Governments' push for net-zero

Tax – including pricing – and regulation are two of the biggest levers they can pull. Tax has the capacity to both change behaviour and encourage investment in clean businesses and low-emissions technology, while regulation has the ability to stop certain practices outright, as happened with ozone layer-damaging CFCs in the 1990s.

Different countries will take different approaches to taxing emissions. Some will use the carrot, and others the stick, or both, depending on their respective context. And, as we have recently seen with war in Europe, that context can change rapidly.

Raising taxes

If a government chooses to heave on the tax lever, it has three basic options: pricing, incentives and increases. Tax increases are the bluntest of the three: they can punish businesses for carbon-intensive practices, help raise revenue to invest in renewable energy and ecological rejuvenation, and force companies and consumers to pick less polluting strategies, products and services.

But tax rises can also have a deleterious effect, passing costs on to those who can least afford to bear them and pushing economically viable companies out of the market. Taxing fuel for car users, for example, could end up pricing drivers off the road.

Chris Morgan, KPMG’s head of responsible tax, says: ‘Alternatives need to be available – for example, in the shipping industry. A few years ago if you raised taxes on heavy fuel, the cost of freight would have skyrocketed. But since synthetic fuels have become available in the maritime business, a tax would be more effective, encouraging voluntary movement away from polluting heavy fuels.

Pricing carbon

Pricing, says Morgan, is ‘probably the best way to tackle temperature rises if you listen to economists and academics, because it drives change and provides stability in the direction of travel’. Taxes, he adds, ‘are too slow an instrument to be used alone, and need supplementing with regulation’.

In theory, pricing puts a cost on carbon emissions associated with particular products and services. This can then either be taxed outright on fuel or emissions, or be used in a ‘cap and trade’ system that sets an ever decreasing maximum cap on the entities it covers, allowing those entities to buy or sell emissions allowances as required.

Cap and trade is generally thought to be a more efficient system. ‘It focuses efforts on decarbonisation where there are quick wins, but it’s a much trickier system to run,’ Morgan says. For developing countries where supply chains are somewhat shorter, it can be simpler; but in highly developed countries, it quickly becomes complex.

Innovation incentives

The carrot is often a more popular approach in North America. Morgan says that the region is more ‘culturally resistant to the government carrying a big stick’.

Emissions trading schemes, tax rises and regulation can all help reduce carbon footprints, but incentives encourage the large-scale innovation required to develop new sources of energy, clean up existing damage to the environment, and upgrade infrastructure so it can use alternative power.

‘We shouldn’t get too hung up on which approach to take,’ Morgan says, ‘since a bit of every approach may actually be the most effective way of tackling the problem quickly.’

Accounting for emissions

While the approaches may differ, there will be one common denominator: more, and more detailed, measurement and subsequent reporting. The field of measurement is changing rapidly, both on a scientific level, where the true cost of carbon is calculated, and on a financial level, where regulators and companies attempt to translate industrial activities into broader business and monetary terms.

There are well-used existing measures and reporting frameworks such as the TCFD and GRI. But the ultimate goal of calculating and reporting carbon emissions has always been a broadly accepted accounting framework that drives sustainable behaviour. The good news is that, at last, it may be just around the corner.

The IFRS Foundation set up the International Sustainability Standards Board (ISSB) in 2021 to design a framework for accounting for sustainability, including integrating financial accounting into the picture for the first time. But there remains a gap between the ISSB’s approach and the EU’s, with the former focusing on financial implications, and the latter focusing on sustainability – and impact, in particular.

Banking challenges

A recent report from Imperial College Business School points out that the constantly changing investment landscape also demands new accounting standards for new asset types. In particular, certified carbon offset credits (also known as carbon offsets) – measurable emissions reductions from certified climate action initiatives – remain misunderstood as financial instruments, which creates a barrier to standard-setting in this space.

The report notes that the current lack of clarity and guidelines around carbon markets’ financial accounting and risk management has significant implications for banks’ regulatory capital requirements in their role as intermediaries in the emissions trading system.

It recommends that rather than being classed as intangible assets or inventories, carbon offsets should be thought of as investable assets used as part of a bank’s offering to corporate clients for offsetting and hedging purposes.

Business impact

In the meantime, volatility for business abounds. While recent events have led to a pause in progress – some coal-based power plants in Europe have been fired back up, for example – in general, the move towards decarbonisation has accelerated. Western nations in particular are looking for renewable alternatives to release themselves from the bonds of Russian gas and oil.

Businesses should not sit and wait to see how it shakes down. Morgan advises: ‘They should continue to horizon-scan, understand what’s out there in terms of incentives, analyse the impacts of regulation and taxes on their supply chain, and identify where quick wins can be had.’

As for accountants and other finance professionals, Morgan says: ‘Their role is to help their clients understand the reporting side of things, in particular to assist them in telling a coherent and consistent story to both the public and regulators.’

On the advisory side, he adds, finance professionals should ‘wade into helping companies with their decarbonisation strategy: how to measure carbon output, and how to make changes to the business, tax and legal side of the business in the face of their findings’.