Blog: The disclosure of climate risks “clearly absent” in the financial statements? Will regulators act to demand more? | Cooley LLP

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In one of the illustrative comments of Corp Fin just posted sample comment letter on climate issues, Corp Fin is asking companies to explain their interest in providing the same type of broad climate-related disclosure in their SEC filings as in their corporate social responsibility reports . A place in company files with the SEC where climate-related disclosure is “conspicuously absent,” according to this report of the Carbon Tracker Initiative, appears in the financial statements. Although many companies face serious climate risks and many have even made net zero commitments, the report “found little evidence that companies or their auditors have factored climate-related issues into financial statements. of 2020 “. According to the lead author of the report, “[b]Given the significant exposure of these companies to transition risks, and with many announcements of emissions targets, we expected to see climate issues in finance significantly more than we found. . Without this information, there is little way to know the extent of venture capital, or whether funds are being allocated to unsustainable companies…. The disclosure of financial statements was so poor, the report concludes, that investors were essentially “blind”.

One of the reasons may be, as one commentator observed in this Bloomberg article, that much of the focus is on anticipating requirements that the SEC may impose in the future, but that companies may ignore current requirements. According to the commentator, “[n]o The American accounting rule explains how to take into account climate change or environmental impact. Nonetheless, “many rules require judgments and assumptions that take environmental considerations into account…” Businesses can have a blind spot on this matter. “

You may recall that in May Lindsay McCord, chief accountant of Corp Fin, said that SEC staff “were examining how state-owned companies account for climate-related risks and impacts on their operations on the market. basis of existing accounting rules “. According to McCord, when reviewing documents filed with the SEC, staff would consider the impact of environmental issues in applying current accounting standards, such as retirement standards, environmental obligations and contingencies. losses. March advice of the FASB addressed a number of GAAP-related topics and provided illustrative examples of how they might “intersect” with ESG. These included the assessment of going concern, the risks and uncertainties that could significantly affect the amounts presented in the short-term financial statements, the net realizable value of inventories, taxes, contingencies and liabilities. asset retirement obligations; and impairment of tangible and intangible assets, such as goodwill or other intangible assets with indefinite useful lives.

For example, under FASB guidelines, environmental issues could affect the estimated useful life of an intangible asset with a finite life, such as technologies developed. Likewise, a more energy-efficient product could have been developed as a replacement for an older product based on less energy-efficient technology, or green technology could have been acquired but might not have had commercial success than expected. Tangible fixed assets, such as tangible fixed assets, are subject to depreciation. In this case, the estimated salvage value or useful life of these assets could be affected by the introduction of more energy efficient products. Additionally, when indicators of impairment are present, a long-lived asset should be assessed for collectability. Environmental issues that could indicate a degradation of a manufacturing plant may include, for example, significant declines in market demand for products or regulatory changes that negatively affect the business. (See this post from PubCo.)

In the United States at least, these financial statement requirements may well be changed to take into account climate risks more explicitly. This Bloomberg article reports that the PCAOB’s interim chief auditor told a conference last week that PCAOB staff are “monitoring the debate” on ESG reports, and “testing[ing] and see again[ing] broader climate disclosure rules, ”given the likelihood that the SEC will require more disclosure. “We are looking at what we have and how it could be changed,” she said. According to the article, the PCAOB rules “on how auditors review information included in notes to financial statements and management’s discussions and analyzes could be involved, as could a general attestation standard.”

Like the SEC, the FASB has invited the public to comment on its future standards agenda, including climate-related issues, for example whether there are “common ESG transactions in which there is a
lack of clarity or need to improve associated accounting requirements. For example, as reported by Bloomberg, it may be “questions about accounting for investments in emissions allowances, carbon offsets, renewable energy credits and wind farms, or whether there are other current transactions related to ESGs why accountants need more clarity ”.

The Carbon Tracker Initiative report examined 107 carbon-intensive state-owned companies to assess whether they “factor in significant climate-related risks in their financial reporting.” Of the 107 companies, 94 were companies targeted by Climate Action (CA) 100+ (described as companies “identified as having a significant carbon footprint and / or as crucial for the energy transition”). The companies studied belonged to the following industrial sectors: “33% of oil and gas, 17% of transport, 13% of utilities, 7% of cement, 7% of consumer goods and services and 23% of other industries (including including mining, chemicals and steel). In addition, 41% were located in UK / Europe, 37% in US / Canada, 14% in Asia and 8% in emerging markets (excluding Asia). The report found that more than 70% of companies reviewed “fail[ed] to disclose climate risk in finance ”(although UK / Europe companies have been shown to be the most transparent). The report also found that, perhaps given their long track record of emissions and similar environmental issues, “energy companies have provided the most evidence and transparency around addressing issues related to energy. climate in their financial and audit reports… .. These companies were the most visible in terms of supply / detail of the assumptions used, even if they do not always take into account the climate in these assumptions, nor do they align them with the Paris favorite results. “

Here are some of the main findings of the report:

  • “There is little evidence that companies include significant climate-related issues in their financial statements.
  • Most climate-related assumptions and estimates are not visible in the financial statements.
  • Most companies don’t tell a consistent story in their reports.
  • There is little evidence that auditors take into account the effects of significant climate-related financial risks or climate strategies announced by companies.
  • Even with considerable observable inconsistencies in company reports (“other information” and financial statements), auditors rarely comment on the differences.
  • Companies do not appear to be using “Paris-aligned” assumptions and estimates.

For example, the report noted, as in the FASB guidelines, the depreciation of long-lived assets could be affected “by the energy transition due to declining demand for products or prices for raw materials, among others. However, few companies disclosed these inputs, leaving no way of knowing if the climate had been taken into account. This is distinctly distinct from information that is outside the financial statements, such as sustainability information. The report also found that none of the companies had incorporated Paris-aligned assumptions in their financial statements, even through sensitivity analyzes, despite requests from many investors.

Additionally, consistent with Corp Fin’s example comment noted above regarding consideration of information in CSR reports to be included in SEC filings, the report also raised concerns about “inconsistency” between business relationships ”. The report found that “72% of companies showed no evidence of tracking other discussions on climate risks or emissions targets to their treatment in financial statements, or explained differences. Despite this, 63% of auditors’ consistency checks did not identify these inconsistencies. “On this point, a co-author of the report expressed his disappointment that” companies recognize that the energy transition is likely to have a negative impact on their results, that their auditors identify prospective assumptions as critical audit questions subject to significant uncertainties, yet see little or no disclosure about the assumptions underlying the accounts, let alone an understanding of how management and auditors believed those assumptions to be reasonable. “

The researchers recommended that companies “disclose climate-related estimates and forward-looking assumptions, such as remaining useful life and projected carbon or commodity prices, to show how they account for climate-related risks. (and their own climate goals) ”. The recommendations also suggested that auditors “ensure that financial statements are consistent with other information provided by companies on climate-related matters, that assumptions and estimates that impact on the climate are adequately reviewed in audits and disclosed in a transparent manner in company reports, and that investor requirements regarding sensitivities are met.

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