I imagine that every reader is aware of the Dutch tulip bubble of 1634-37, which came and went in less time than it takes the International Accounting Standards Board (IASB) to produce an exposure draft (ED).
The mania was notable for many reasons, but one of the lesser known developments was the introduction of tulip futures. You could buy tulips on credit and you could speculate on forward prices. More recent crises have also been supercharged by leverage and derivatives; the Dutch were truly ahead of their time.
This came to mind recently when I was looking at the accounting for carbon-related instruments. I think you can make a strong case that tulips were in effect financial instruments. They had tangible form but they were also an investment asset. I sometimes wonder what an ED on the accounting for tulips would have looked like. The impairment test might have been genuinely funny.
To my mind, tulip futures, crypto currencies and carbon-related instruments are all financial instruments. There is a market price; people trade them to mitigate risk and to make money, and disclosure should reflect this. I once heard former IASB chair Sir David Tweedie joke that his ideal standard on financial instruments would contain two sentences:
- Mark all assets to market at the end of every period and take the resulting gain or loss through the income statement.
- Go back and reread the first sentence.
I find it quite hard to argue against this.
A report looking at carbon-intensive companies found the standard of accounting to be woeful
Opaque mess
ACCA and the Adam Smith Business School at the University of Glasgow recently published a report, Reality of accounting for carbon-related instruments. The conclusions were not encouraging. It looked at 300 carbon-intensive companies and found that the standard of accounting was woeful (my adjective, not theirs).
The first problem is that carbon-related instruments come in many forms. The second is that narrative disclosure is poor and the third is that you can’t easily trace the impact on the financial statements. The phrase ‘opaque mess’ springs to mind.
From an investor’s perspective, this is very unsatisfactory. There is always a cost in buying and selling financial instruments, so it’s fair to assume that companies are doing this for a reason. The first thing I would like to see is a proper narrative discussion explaining the motivation.
One can make a similar point about currency hedging; my first question is always: ‘Why are they doing this?’ Answers will vary from company to company but should help investors to understand what is going on.
Tesla made US$2.75bn from selling carbon credits, compared with US$8.4bn in net income
These are not just esoteric issues. In 2024, Tesla made US$2.75bn from selling carbon credits to other car companies, compared with US$8.4bn in total group net income. For the buyers, this is a legal way to mitigate fines from making polluting vehicles. Understanding these transactions is a key part of analysing what is happening in the global automotive industry. I can see why the buyers might want to keep this quiet – it’s a little embarrassing, to say the least – but as an investor I want to know what is going on.
Tracking the story
The other big issue for me is being able to track all this through the financial statements. I want to know what the costs are, where they are being booked and where to find all this on the balance sheet. Maybe IFRS 18, Presentation and Disclosure in Financial Statements will help with this, if implemented well.
At a high level, it seems to me that the trading of carbon assets is primarily a form of hedging. The underlying (and laudable) idea may have been to price the cost of emitting carbon dioxide fairly, but the outcome has been disappointingly obfuscatory.
My solution would be to add a third sentence to the Tweedie dictum: tell investors what you are doing and why.
