Financial statements should provide investors with a clear, honest picture of a businesses’ activities and financial well-being. In reality, far too many are failing to do so. How? By ignoring material climate-related financial risks.
A September report by the think tanks Carbon Tracker Initiative and Climate Accounting Project laid this out in black and white. They assessed 107 publicly traded, high GHG emitting companies and found that over 70% did not show that they had considered climate matters when preparing their 2020 financial statements. Furthermore, for 72% of companies, the presentation of climate matters in their financial statements did not align with the information provided in discretionary disclosures, like sustainability or climate reports.
Put simply, most firms do not factor climate risks in their most important disclosures, and the few that do often do so in a way that is inconsistent with their other public-facing communications.
What’s more, the think tanks found that auditors — the very organizations charged with scrutinizing and verifying the accuracy of businesses’ financial statements — are turning a blind eye to these errors and omissions. Eight in ten auditors produced no indication that they had considered material climate matters in their audits, and the think tanks had “significant concerns” with 59% of the consistency checks auditors were obliged to perform for their clients.
These findings should serve as a call to action for climate-conscious investors. In response, they should demand that climate matters are reflected in the financial statements of all the companies in their portfolios, and push them to improve their climate governance to ensure proper oversight of the reporting process. This kind of pressure could be applied through regular investor relations activities or by the proposal of climate-specific resolutions at annual shareholder meetings.
Such demands are perfectly reasonable. In fact, guidance from auditing and accounting standard-setters suggests that consideration of climate matters in financial statements should already be routine. A ‘Staff Audit Practice Report’, published by the International Auditing and Assurance Standards Board (IAASB) in October 2020, made clear that an auditor’s job includes judging whether a financial statement properly reflects climate change impacts.
Similarly, last November the International Financial Reporting Standards (IFRS) Foundation, which oversees accounting standards used in over 140 jurisdictions, emphasized that companies must consider climate matters when applying IFRS Standards “when the effect of those matters is material in the context of the financial statements taken as a whole”. ‘Material’ here being defined as anything that, if omitted, misstated, or obscured, could influence decisions that investors make on the basis of financial statements.
However, right now investors do not appear to be pushing their portfolio companies to adhere to such standards. In a recent study, Greenpeace found that auditors received over 90% support in 2021 in the annual general meetings of 74 ‘High-Carbon Companies’ that were part of the Carbon Tracker Initiative/Climate Accounting Project sample, the majority of which, remember, did not reflect climate matters in their financial statements appropriately, if at all.
Significantly, few large asset managers — even those that are on record saying they would turn on portfolio companies’ auditors if they fell short on climate issues — voted against. For example, BlackRock voted against only one auditor of the High-Carbon Companies, while SSGA opposed just two.
This suggests that investors’ climate actions have yet to match their rhetoric. In fairness, the mobilization of financial institutions in support of climate goals is still in its early stages. The various initiatives under the umbrella of the UN’s Glasgow Financial Alliance for Net Zero, for instance, are less than a year old. Once asset managers, asset owners, and other investors get to grips with their responsibilities as climate stewards, it is likely that they will take a more aggressive approach to ensure portfolios companies’ financial statements incorporate climate matters appropriately, and that their auditors guarantee the same.
However, to make certain, regulatory intervention may be required. In its report, Greenpeace recommends that the UK government set specific duties for company directors and auditors, so that in the notes to financial statements it is made clear whether and how they have used assumptions/estimates in their accounts which align with a 1.5°C corporate climate strategy.
Precisely how climate finance alliances choose to address the omission of climate matters in financial statements, and how legislatures and/or regulators will intervene, remains to be seen. However, as the slew of reports and guidance documents released this year show, this is a hot topic that is likely to attract more scrutiny, not less, in 2022 and beyond.