Big four auditors face investor calls for tougher climate scrutiny announces a recent story on Reuters.

Written by Matthew Green and Simon Jessop, it starts out like this:

• European investors managing assets worth more than 1 trillion pounds ($1.28 trillion) are pressing top auditors to take urgent action on climate-related risks, warning that failure to do so could do more damage than the financial crisis.
• The case for tighter auditing has been bolstered by public statements from regulators and accounting watchdogs highlighting the potentially systemic risks that climate change could pose.
• In a letter sent in January to the so-called Big Four — EY, Deloitte, KPMG and PwC — the investors said they were concerned that climate change was being “ignored” in accounting and audits. The letter was seen by Reuters and its contents are being made public for the first time.
• “The overarching thing is that we don’t want another financial crisis, and this could be a lot worse,” said Natasha Landell-Mills, head of stewardship at asset manager Sarasin & Partners, which is spearheading the campaign by 29 investors.
• Auditors are not giving enough weight to a potentially rapid transition towards a low-carbon future as governments implement the 2015 Paris Agreement to curb climate change, they said.
• … “we need our auditors to be on the front foot and raise the alarm where executives fail to reflect foreseeable losses or liabilities,” Landell-Mills told Reuters.

That use of “fail to reflect” points to an ambiguity in what’s being alleged: is the issue that auditors are overlooking identifiable non-compliance with IFRS, or that they’re not somehow going further? One might think it must be primarily the latter – after all, IFRS doesn’t use the phrase “climate change” anywhere in the standards. And as we’ve covered before, the IASB is explicitly staying away from the field of sustainability reporting. So you might argue there’s no requirement for auditors to be on the front foot of legs that aren’t theirs (or something along those convoluted lines).

But then comes IFRS Standards and climate-related disclosures, a brief from IASB member Nick Anderson.

• Climate-related risks and other emerging risks are predominantly discussed outside the financial statements. However, as set out in (the Practice Statement) Making Materiality Judgements, qualitative external factors, such as the industry in which the company operates, and investor expectations may make some risks ‘material’ and may warrant disclosures in financial statements, regardless of their numerical impact. Given investor statements on the importance of climate-related risks to their decision-making, the implication of the materiality definition and the Practice Statement is that companies may need to consider such risks in the context of their financial statements rather than solely as a matter of corporate-social-responsibility reporting.

The brief acknowledges that climate-related information is and will continue to be predominantly provided outside the financial statements, in MD&A and elsewhere, while emphasizing: “disclosures made in other documents will not compensate for the omission of required disclosures in the financial statements and are therefore subject to audit in most jurisdictions.” I’m not sure that sentence scans perfectly, but the basic point is clear. Some examples of this include:

• a company may need to disclose information about climate-related risks even if the company did not recognize any material impairment or other impact in the financial statements, or, in the extreme, even if a company was not exposed to these risks, but investors would reasonably expect that it was.
• a company may need to explain its judgement that it was not necessary to factor climate change into the impairment assumptions, or how estimates of expected future cash flows, risk adjustments to discount rates or useful lives have, or have not, been affected by climate change. Financial sector companies may need to consider disclosing to what extent their investment or loan portfolios are exposed to climate risk and how this risk has been factored into the valuation of these assets.

The brief is meticulous and well-argued, but obviously pushes up against various practical problems – in particular the voluntary nature of the practice statement and, again, the total absence of the topic from the standards themselves. After all, you might say, given all the trivial disclosure requirements that IFRS does specify, if it intended to cover something this big, it could easily have said so. Of course, that would imply a static text rather than a living one, triggering a train of thought that, not for the first time, may suggest analogies with the role of a nation’s supreme court, and the relative weighting its members may choose to place on a statute’s “original intent.” Still, whatever your philosophical or ideological view on that, it seems that the “urgent action on climate-related risks” desired by some constituents goes far beyond anything that anyone can argue to be within the existing scope of IFRS. It remains to be seen whether and how that gap will be closed, or whether we’ll slowly burn up within it…

The opinions expressed are solely those of the author