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Heightened expectations of climate-related disclosure and assurance

6 minutes  15.05.2019 Sarah Barker, Ellie Mullholland

As reporting season approaches, financial report preparers are grappling with new expectations concerning the disclosure of financial impacts associated with climate change.


Key takeouts


Corporations are facing increased pressure to apply climate-related governance, strategy, risk metrics and disclosure.

 

Report preparers, assurers and auditors must approach climate change-related issues with the same degree of rigour as any other financial variable.

 

Our Climate Risk Governance team can help you determine if your finance and governance teams are ready.

 

Climate change has rapidly mainstreamed as a financial risk issue in Australia, driven by institutional investors and market regulators. Disclosing corporations face increased pressure to apply the governance, strategy, risk metrics and disclosure framework set out in the 2017 Recommendations of the Bloomberg Taskforce on Climate-related Financial Disclosures. The release of a joint bulletin by the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board’s (AuASB) on the relevance of climate risk assumptions to accounting estimates indicates that financial statements will now also be the subject of increased scrutiny.

As a consequence, report preparers, assurers and auditors must approach climate change-related issues with the same degree of rigour as any other financial variable. A failure to do so may leave corporations and their directors increasingly exposed to claims for breach of duty and/or misleading disclosure under the Corporations Act.

Preparing to report on climate-related financial risks

Many finance and governance professionals feel they lack capacity on climate-related financial risks, and are ill-prepared to deal with this issue in the assurance process. As climate-related financial risk reporting moves swiftly into the audit mainstream, how can you prepare?

The way forward for climate-related reporting

In this article, our Climate Risk Governance team set out a number of recent developments relevant to financial report preparation that are critical to the provision of a true and fair view of financial position, performance and prospects, and to the management of misleading disclosure risks under the Corporations Act.

Background

Climate change as a key governance and disclosure issue

Leading market stakeholders – from large institutional investors, to credit ratings agencies and prudential regulators – now recognise climate change as a significant economic and financial risk (and opportunity) over both the long- and shorter-term. Such risks and opportunities arise not only from the physical or ecological impacts of climate change, but associated economic transition risks (such as capital market dynamics, including technological developments, and shifting investor, insurer and customer views), and litigation exposures (both regulatory and private).

Transition to net zero emissions

The catalyst for this evolution in mainstream market concern is often attributed to the Paris Agreement (2015). That Agreement commits 196 signatory countries to:

  • limiting the 'increase in the global average temperature to well below 2°C above pre-industrial levels';
  • shifting the global economy to an emissions platform of net zero in the second half of this century.

With global average temperature increases already exceeding 1.1°C, investors are pressuring investees to develop and disclose
Paris Agreement-aligned emissions reduction strategies, and to show how they plan to withstand business disruption during the transition to a low-carbon economy.

Recognising risks of global transition in financial reporting

Baseline disclosure expectations around climate-related financial risks have been elevated accordingly. The ‘voluntary’ disclosure Recommendations of the Bloomberg Taskforce on Climate-related Financial Disclosures (2017) (TCFD Recommendations) are rapidly moving from ‘best practice’ to standard. And the bar is set to be raised further this annual reporting season, with the Australian Accounting Standards Board and Auditing and Assurance Standards Board’s joint guidance on materiality assessments regarding climate-related assumptions within financial statement accounting estimates.

We have set out some of the key developments relevant to financial report preparation and assurance in 2019.

1. TCFD and forward-looking stress tests: from ‘best practice’ to base expectation

Financial statements must provide true and fair view of financial position and performance (s 297 Corporations Act). Compliance with accounting standards is required (s 296), but additional information must be provided where that is necessary to provide a ‘true and fair view’ (note to s 297).

The accompanying director's report must contain information reasonably required by shareholders to make an informed assessment of operations, financial position, business strategies and prospects for future financial years (s 299A).

Within that legislative context, the TCFD Recommendations provide a voluntary framework on the kind of information that must be analysed and disclosed in order to truly and fairly represent (and enable assessment of) the impact of climate-related risks on financial positions and prospects, in a consistent form
that is decision-useful for investors, lenders and insurance underwriters. The TCFD contemplates not only the disclosures themselves, but the risk metrics and targets, strategy and governance processes within which climate risk issues are managed.

A significant proportion of mainstream institutional investors (including the US$30 trillion Climate Action 100+), along with regulatory bodies from ASIC and APRA to the ASX, have called on corporations to have regard to the TCFD Recommendations. More specifically, the absence of credible process of forward looking stress-testing, and disclosure of its results, has become a common topic for shareholder engagement, proxy voting directions and resolutions.

Stress testing and scenario planning

A central plank of the TCFD Recommendations relates to the conduct, and disclosure, of stress-testing and scenario planning of business strategies against a plausible range of climate futures – including a ‘sub-2°C’ emissions pathway consistent with Paris Agreement targets.

Despite its importance to investors, financial report preparers, directors and auditors often struggle with the concept of stress-testing and scenario planning, concerned that disclosure on a ‘forward-looking’ basis may expose them to litigation.

Whilst understandable, such concerns often misapprehend the function of climate risk stress-testing: not as a prediction of likely outcomes, but as a risk management tool to consider the spectrum of strategic challenges it presents, which are without historical precedent.

2. Materiality of climate risk assumptions in financial statement accounting estimates

TCFD-related disclosures are ordinarily focused within the narrative portions of annual reports. In 2019 that focus is set to expand to financial statements, with the Australian Accounting Standards Board and Australian Auditing and Assurance Standards Board issuing joint guidance on the relevance of climate related risks to accounting estimate materiality assessments (from asset fair values, impairments and changes in useful life assumptions to onerous contract provisions).

With narrative reports ordinarily falling beyond the scope of the financial audit engagement, the AASB/AuASB Guide is particularly significant in its repositioning of climate-related risks squarely within the scope of external audit scrutiny.

3. Litigation by shareholders and regulators

Challenges to climate-related misrepresentations (or omissions) under misleading disclosure laws – on the same basis as any other element of financial performance, position or prospects – are far from theoretical. Shareholder class actions alleging a misrepresentation of climate related financial risks, and/or a breach of directors’ duties for a failure to govern for those risks, have already been filed in the US and Europe. In Australia, actions have been brought against large listed companies and superannuation funds. And ASIC and APRA have indicated they are monitoring companies’ climate-related financial disclosures.

4. Capacity building by financial report preparers and audit teams is critical

The speed with which climate risk reporting norms have developed has caught many report preparers unprepared. This places reporting corporations and their directors at significant risk. The imperative to rapidly develop climate-related financial risk literacy is clear – to prepare for new lines of inquiry from auditors, to satisfy heightened investor information demands, and to guard against the very real risk of litigation.

Please contact a member of our Climate Risk Corporate Governance team if you would like to discuss how we can assist with your financial reporting.

Are your finance and governance teams ready? View our report and how we can help.

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