These letters are the latest in an engagement that was initiated in January 2019. They set out once again investors’ expectations for auditors to provide greater, and more quantitative, disclosures relating to how material climate considerations have been taken into account in the audit process.
Investors wish to understand how auditors have examined three key things in company accounts:
- how expected physical impacts from climate change, as well as changed economic prospects from decarbonisation, are being factored into critical accounting assumptions and judgements;
- how the entities’ emission reduction commitments (which are increasingly detailed in mandatory TCFD disclosures) are reflected in forward-looking assumptions; and
- how entities’ prospects might be impacted by an accelerated policy effort consistent with a 1.5C aligned pathway, provided in the form of sensitivity analysis in the Notes to the accounts.
The letters set out more recent regulatory guidance and supervisory notices, including detailed recommendations from the Financial Reporting Council published in July. This guidance echoes the requests from investors, and explicitly calls on companies to consider providing 1.5C sensitivities given the expressed investor desire for these, and thus their materiality to investment and stewardship decision-making.
The above should not detract from clear progress over the past year by both companies and auditors, as set out in the FRC review. This has, however, not been universal and most disclosures remain high level. Carbon Tracker's report “Still Flying Blind” provides evidence of the need for more action. Above all, it is notable how few companies have made changes to assumptions despite the climate crisis representing perhaps the greatest social and economic headwind humanity has faced, and the bold commitments on carbon emission reductions being made by companies, likely to involve expensive capital outlays or changes to business operations. Investors are, therefore, seeking greater detail to provide comfort that individual companies’ accounting assumptions and judgements have been fully tested for shifting outlooks linked to the energy transition.