain BHS in 2016 as a result of serious accounting failures.
Accordingly, certain investors – such as UK retirement fund Railpen and UK asset manager Sarasin & Partners – are ramping up action against companies and auditors on this front, such as by voting against accounts lacking sufficient climate disclosure and urging their peers to do the same. But progress is slow.
Accountancy and auditing standard-setters, such as the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standards Board (IAASB), have for at least two years required consideration of material climate risk. But companies and auditors are generally not applying this when it comes to financial accounts, says Sue Harding, a member of the Climate Accounting Project, an informal team of accounting and finance experts convened by the UN-backed Principles for Responsible Investment (UN PRI).
The IAASB states: “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.”
This was acknowledged by the six biggest auditing firms – BDO, Deloitte, EY, Grant Thornton, KPMG and PwC, under the mantle of the Global Public Policy Committee – in a letter in December 2020. However, the committee also wrote that it supported the development of a principles-based, globally consistent framework for “non-financial” reporting standards.
Lack of certainty over climate risk
And there’s the rub: there remains disagreement over whether or which climate risks are financial risks, as the response to Stuart Kirk of HSBC’s recent comments made very clear – and it is still left to the market to decide.
Many investors – such as signatories to $68trn investor initiative Climate Action 100+ (CA100+) – say climate change is unquestionably a material financial risk. But companies typically baulk at having to take on a greater disclosure burden, especially in an area they are not familiar with. And their auditors are unlikely to take a hard line with their corporate clients if they are not explicitly required to.
Accordingly, 70% of 107 listed carbon-intensive companies and 80% of auditors failed to disclose climate-related risks in the financial statements and audit reports, found a report from London-based think tank Carbon Tracker in September last year (see chart below). Forty-three of the companies were based in Europe, 40 in North America, 15 in emerging markets and nine in Asia.
This is a systemic problem, says David Pitt-Watson, leader of the Climate Accounting Project. Climate risk needs to appear in the financial accounts because then it is incorporated into a company’s financial models and strategy, as it needs to be, he adds. Reforms being introduced by the likes of the US’s Securities and Exchange Commission and the International Sustainability Standards Board need to ensure that, Pitt-Watson argues.
Regulatory pressure is at least building across jurisdictions. In 2020, the UK’s Financial Reporting Council did a thematic review of climate disclosures and found audits did not meet accounting standards, and on 15 June this year released a consultation on whether to publish quality indicators for the largest UK audit firms, including on climate.
Investors' voting reluctance on climate disclosure
However, investors could be doing a lot more to push the agenda.
In a move led by Sarasin & Partners, CA100+ for the first time urged its 700 member firms to vote against the audit committee chair, auditor and the company’s accounts at Irish building materials company CRH over its inadequate disclosure on climate change at its AGM on 28 April. Yet only 2.06% of CA100+ signatories did so.
Indeed financial charity ShareAction issued a report last month arguing that CA100+ was falling short of delivering meaningful progress on climate and needed to be a lot more transparent about – and set a higher bar for – the aims and outcomes of its engagement with companies.
Sarasin & Partners is a particularly vocal advocate on this issue, with Natasha Landell-Mills spearheading its push as a London-based partner and head of stewardship at the £15.2bn firm. She had noted after the 2008 financial crisis that banks had been failing to reflect material risks in their accounts and that auditors were nonetheless signing them off. The implications of that are clear.
Now Landell-Mills says the same issue is happening with climate risk.
Accordingly, Sarasin voted against the reappointment of the auditor at 16 companies last year due to their failure to demonstrate adequate testing for decarbonisation, noting that it was “virtually alone” among investors in doing so.
Proxy voting advisory firms could also be doing more, says Landell-Mills. She contributed to a study, published on 13 May, that found that ISS and Glass Lewis were failing to consider whether climate risk was being properly incorporated into carbon-heavy companies’ financial statements or by the auditors charged with calling out potential financial representation.
Similarly, Railpen, the £37bn retirement fund for the British rail industry, has a policy to vote against auditors that are signing off on accounts that it feels do not adequately incorporate climate risks.
In the US, meanwhile, sustainability-focused $60trn investor network Ceres is making similar efforts. It released a report in June 2021 that analysed how the US oil and gas industry should consider climate change to comply with US financial disclosure standards and investor expectations.
Ceres is engaging with auditors on the issue, says Tracey Cameron, director of corporate climate engagement. “There has been a slight bit of improvement this year, but I would say it is not nearly enough.”
Auditors acknowledge key role in climate risk
When contacted by Capital Monitor, the ‘big four’ auditing firms – Deloitte, EY, KPMG and PwC – did acknowledge they had an important role to play in providing assurance on climate risk disclosures and outlined the efforts they were making on this front.
For instance, PwC introduced mandatory consideration of climate-related financial reporting risks for all of its audits in the UK in December last year, says Hemione Hudson, UK head of audit: “We now reference climate change considerations within our audit reports for FTSE 350 organisations, with greater detail given where we have identified the entity as facing higher climate risk.”
Meanwhile, Larry Bradley, New York-based global head of audit at KPMG International, admits the firm can do more to encourage those it audits to consider appropriate climate risk disclosure in financial accounts and recognises.
Accordingly, in June last year KPMG launched a financial reporting resource centre to help its teams audit climate change risks, Bradley says.
Deloitte and EY also said they had enhanced internal guidance and training on climate-related information, the former in August last year. EY did not say when it had done so before this article went live.
Auditors appear keen to do better when it comes to climate risk reporting. With the launch of the CA100+ accounting and audit indicator in March this year, it may soon become clearer if their rhetoric matches reality.
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