A major report from Carbon Tracker warns most of the world's most polluting firms are failing to embed climate issues into their financial reporting, as Industry Tracker warns steel sector's window to align with climate goals is closing rapidly.
Net-zero targets may have swept the private sector over the last two years, but most of the world's biggest corporate polluters are failing to disclose their exposure to climate-related risks in their financial statements, according to fresh research from Carbon Tracker.
In a new analysis published Thursday morning, the influential think tank warned of a "glaring absence" of climate risks in the financial reporting at large publicly listed companies. A study of the 2020 financial statements of 107 carbon-intensive companies around the world found that 70 percent of firms could not provide evidence that they had considered climate impacts in their accounting, and did not provide any reasoning for their omission. Meanwhile, no financial statements of the companies surveyed — a group which included BMW, Danone, Nestle, Unilever, Royal Dutch Shell and BP — used assumptions or estimates deemed to be in line with the net zero pathway required by the Paris Agreement.
The minimal role given to climate risks in corporate financial reporting highlighted by Carbon Tracker's research raises serious questions about how seriously companies are reckoning with the material impacts of global temperature rises and the various technological, investment, regulatory and commodity trends that will be driven by the net zero transition. After all, firms may have established impressive emissions reduction goals, but their company accounts provide no assurances they are seriously factoring climate-related risks into the assumptions and estimates that inform their investment decisions.
The glossing-over of these climate matters really does matter. Many numbers set out in a company's financial reports are based on estimates and assumptions about the future, and as such firms and their shareholders could be hurt if these assumptions are flawed. As Carbon Tracker points out in its report, companies that fail to acknowledge the ways they are affected by increasingly stringent climate regulation, decreasing projected demand for oil and gas, the move to renewable energy and growing demand for "green" goods run the risk of overstating their assets or understating their liabilities. And the lack of transparency is set to frustrate the growing number of investors around the world that have pledged to meet net zero across their portfolios and are striving to reduce their exposure to stranded assets, as well as other climate and transition-related risks.
Barbara Davidson, senior analyst at Carbon Tracker and lead author of the report, said progress towards the net zero transition could be hampered if companies did not start more explicitly including climate factors in their financial accounts.
"Based on the significant exposure these companies have to transition risk, and with many announcing emissions targets, we expected substantially more consideration of climate matters in the financials than we found," she said. "Without this information there is little way of knowing the extent of capital at risk, or if funds are being allocated to unsustainable businesses, which further reduces our chances to decarbonize in the short time remaining to achieve Paris goals."
The report, "Flying Blind: The glaring absence of climate risks in financial reporting," is based on a study coordinated with the Climate Accounting Project (CAP). It warns the auditing industry is also guilty of enabling the widespread omission of climate-related issues from major corporates' financials. Despite growing consensus among the global accounting and auditing sector that climate-related risks should be a mainstay of company accounts, the study reveals that 80 percent of auditors in the study did not assess the material effects of climate in their checks.
The report also notes that neither companies nor their auditors sought to fix major inconsistencies related to climate-related risks common across accounts of all industries surveyed. The findings reveal the overwhelming majority of companies — 72 percent — did not link mentions of climate in their 2020 financial documents to other strands of company reporting, such as emissions targets or sustainability disclosures. Sixty-three per cent of auditor consistency checks did not pick up on this shortcoming, the report notes.
Rob Schuwerk, executive director of Carbon Tracker North America, said the findings had revealed major loopholes in company and auditors' financial reporting processes that needed to be addressed. "It is disappointing to see companies acknowledge that the energy transition is likely to adversely impact their results, to have their auditors identify forward-looking assumptions as critical audit matters subject to significant uncertainties, and yet see little to no disclosure about the assumptions underpinning the accounts, much less an understanding of how management and auditors believed those assumptions to be reasonable," he said.
Carbon Tracker has urged companies to enhance their reporting practices by publishing climate-related forward-looking estimates and assumptions, such as remaining useful lifespans for assets and projected carbon or commodity prices. This would demonstrate clearly how they are embedding climate-related risks and their own climate targets into their decision-making, and provide investors with more transparency over the risks related to their investments.
Meanwhile, the think tank has also called on auditors to ensure that climate-impacted assumptions and estimates are carefully scrutinized throughout the auditing process and transparently disclosed in company reports. It added that auditors must also ensure financial statements are consistent with other company disclosures about climate-related matters.
In addition, regulators and investors have a crucial role in improving the climate risk reporting landscape, according to the think tank. Regulators should work to identify and address inconsistencies and audit failures as part of ongoing supervisory and enforcement reviews, it said, whereas company shareholders should set high expectations from their portfolio companies for climate-related risk reporting for the 2021 accounts season and consider them in all voting and investment decisions.
In another report that sets out the critical importance of firms and investors retiring any assumptions about a business-as-usual future, a separate study out this week has highlighted the European steel industry must act now if it wants to stand a chance of keeping the sector in line with global climate goals, arguing just a small window of time remains for firms to make critical investments in technologies that would put them at the forefront at the net zero transition.
The report, produced by Industry Tracker, calculates the steel sector is on track to burn through its remaining carbon budget by 2035. As such, it warns the sector must stop renewing carbon-intensive blast furnaces by 2030, noting how these hugely expensive pieces of infrastructure last for up to 20 years and are not economic to shut down prematurely. Firms have until 2033 to begin investing in new technologies, in particular furnaces powered by renewable hydrogen, if emissions targets are to be met, it warns.
The study adds that even the most ambitious transition strategies unveiled by European steel firms threaten global climate goals, because they rely on making the lion's share of emissions cuts after 2030, a timeline that will lock in carbon-intensive methods across the steel industry for decades to come.
Carole Ferguson, managing director of Industry Tracker, said the steel sector had an opportunity to shed its role as the "problem child" in the net zero transition and instead become a climate leader that drives the growth of the green hydrogen economy. "With momentum starting to build for new technologies, particularly green hydrogen, steel companies have the opportunity to break out of their current capital-intensive business models," she said.
Pinning the cost of shifting to green hydrogen at between $4 billion and $34 billion for companies — depending on their size — Industry Tracker warns steel firms must act to raise finance for the transition through partnership opportunities. Subsidies, direct public funding and investment capital must be also made available to help companies to embrace greener operations, it states.
Taken together, both Industry Tracker and Carbon Tracker's reports highlight the critical need for companies and investors to eschew a business-as-usual approach and start planning for inevitable trends driven by the net zero transition. While a daunting prospect for many industries — steel, aviation, cement and shipping, to name just a few — this preparedness will ultimately pay off. After all, a business plan that carefully navigates the challenges presented by net zero trends is a far more enticing prospect for investors than a strategy that promises good short-term profits but risks crippling firms' balance sheets with stranded assets. And to get there, firms must follow up their net zero targets with a push to embed climate and transition risk into the financial estimates and assumptions that underlie major business decisions. In the long run, no one can fly blind indefinitely.