Disclosing climate-related matters, or: not seaworthy!

As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 38 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA recently published some extracts from its confidential database of enforcement decisions on financial statements, covering twelve cases arising in the period from December 2020 to January 2023, with the aim of “strengthening supervisory convergence and providing issuers and users of financial statements with relevant information on the appropriate application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while. Here’s one:

  • The issuer is an international shipping company operating in the transportation of refined oil products. The issuer operates a fleet of owned and leased vessels. The entire fleet is considered a single cash-generating unit. The fleet’s recoverable amount is defined as the higher of its fair value less costs to sell and its value in use, which is the net present value of the cash flows from the vessels’ remaining useful lives.
  • In its non-financial statement included in the 2021 annual financial report, the issuer presented ‘Climate change related risks and opportunities’, including:
    • future environmental regulations and directives,
    • supply and demand disruptions for transported commodities, and
    • re-routing risks.
  • In the note regarding accounting policies in the 2021 financial statements, the issuer stated that “The carrying value of vessels may significantly differ from their market value. It is affected by the Management’s assessment of the remaining useful lives of the vessels, their residual value and indicators of impairment.”
  • However, the issuer did not provide any further information in relation to climate-related matters in the notes to the financial statements.
  • Upon request, the issuer confirmed that it had considered climate-related risks in the 2021 financial statements and that the recoverable amount of the fleet was not significantly affected by climate-related matters.

The enforcer (as ESMA likes to term it) concluded the issuer’s financial statement disclosures weren’t sufficient to meet the requirements of IAS 1 on significant accounting policies, judgements and sources of estimation uncertainty; it based the conclusion on “qualitative and quantitative factors such as (i) the materiality of the amount of tangible assets (and related depreciation) in the issuer’s financial statements, (ii) the issuer’s high exposure to climate change, and (iii) the lack of consistency and coherence between the risks disclosed in the non-financial section in the management report related to climate change and the information included in the financial statements.” In particular, it required the issuer to disclose the use of any climate-related factors as sources of estimation uncertainty or causes for significant judgements regarding the assets in the scope of IAS 16, and information as to whether the issuer considered climate change when assessing whether and why the expected useful lives of non-current assets and their estimated residual values should be revised.

This all chimes with, among other things, IFRS Standards and climate-related disclosures, a brief from a few years ago by 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….

Anderson’s illustrations included:

  • 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 ESMA example might have been designed to give real-world credibility to those examples. Of course, norms and expectations are evolving rapidly in this area; however persuasive the argument that the above is just a basic application of existing standards, it’s unlikely that ESMA would have published such an item even five years ago (I mean, they didn’t!). As it is, with the ISSB now fully established and given the IASB’s new emphasis on connectivity, the current example will probably soon be supplanted by bigger and better ones…  

The opinions expressed are solely those of the author.

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