Climate change and the accountancy profession

23rd September 2007

We can't escape climate change. It has infiltrated our daily press reports. It is a mainstream subject in political debate. While climate change is a natural phenomena that has taken place over millennia, it is the speed with which the change is now accelerating, and the huge contribution to climate change that is now accepted as human-made that concerns us all. Niki Leahy FSN senior writer looks at the impact of climate change on the role of the accountant.

Risk aversion drives climate change up the business agenda, with a majority of companies recognising that it at least poses regulatory risks to their business. The recently published Fourth Carbon Disclosure Project records that, "taking climate risks into account is now becoming part of smart financial management. Failure to do so may well be tantamount to an abdication of fiduciary responsibility and indication of poor management".

The effects of disruptive weather patterns on flooded homes and businesses in several parts of the UK this summer have been stark. Climate change is both an economic and environmental challenge. Swiss Re, the world's largest insurer estimate that annual global damages from the effects of climate change could reach $150 billion in less than ten years. The Society of Lloyds recently noted that between the 1960's and 1990's the number of natural catastrophes doubled, while insurance losses increased seven fold.

The effects of climate change on business are now becoming widely documented, in terms of changes to markets, customers, supply chains and demand curves. Climate change impacts business value by encroaching on regulatory compliance, competitive position and corporate reputation. The most prominent and immediate risk relating to climate change is rising energy costs, and the emerging monetization of carbon.

The accountancy profession has a pivotal role in assessing, reporting and auditing sustainability information. Measurements of the effects of climate change and carbon management are integral to sustainability accounting, particularly in the light of increased director liability and board accountability for risk management. The measurement and reporting of carbon emission output also has implications for assurance and external verification procedures.

Carbon management requires a systematic and rigorous assessment of the impact of greenhouse gas emissions on the organization's commercial strategy, assets values, investments and operational activities. Companies also need to assess the risks, threats and opportunities for their business associated with operating in a carbon constrained economy.

The disclosure of annual organisational output of greenhouse gas emissions is becoming a standard reporting item for many businesses. It directly related to the assessment and disclosure of visible and potential corporate liabilities arising from climate change. Effective carbon management requires a company to maximise the value of its carbon assets, in order to capitalise on new low carbon products and services, (including emissions trading). It also requires the company to minimise the financial impact of its carbon liabilities.

Table 1 below outlines the impacts of climate change on business.

TABLE 1 IMPACTS OF CLIMATE CHANGE ON BUSINESS;

CARBON MANAGEMENT DRIVERS

Regulatory compliance

Cost

Revenue

Reputation / sustainability

Climate policy

-

EU ETS reporting

Direct policy impact

-

EU ETS

-

CCA

-

UK ETS

-

Renewables obligation

Pricing

-

market conditions

Investor relations

-

carbon disclosure

-

litigation risks

Environmental licensing

-

IPPC

Indirect policy impact

-

energy costs

-

raw material costs

New low carbon product markets

Consumer branding

Building regulations

Insurance premiums

New income streams

-

carbon credits

-

ROC

Staff relations

-

recruitment

-

retention

Company reporting

-

EU ETS accounting

-

EU AMD, (material & social risks)

Supply chain risks

Threat to existing markets

-

substitute products

Community relations

-

expansion opportunities

Stranded assets

Business disruption

-

weather effects

Public Affairs

-

threat of new regulations

Tax rebates / shields

Table adapted from "Best Practices in Strategies for Managing Carbon" , IFC Consulting 2005.

By placing a price on carbon, the 1997 Kyoto Treaty established a rudimentary carbon economy. In the EU this is manifest in the Emissions Trading Scheme, (EU ETS) which began in 2005, and which will enter a second phase in 2008. The problems of the first phase of the Scheme are well documented in terms of the over supply or over issue of carbon allowances. The second phase of the Scheme aims to reduce the amount of allowances available, tightening supply and thereby encouraging companies to cut their carbon dioxide output. In addition, the present UK government has promised to meet stricter targets than those agreed at Kyoto on cutting greenhouse gas emissions by 2010. Policy watchers expect that this burden will fall on business sectors currently outside the remit of the EU ETS, including aviation, retailing, leisure services, parts of the public sector and non intensive small and medium sized business energy users. Companies incorporated in the Scheme will need to keep records of energy consumption from which targets for cutting usage would be set by government.

Despite the current political wrangling over the allocation of national carbon allowances, it is widely expected that the second phase of the EU ETS will increase the regulatory burden and costs to business associated with their output of GHG emissions. It will also maximise the value of issued carbon allowances, thus giving firms incentives to capitalise on potentially valuable assets and project based carbon credits.

An EU company participating in the ETS should account for the emissions allowances it receives from the regulator as intangible assets. As it produces emissions, it needs to recognise a liability for the obligation to deliver allowances to cover those emissions. The accountant's role will be to integrate climate change and carbon finance issues into mainstream investment decision making and management strategy. This means accountants should estimate the commercial risks of future carbon constraints, and their likely impact upon corporate performance and shareholder value. The effective management of carbon risk requires that any asset divestiture, acquisition or alteration to operational plans is assessed in terms of its impact on the output of GHG emissions. Due diligence should also consider the impacts of GHG emissions and other measures of sustainability on asset values.

Accountants are also developing standardised accounting tools to incorporate GHG emissions & credits into balance sheet assets or liabilities, as well as ensuring that actuarial guidance considers all aspects of climate change. Guidance on accounting for GHG emissions is increasingly included in tax planning and risk management procedures, so that tax efficient mechanisms for dealing with emissions credits are used.

Accountants are integral in the development of rating mechanisms for carbon credits arising from emission reduction projects, and for rating the credit quality of counterparties to emissions trades. They are also responsible for developing quantitative tools for incorporating carbon risks into debt ratings.

Accountants have a key role in the assessing the impact that changing patterns of supply and demand for carbon will have on the company's energy supplies. The accountancy function should also evaluate the value to the organisation from reducing GHG emissions via fuel switching and increased operational and energy efficiency. This encompasses the investment appraisal of the company's energy efficiency options, as well as potential investment in dedicated electricity generating plants and combined heat and power production. There are various commercially available integrated planning models that assess forward price curves and material impacts on asset valuation from variations to carbon emissions and fuel costs. Carbon management implementation plans identify both technical and enabling measures as well as feasibility studies required to implement carbon reduction measures.

Both the Climate Change Bill published earlier this year, and the recently published UK energy white paper indicates that businesses face increasing curbs on emissions of greenhouse gases. These will incorporate both regulatory measures as well as fiscal restraints. Future articles will consider other economic instruments designed to minimise the climate change impact of the business sector. Systematic carbon management will increasingly offer companies opportunities for driving strategic advantage and commercial competitiveness. Incorporating carbon prices into mainstream financial planning is here to stay.

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