A new challenge for accountants and auditors - Climate change risks and financial disclosures - DAC Beachcroft

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A new challenge for accountants and auditors - Climate change risks and financial disclosures

Published 17 December 2020

We are in a climate emergency and its impact is now recognised as a business risk. Climate change brings with it a series of new business risks (as well as opportunities) and business decisions are increasingly focusing on corporate social responsibility and the development of environmental, social and governance strategies (ESG). This will increasingly impact on the role of accountants in the re-evaluation of business risks and asset values, reporting on the “green credentials” of businesses and the compliance with regulatory and climate related disclosure requirements. 

The UK, along with other countries has, to date, been applying principles of climate related risk disclosure on financial companies on a voluntary basis. This has now changed as on 9 November 2020 the Chancellor announced plans to make Task Force on Climate-related Financial Disclosures (TCFD) aimed at enhancing firms’ approaches to managing climate related financial risks mandatory for large companies and financial institutions by 2025. The UK is the first G20 country to do this. The Chancellor stated that the disclosure rules and regulations will capture a significant portion of the economy, to include listed commercial companies, UK-registered large private companies, banks, building societies, insurance companies, UK-authorised asset managers, life insurers, FCA regulated pension schemes, and occupational pension schemes.

On 9 November 2020, the Government-Regulation TCFD Taskforce also published its interim report with a roadmap for implementing mandatory disclosures, many of which will come into force by 2023. The report states “Given the urgency of the climate threat, we have highlighted the need to assess, manage, and deepen our collective understanding of the financial risks from climate change. A voluntary approach to climate-related financial disclosure may not be sufficient. Instead, the taskforce advocates a move towards mandatory TCFD-aligned disclosures across non-financial and financial sectors of the UK economy”. The report sets out an indicative path over the next five years towards mandatory TCFD aligned disclosures “with most action occurring over the first three years – towards comprehensive and high-quality information on how climate-related risks and opportunities are being managed across the UK economy”. 

The implementation path presented in the roadmap builds on initial steps already taken to introduce TCFD aligned disclosures in respect of certain listed companies, banks and building societies, insurance companies and occupational pension schemes. The Financial Conduct Authority has stated that all companies with a premium listing on the London Stock Exchange will be required to make climate-related financial disclosures in line with the recommendations of the TCFD, with the new rule taking effect for accounting periods beginning on or after 1 January 2021, so that the first reports will be required in 2022 and with disclosure initially being on a “comply or explain” basis. This would mean companies would have to explain to shareholders and other stakeholders why they were unable to comply with the disclosures. It is expected that this obligation will then change to mandatory disclosure.

The Bank of England also announced that it will hold climate stress tests in June 2021, the objective being to test the resilience of the largest banks, insurers and the financial system to different possible climate pathways and provide a comprehensive assessment of the UK financial system’s exposure to climate-related risks.

On 10 November 2020 the Bank of England, Financial Conduct Authority, Financial Reporting Council (FRC), The Pensions Regulator, Department of Work and Pensions, Department for Business, Energy and Industrial Strategy and HM Treasury, published a joint statement in support of the International Financial Reporting Standards (IFRS) Foundation’s recent consultation paper proposing that it establishes a new standard setting body for sustainability disclosures. Throughout 2020 the FRC has undertaken a review of climate related considerations by boards, companies, auditors, professional bodies and investors. The FRC published a Climate Thematic Review “Time to raise the bar on climate change reporting”, https://www.frc.org.uk/news/november-2020/climate-pn which provided examples of best practice and deficiencies in disclosure in financial statements. In the Foreword the review states “Accounting and actuarial bodies are beginning to address climate-related issues in their regulatory remits, but practice is mixed. To consider the many facets of an issue like climate change, those in and entering the professions need to be trained appropriately to face these challenges within their work”. In relation to audits the FRC stated “audits reviewed indicated that auditors need to improve their consideration of climate-related risks when planning and executing their audits

The types of financial risks which a business may face as a result of climate change can be divided into:

(i) physical risks to assets, such as risks resulting from extreme weather events;

(ii) transition risks, which arise from mitigation steps associated with the transition to a low-carbon economy. According to the TCFD, they “may entail extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements related to climate change”; and

(iii) liability risks – for example with compensation being sought for losses suffered – such liabilities likely to be closely associated with disclosure obligations not being met.

Accountants will need to advise their corporate clients on disclosure obligations and compliance with regulatory requirements. In addition, to advise clients on potential financial impacts of the move to a low carbon economy and the physical, transition and liability risks associated with climate change. Climate change is one of the DACB Informed Insurance “Critical Uncertainties” https://insurance.dacbeachcroft.com. Scenario planning is seen as a key tool with the highly disruptive potential impacts from rising global temperatures being uncertain and the challenge to firms to build operational and financial resilience. It is clear that accountants will have a central role to play. Please see our recent climate change webinar at https://dacbeachcroft-1.wistia.com/medias/l3b1jb76q2.

For more information contact 

environmentallaw@dacbeachcroft.com

Authors

Gill Burnett

Gill Burnett

Newcastle

+44(0)191 404 4117

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