The green transition may depend on auditors
At this week’s COP26 climate talks in Glasgow, government ministers, finance officials, green activists and corporate leaders have paraded across the stages. One group that has not been highly visible, however, is the world’s auditors and accountants. That is a mistake.
For while the corporate and government pledges emanating from the talks have often provoked as many questions as answers, one issue is already clear: climate change action is about to put corporate auditors under the uncomfortable — and unaccustomed — glare of the spotlight.
That is because companies are facing rising pressure to come clean about their carbon emissions (and other green issues). Yet the framework for measuring this is still fluid, at best. So the onus is now on auditors to make all manner of judgment calls about green issues, to a degree that few ever expected — or have been trained for.
To understand why this matters, consider two announcements in Glasgow this week, from groups with ugly acronyms: Gfanz (or Glasgow Financial Alliance for Net Zero) and ISSB (International Sustainability Standards Board).
On Wednesday Mark Carney, former Bank of England governor, declared that 450 global financial institutions managing $130tn of assets had joined Gfanz, and pledged to use their financial muscle to promote decarbonisation and meet net-zero emission targets by 2050.
Green activists (correctly) complain that this eye-popping $130tn figure probably includes double-counting, and it is still unclear how much meaningful change those long-term goals will spark in the short term. Fears of greenwashing abound. But the announcement shows the speed at which the zeitgeist in finance is changing, as lenders come under pressure to prove their green credentials. As Carney notes, seven months ago, when the Gfanz was started, it only had a measly $5tn assets.
The key point that investors need to understand is that this shift is cascading into the clients of lenders — ie corporations — as well. The first test could come in the realms of steel and aviation: Jane Fraser, chief executive of Citi and a Gfanz leader, revealed on Wednesday that these two business sectors will be what the alliance targets first.
However, the pressure to adopt net zero pledges will inevitably spread through other sectors. While investor scrutiny has hitherto been focused more keenly on listed companies than unlisted entities, Larry Fink of BlackRock (and another Gfanz leader) is now demanding that targets be imposed on private capital too.
Politicians are also jumping on the bandwagon. On Wednesday, the British government announced it would make it mandatory in the future for companies to reveal their net zero plans.
All this will heap pressure on auditors to assess companies’ net zero pledges, but the question of how to do that is far from answered. At present, voluntary green accounting systems make up a confusing alphabet soup, swimming with different acronyms. The new ISSB framework, which is currently being developed by the International Financial Reporting Standards foundation, is supposed to create more clarity and consistency.
In theory this should make the work of auditors and accountants easier. The IFRS has credibility, since its standards are used in much of the world, aside from the US. Unusually, the body is not simply trying to overhaul reporting standards with the ISSB, but to apply the framework to audit processes too. Yet standard setters never move particularly quickly. Erkki Liikanen, chair of the IFRS foundation, told the COP26 meeting on Wednesday that companies could be using ISSB in a couple of years, but this may prove optimistic.
It is unclear what will happen in the meantime, or whether the US or China will adopt the eventual framework. Even if the details are thrashed out quickly and adopted globally, the hard truth is that measuring green issues will probably remain something of an art, not a science.
There is controversy, for example, around how to measure the efficacy of the carbon offsets market, or the green credentials of energy sources such as natural gas. There is also profound uncertainty about future projections of carbon emissions and carbon prices.
A cynic might point out that auditors have no right to complain about all this ambiguity. After all, the reason the profession can charge high fees is precisely because it is paid to make tricky judgments. But rarely has the profession been asked to make such slippery calls at a time when the stakes are so high, the mood is shifting so fast and scrutiny is growing.
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To cite one example: this week a coalition of asset managers with $4.5tn assets warned the Big Four audit firms that they will vote to end audit contracts at companies unless their judgments about green corporate issues become more credible. If nothing else, this will put the auditors under more scrutiny, and underscore that they could face reputational and liability risks if they ignore or misjudge climate risks.
Green battles are no longer only being waged with placards on the streets or on government podiums, but in corporate committee rooms too. Perhaps it is time for activists to retrain as auditors — this new front in the climate war could yet turn out to be a potent force for change.
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