Companies need to make sure climate risk is reflected in financial statements

What’s happening? Thirty-four investors with at least $7tn of assets have said they could challenge directors of Europe’s 17 biggest companies over their climate risk accounting because the firms are not moving fast enough in the low-carbon economy transition. Companies targeted include bp, VW, Arcelor Mittal, Glencore, Daimler, Shell and Renault, and the investors have said a firm’s true value cannot be understood without knowledge of embedded climate risks. The investors said although most companies have announced net-zero targets, most have yet to match their accounts and other practices with these. (Reuters)

Why does this matter? Climate risks can pose a significant financial threat to companies and investors are therefore increasingly demanding these are incorporated into financial statements. Rathbones Group, for example, has said that ensuring company accounts are aligned with a 1.5C future is a critical part of its commitment to become a net-zero investor.

Examples of investor action – Rio Tinto’s investors recently voted against the firm’s financial statements due to a lack of clarity on climate risks. Sarasin & Partners, for example, said it voted against the firm’s decision to retain KPMG as auditor and questioned the performance of the audit committee.

Climate Action 100+ (CA100+) has recently backed a shareholder resolution at Irish building supplies firm CRH over climate accounting. CA100+ said that CRH’s financial statements fail to display how material risks have been considered and how climate targets are incorporated into assessments of assets and liabilities.

Investors put pressure on auditors – The latest letters sent by the 34 investors have been copied to the lead audit partners for each company. Auditors have been facing greater pressure from investors to consider climate risks – in November investors managing a total of $4.5tn wrote to Deloitte, EY, KPMG and PwC warning they will vote against the reappointment of the “Big Four” auditors by the companies in which they invest unless future audits include climate risk.

The investors referenced research from Carbon Tracker and the Climate Accounting Project that found that more than 70% of 107 listed firms assessed did not accurately reflect climate risks in their 2020 accounts.

The next accounting scandal? With auditors failing to consider climate risks in accounts a situation could arise where a company has significant climate risks which are not being communicated to investors and other stakeholders. Should these risks have a material impact on the firm this could result in an accounting scandal similar to those seen by auditors in the past. For instance, KPMG faced a lawsuit in 2020 over its alleged negligence in its audits of Carillion.

Incoming standards – Standards are being developed to aid the reporting of climate risks. The International Financial Reporting Standards Foundation has recently released draft corporate sustainability and climate disclosure standards through its International Sustainability Standards Board (ISSB). The ISSB proposals are designed as a global baseline for sustainability disclosures. Companies will be required to report sustainability-related financial information alongside financial statements.

The proposals build upon the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and embeds the Sustainability Accounting Standards Board’s (SASB) industry-based standards development approach.

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