Partner, Head of Stewardship
Natasha Landell-Mills, CFA
Partner, Head of Stewardship
Natasha oversees the firm's stewardship activities. Specific areas of work include steering the integration of environmental, social and governance (ESG) matters into the investment process, managing voting and engagement, and leading outreach on several policy and market-related matters.
This article was originally published by Reuters Breakingviews.
Greenwashing is insidious. Companies that give an impression of combating climate change while doing little discourage more determined steps to protect the planet. Those that mask the risks from global warming in their financial statements are particularly harmful.
Few are better placed to police potential accounting misstatements than company auditors. Yet they remain silent. Aside from a handful of exceptions including at Royal Dutch Shell (RDSa.L), BP (BP.L), National Grid (NG.L) and Enel (ENEI.MI), auditors continue to sign off company accounts as if the climate crisis did not exist.
Investors have the power to demand better. But governments can also help speed up the process. That is why money managers and advisors representing more than $2.5 trillion last week wrote to Alok Sharma, president of the United Nations’ upcoming COP26 climate conference, asking for heads of state to set a clear timeline for companies to produce accounts consistent with limiting global warming to 1.5 degrees Centigrade above pre-industrial levels; and for auditors to call out where they don’t.
Right now, auditors are falling short. Audit opinions published alongside 2020 accounts for listed fossil-fuel related companies in Europe and the United States hardly mentioned climate change. Where they did, it was cursory and most claimed there was no risk of material misstatement, according to a recent report by Carbon Tracker.
These “clean” audit opinions are being issued while accountants proclaim leadership on climate change. Alongside grand pledges to achieve net-zero carbon emissions before 2050, the “Big Four” audit firms are expanding their lucrative units that advise companies on how to report climate risks and develop carbon-neutral strategies. The hypocrisy is breathtaking.
The energy transition will take time
Nevertheless, the challenges it presents should inform the accounting assumptions that underpin companies’ calculation of profit and capital today. It cannot make sense for companies to publicly proclaim material climate risks and bold net-zero ambitions while ignoring these factors in their financial statements. To assume business as usual is to ignore the increased liabilities and impaired assets that may result from decarbonisation. Reporting reliable numbers is not just a legal requirement but the key to shifting capital to more sustainable investments.
Take an oil and gas company which has assets worth billions of dollars tied up in extracting, producing and refining fossil fuels. Decarbonisation means long-term structural decline in demand for most of its output. According to the International Energy Agency’s 2050 Net Zero report, no new investment can take place if global warming is to be limited to 1.5 degrees Centigrade.
The IEA predicts oil prices of $35 per barrel by 2030, falling to $24 by 2050 as fossil fuels are phased out. Producers will also face clean-up liabilities and extra costs from capturing and storing carbon emissions. In many cases, assets will have a shorter life because they will no longer be economically viable at lower oil prices. Ignoring these profound shifts will likely result in accounting misrepresentation. Distorting a company’s financial position consciously and persistently amounts to fraud.
It’s not just oil and gas companies that face this challenge
Makers of cars with internal combustion engines or aeroplanes are largely misaligned with decarbonisation. Industries from cement manufacturing and intensive agriculture must be transformed in pursuit of net-zero emissions. This means revising their accounts today.
The “Big Four” audit firms have started to recognise the problem. In December 2020, they promised to implement new guidance by the International Auditing and Assurance Standards Board to consider material climate factors in the audit process. But these same audit firms are still quietly signing off unmodified accounts for businesses that have no clear future in a net-zero world.
It is therefore time investors held auditors to account. Last October, global firms representing over $100 trillion in assets under management called publicly for accounts to be drawn up on the basis of limiting global warming to 1.5 degrees Centigrade. Shortly afterwards, the Institutional Investors Group on Climate Change published detailed expectations for both audit committee directors and auditors.
Investors can use companies’ annual general meetings to back up these calls. They can hold audit committee members to account and use votes to remove auditors that do not alert shareholders to unsustainable and unreliable accounting.
Last year, Sarasin & Partners voted against the reappointment of the auditor at 16 companies due to their failure to demonstrate adequate testing for decarbonisation. This was over half the companies we had identified as at material risk from climate action. We were virtually alone. Looking beyond our own holdings, auditors at Exxon Mobil (XOM.N), Chevron (CVX.N), and ConocoPhillips (COP.N) were this year reappointed with support from shareholders representing over 95%, even though the financial statements contained no meaningful disclosure on how decarbonisation might impact the companies’ financial position. The same is true for most of the largest listed energy, transport, and materials companies.
This accounting blind spot is inconsistent with the interests of shareholders and the public. Investors can demand auditors improve. They should make clear today that they will no longer reappoint audit firms that fail to call out climate misrepresentation. At the same time, proxy voting advisors such as ISS and Glass Lewis should ensure their recommendations consider material misrepresentations linked to climate change. They should do this alongside holding audit committee directors to account.
Governments can act, too. Nations gathering at COP26 in Glasgow this November could make clear that all companies must deliver financial statements consistent with achieving net-zero carbon emissions by 2050. Along with existing plans for mandatory reporting of climate-related disclosures, this could drive system-wide shifts in capital. Until then, companies and their auditors will be free to continue with large-scale greenwashing.