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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.

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