As COP26 finance adviser and UN special envoy Mark Carney made clear at the IFAC and ACCA Climate Week event in September 2020, the accountancy profession is essential to the world’s achievement of a low-carbon economy.
Of course, the contribution of individual accountants to the transition will depend on their role, but there are few activities that accountants undertake that do not require them to think about climate impacts and their financial consequences.
The transition to a net-zero world capable of keeping global warming below 2°C requires climate-literate accountants who can:
- advise their clients and employers on the risks, liability and reputational damage arising from corporate activity that contributes to climate change
- support the strategic, operational and financial assessment of climate change, and steer their organisation towards the opportunities that decarbonisation brings
- provide management and investors with the information they need to understand the current and prospective impact of climate-related matters on an organisation, and its financial position and prospects.
The transition to a net-zero world capable of keeping global warming below 2°C requires climate-literate accountants
It may have been slow to start, but a low-carbon transition is underway. It will change how economies operate, creating both uncertainty and, at the same time, significant opportunity.
Governments and businesses are rapidly setting net-zero emissions targets. Some jurisdictions such as the EU, US and China are setting increasingly aggressive targets. In total to date, about 120 governments and a fifth of the world’s 2,000 biggest listed companies have made net-zero commitments.
However, these ambitious commitments disguise the reality: that business-as-usual remains prevalent.
The MSCI’s Net-Zero Tracker gauges the progress of the world’s public companies toward reducing emissions. It shows that without any change in their current emissions (which remain at 2013 levels), listed companies will deplete their remaining emissions ‘budget’, based on meeting the Paris Agreement’s target of limiting global warming to 1.5°C, in just five years and eight months. Companies have 21 years before they use up the emissions budget to limit global warming to a less ambitious 2°C.
Net-zero emissions commitments give a clear signal of intent to achieve the targets of the Paris Agreement, but there is significant work to be done – in particular, companies putting in place targeted strategies and robust short and medium-term targets, and ensuring, where possible, that future investments are clearly aligned.
Climate Action 100+ has put in place a net-zero company benchmark to help track business alignment with the Paris Agreement.
More than 40 asset managers, including Vanguard and BlackRock, signed up to the Net Zero Asset Managers Initiative, pledging to make their portfolios net-zero by 2050 or earlier.
In his annual letter, BlackRock CEO Larry Fink calls on all companies ‘to disclose a plan for how their business model will be compatible with a net-zero economy’. Capital markets have started to make decisions about the transition to renewable and sustainable energy, with the cost of capital for fossil fuel options increasing. Financial capital is seeking solutions to reduce greenhouse gas emissions.
Meanwhile, driven by the significant threat of climate-related stranded assets, central banks and financial supervisors are assessing their role in ensuring the resiliency of the financial system and the solvency of financial institutions (see Adapting Central Bank Operations to a Hotter World).
A major challenge for investors and the capital markets is that climate risk disclosure globally is inadequate. For climate risk to be fully reflected in company valuations, every company, bank, insurer and investor needs to disclose their climate-related risks on a standardised basis. Company valuations in a 2°C or lower world will likely be very different given the potentially significant implications on future cashflows.
Climate change can only be fully taken into account in valuations when companies have incorporated climate-related risks in their financial planning and performance. As climate is increasingly integrated into corporate decision-making and reporting, valuations will better reflect the actual and potential climate impacts.
Accounting and finance professionals have a critical role in achieving global net-zero emissions. In particular, CFOs and finance teams provide the information needed to drive decisions and allocate capital, and typically interface with the capital markets. Accounting4Sustainability’s Net zero – a practical guide for finance teams highlights the key activities of finance teams in helping to achieve net zero in their organisations.
We heard from KPMG at IFAC’s recent Professional Accountants in Business Advisory Group meeting that a significant challenge in climate-risk assessments and disclosures is that climate impacts are not quantified and monetised.
Quantification helps to drive medium and long-term planning, and is where accountants involved in financial planning and analysis can significantly contribute – by providing financial-related information about profits and valuations that reflect climate-related risks and events.
Without quantification of climate risks and opportunities, companies will find it hard to compare climate change against their wider enterprise risks, and investors will be unable to make informed decisions about the allocation of their capital.
There is also a critical link between internal financial planning and external reporting, of which accountants need to be aware. Carbon pricing is essential to understanding climate risk and a company’s economic outlook. Consequently, carbon pricing assumptions from internal financial planning need to carry through to financial reporting.
Without quantification of climate risks and opportunities, companies will find it hard to compare climate change against their wider enterprise risks
Inconsistent use of carbon pricing assumptions in asset and liability valuations for accounting and public disclosure hides from investors the potential for adverse effects of lower asset values, higher impairment losses, shorter estimated useful lives, and earlier asset retirement costs.
Rising to the occasion
Understanding and communicating how their company is becoming net-zero compatible will be part of any finance leader’s conversations with boards, investors and other stakeholders. They will need to explain risks and opportunities, targets and KPIs, prioritisation of capital investment, and financial impacts, including how climate change relates to accounting estimates and judgements used in the preparation of financial statements and reports.
For climate reporting to move beyond being a marketing exercise to providing information that boards and investors need to enable decarbonisation, accountants need to be part of the equation and rise to the occasion.