Climate risk reporting

What to expect from your finance team and auditors

The increased focus on climate risk will have a major impact on financial reporting. For audit committees, that means increased demands on your finance team and auditors.

This discussion between Adam Cunningham, ESG and climate risk expert and John O'Donoghue, Lead Partner, ESG reporting and assurance, highlights some of the key changes that audit committees should expect to see.

Why the focus now?

You only have to look at the news to see the intense focus on climate risk coming from investors, regulators and stakeholders. The pandemic highlighted that global challenges need a globally coordinated response. The Paris Agreement was adopted in 2015 but we're seeing a renewed focus on what it means for the economy and the role the corporate sector needs to play.

Investors are seeking greater transparency. The value of many of their portfolios is changing due to climate risk. The current view is they're not getting sufficient information to make judgements and investment decisions on climate risk.

There is increased focus by regulators on reporting in this area. In Australia, ASIC, APRA and both the Accounting and Auditing Standards Boards have issued additional disclosure guidance. The UK and New Zealand have started to mandate specific climate risk related disclosures.

It’s clear, climate risk and financial reporting disclosures are not perceived to be aligned. Companies may issue a lot of disclosures and other market releases such as sustainability reports containing climate risk information. However the link between that information and what’s in the financial report is often not visible or apparent.

What are we seeing?

As auditors, we are seeing climate risk filter into financial reporting more than ever, and not just in the industries one might expect.

In the financial statements, we are starting to see disclosures with respect to key estimates and judgments, potential changes in useful lives of assets and impairments as well as provisions, contingent liabilities and onerous contracts resulting from climate risk. In financial services, organisations are looking at their exposure to other organisations that may be directly impacted by transitional climate risk, with the banking sector considering this in determining provisions for the estimated impact of potential future credit losses. These are not small impacts. In the energy sector, Repsol and Chevron had multi-billion dollar impairments recently, partly as a result of environmental risk. It's become an area of focus that organisations can't afford to ignore.

Organisations are starting to disclose the results of scenario analysis undertaken to support their impairment assessment. That includes sensitivity analysis disclosures on Paris Agreement-aligned scenarios. Normally these would be conducted internally but we’re starting to see public disclosure of scenarios, outlining the potential outcomes and impact on the carrying value of assets.

Climate risk is also coming through in valuations and not just from an impairment perspective. From an acquisition perspective, climate risk is being factored into what a company is prepared to pay as well as the value they ascribe to various components.

We are seeing the increased demand from stakeholders for climate risk information starting to flow through to the key audit matters in auditor’s reports. While knowledge about climate risk is still evolving and auditors are grappling with how to assess it, there’s demand for more information and that will mean more disclosure.

What should be included in financial reporting?

Firstly, the key assumptions that could impact carrying value of assets or liabilities related to climate risk need to be considered. Disclosure is important but the hard work comes before that: collecting the evidence to support the conclusions being made. Transparency is also important, that’s what the markets are looking for. Even if something doesn’t have a quantitative impact on an asset or liability valuation, there still may be a requirement to put some disclosure around it because of sensitivity.

Other market disclosures, most importantly in Australia, the Operating and Financial Review (OFR), often include very detailed climate risk information including the potential impact of that risk. There needs to be consistency so investors aren't left with a disclosure in the OFR that isn't consistent with or linked to the financial statements.

Sometimes companies might do all the work and conclude that climate risk isn't material for them. Do they disclose nothing, because it's not material? Investors and other stakeholders are hungry for information, so companies that disclose nothing could be inviting others to draw their own conclusions. Additional disclosure and transparency are important.

How should your finance team prepare for climate risk reporting?

To put it simply, there will be more work to do. More time will be required to understand what the climate risk is and how will it impact financial statements.

For professional development, climate change reporting is only going to get bigger and more mainstream. There is no avoiding it. Finance professionals should familiarise themselves with the Task Force on Climate-related Financial Disclosures (TCFD) as a starting point.

Finance professionals need to be prepared to answer questions on climate risk from Boards and Audit Committees. Directors are going to be really interested in this area. PwC recently published A shift in expectations, outlining considerations and expectations for ESG reporting and the changing role of the Board. This will help finance professionals understand the type of questions they should be ready for.