AIQ: Cleaning up capitalism

Counting emissions and accounting omissions

The struggle to measure, monitor and manage corporate net-zero efforts

Accurately measuring, monitoring and managing net-zero initiatives is a major task for policymakers and corporate executives, which should be reflected in financial accounts.

Efforts continue to capture information better, within the natural world and the financial one that underpins flows of capital. Can accountants really save the world, as Peter Bakker, CEO of the World Business Council for Sustainable Development, audaciously suggested?1

A good place to start is to look at what we know. Take the carbon cycle, the backbone of life, which links an astonishing range of organisms and processes.

Just over a decade ago, researchers were contemplating where around one billion tonnes of warming carbon dioxide (CO2) might have gone. Scientists assumed some of the carbon produced by human activities had been sequestered by trees in the vast boreal forests in northern latitudes. In fact, the ‘lost’ mass was later found in tropical zones.

Most tropical rainforests are not closely observed. Building an overview involves taking a small amount of experimental data and marrying it with information from ecosystem models and satellite imagery.2 As a result, many of the estimates are inexact. Knowledge of the extent of GHG-producing agricultural activities is patchy too.

The amount of methane leaking from energy systems is another significant unknown. For example, recent US studies suggest network emissions from the Permian basin are three to five times higher than what is being reported.

So, unanswered questions abound. Although there is a formal GHG recording protocol in place and agreed units of measurement, we do not know precisely how much warming gas is being emitted from human energy systems, or from where. Equally, we don’t know the quantity of warming gases natural systems are emitting or sequestering, or where.

Accounting omissions

Accountancy finds itself at the centre of this confusion, charged with producing meaningful financial statements that bring once-considered non-financial disclosures onto the balance sheet. The challenge is doing it in a way that fairly represents what is going on.

There are obvious gaps between the narratives in the front end of company reports, where climate risk is mentioned a lot, and the sparse data appearing in the back end in the audited accounts. This makes it hard for investors to understand investee companies’ true exposures, with assets being valued as if there is no climate issue.

Deeper questions are being asked about the philosophy driving the metrics themselves. Who are accounts for?

Meanwhile, deeper questions are being asked about the philosophy driving the metrics themselves. Who are accounts for?

“The International Financial Reporting Standards Foundation (IFRS) suggests that accounts are primarily for investors,” says Richard Murphy, professor of accounting at Sheffield University Management School and founder of the Corporate Accountability Network. “Implicit within that is a purely financial capital maintenance concept,” adds Murphy.

Murphy believes the approach is inconsistent with sustainability because the financial capital maintenance concept creates a perverse incentive to exploit natural capital. If a resource is not properly valued, it will tend to be overused, and then scarcity forces values higher in the interests of a powerful minority. But the climate emergency needs a universal approach since we only have one planet. Instead, Murphy suggests maintaining environmental capital should be the primary goal for the long-term benefit of society.

Figure 1: Accounting systems as windows on the world3
Accounting systems as windows on the world
Source: Tax Research UK, December 8, 2020

For now, the climate externality is only partially addressed via carbon pricing and there is no explicit mechanism to hold companies to account regarding their net-zero targets.

One solution being discussed is sustainable cost accounting. Devised by Murphy as part of an academic challenge to bring climate directly into financial reporting, it suggests bringing decisions around carbon management onto the balance sheet of larger listed companies as part of TCFD guidelines. (More on Murphy’s views, here.)4

In countries like the UK, where achieving net zero is established in law, Murphy argues a crystalising event has taken place, which should force companies to set out exactly how they intend to achieve and provision for net zero.

Assessing value chain emissions

Take the way in which companies report scope 3 emissions from across their value chains (as distinct from operational emissions). This is a “messy” area, according to Steve Waygood, chief responsible investment officer at Aviva Investors.

“We began asking financial institutions to look through their operational activities to their business activities in 2020,” Emily Kreps, CDP’s global capital markets director says. “We asked what types of companies and issuers are being financed, what the nature of lending is, what credit facilities are being put in place and so on. We found the emissions from those business activities were 700 times greater than operational emissions from organisations making financial decisions.

“As players in the capital markets, financial institutions hold the purse strings and have the power. This is where I see a really significant opportunity for change.”

Questions on the values reflected in data gathering are going to be critical in addressing the climate emergency

Questions on the values reflected in data gathering, about how and what to measure and the value of metrics on the balance sheet are going to be critical in addressing the climate emergency. They will ultimately determine investment flows, who survives and who fails. But agreeing on what happens next is not straightforward.

“We are trying to course correct the global economy – by surveying the terrain, drawing the map and re-planning the route, all at the same time,” says Waygood. He describes the changes being discussed as both too slow for what is needed, but also far too fast for many who find themselves without the expertise they need to navigate.

Let the scrutiny begin.

Would you like to read the whole of AIQ: Cleaning up capitalism?

Subscribe to download a PDF copy or get a printed edition delivered directly to you.

Thank you for requesting a copy of our latest AIQ. We will send this to you shortly.

To keep up-to-date with our latest insights, please visit our main views page.

Please enable javascript in your browser in order to see this content.

Please select the format you wish to receive.

If you wish to receive a printed copy of AIQ, please enter your full postal address below.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive a digital and/or printed copy of the latest AIQ and receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our Privacy Policy.

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805.  Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ.  Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material.  AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”).  AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.

Related views