Climate change will have a major effect on companies’ profits and the value of their assets, so its impact should be reflected in their accounts.
That’s the conclusion of investors managing more than $100 trillion. The money managers and pension funds want companies to publish their 2020 annual reports in line with guidance from the International Accounting Standards Board that calls for incorporating climate-related risks in financial statements.
Where climate change is a material issue, company accounts should be drafted using assumptions and estimates compatible with the economic realities of a warming planet and in line with the temperature targets of the Paris climate accord, the investors said. Auditors should only sign off on reports that include such evaluations, they said.
The rapid warming of the earth caused by unfettered development and exploitation of the natural world threatens not only human and animal life but also the financial prospects for a swathe of businesses. Requiring companies to account for climate-related risks could result in a wave of writedowns and a broad repricing of assets.
“This is a big missing piece of the puzzle, and without it, we won’t really get companies to address climate change,” said Fiona Reynolds, chief executive officer of the Principles for Responsible Investment, the world’s biggest industry body for social investing. While some companies already disclose their strategy for managing risks associated with global warming, incorporating climate into the profit and loss statements and balance sheets will provide investors with a much more comprehensive picture of how material such issues are to their businesses, she said.
The PRI is among a coalition of investor groups pressing for corporate reporting to reflect climate-related risks. Other partners include the Institutional Investors Group on Climate Change, the UN Environment Program Finance Initiative, the UN-convened Net-Zero Asset Owner Alliance, the Pensions and Lifetime Savings Association, the Investor Group on Climate Change and the Asia Investor Group on Climate Change.
Accounting standards play a key role in how companies calculate their profits, demonstrate solvency and remunerate senior executives, so the effects of including climate change risks may be significant. This is especially relevant when dealing with assumptions about the future, such as with regard to the value or profitability of certain assets.
For example, assets like coal-fired power plants that were supposed to operate over many decades with building costs written off over their useful life may find that regulation or environmental activism dramatically shortens the period of depreciation and significantly impairs their profit forecasts.
“Many companies in all sorts of industries are going to have to revalue their assets so that they are sustainable,” said David Pitt-Watson, an investor and fellow at Cambridge University’s Judge Business School. “Otherwise we’re sitting there thinking that the assets have value but really it’s like a bank sitting on a bad loan.”