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Audit firms ignoring climate risk: Client Earth

Software code on screen.

The big six auditing and accounting firms are ‘missing in action’ when it comes to climate risk. Failing to incorporate risks to assets from extreme weather or policy or carbon price related stranded assets risks investors, and corporates, failing to understand the level of risk they face.

  • One trillion dollars worth of oil and gas assets alone are at risk of becoming stranded assets.
  • Coalitions of investors are demanding to know why audit firms have not met expectations on climate risk reporting in financial accounting.
  • Failure to address physical, regulatory or carbon-related pricing risk leaves many sectors from energy to agriculture exposed to stranded asset risk, risking billions in value and market stability. 

It is a given that climate risk has been fundamentally under-reported by some of the largest corporate emitters, even with growing pressure from investors when it comes to company transparency on climate change. Whether this is due to ignorance or design is open to question, but the market requires clarity in order to operate effectively.

Transparency about climate risk lies at the heart of market attempts to alter the trajectory of the economy towards a low carbon, nature positive future. Transparency in understanding and reporting climate risk (and indeed forthcoming requirements about nature and biodiversity) is critical to the effective management of risk, ensuring that appropriate information is presented to investors.

Carbon Tracker’s 2022 Still Flying Blind report found that, for the 134 highly carbon-exposed companies assessed:

  • 98% did not provide sufficient information to demonstrate how their financial statements include consideration of the financial impacts of material climate matters; and,
  • 96% of auditors did not sufficiently address how they considered the impact of climate (p.6)

As a result, investors are left with an ever-growing risk of backing soon-to-be defunct assets – like oil and gas fields – as the world’s energy systems continue to transform. Without proper disclosure, they are facing a lack of transparency when it comes to investment risk and undertaking of stewardship responsibilities

ClientEarth warns audit world is failing to act on climate risk

According to ClientEarth, what that means is that senior leadership from the world’s six largest accounting firms – BDO, Deloitte, EY, Grant Thornton, KPMG and PwC – are failing on their commitments to improve how climate change is addressed in financial reporting and audit.

The first new international standards for corporate reporting on sustainability and climate have only been released recently.  ClientEarth however says it has been engaging with audit firms for some time, writing to ask for clarification on their position – that position being where they stand, and how they view, the current lack of transparency on climate risk in financial reporting and audit – transparency which existing standards already require and investors say must urgently improve.

ClientEarth lawyers have now written to the GPPC, setting out their understanding of the  Big Six’s stance on climate issues for accounting and audit, and urging the GPPC to use its influence to drive improvements.

ClientEarth lawyers say that establishing a public record of the GPPC’s position is a key first step to understanding whether audit firms are in step with regulator and standard setter expectations, and ensuring that climate risk is appropriately presented in financial statements and audit reports.

The GPPC was given opportunity to provide a statement in response to ClientEarth’s letter but failed to do so.

Eighteen months of engagement with audit firms, unanswered

This latest engagement from ClientEarth with leading audit firms is not the first attempt. In May 2023, ClientEarth addressed an open letter to the Global Public Policy Committee (GPPC). This is a group comprised of senior leaders from the Big Six, which is focused on policy issues of global importance but is little known outside of the profession.

In December 2020, the GPPC wrote to the International Accounting Standards Board (IASB) of the IFRS Foundation, the independent body which develops and approves International Financial Reporting Standards.

The IASB had written important new guidance on climate reporting, and the GPPC promised to play its part in supporting greater transparency on climate matters in company financial statements in line with that guidance.

ClientEarth received no written responses to its 2021 letters from the individual firms, but was instead invited to discuss its concerns with the Big Six via the GPPC. Since then, ClientEarth says its lawyers have sought, via the GPPC, to engage with the audit firms to understand how they are implementing their 2020 commitment to drive improved disclosure of climate matters in corporate reporting and audit under existing rules, standards and guidance.

However, ClientEarth lawyers say the auditors’ responses are unsatisfactory, given evidence of continuing deficiencies in accounting and audit practices, and in the face of escalating climate risk.

Lawyers say that despite engaging privately, it is surprising that the GPPC has failed to issue a clear public statement on the audit firms’ position on this topic, making it hard to understand how the auditors are applying existing rules and guidance.

Client Earth is not the only concerned party

In 2022, 34 investors from the Institutional Investor Group on Climate Change (IICGG) collectively representing over $7.1 trillion in assets wrote to 17 of Europe’s largest companies to ask why their expectations about climate related accounting disclosures had not been met.

This followed letters sent in 2020 by investors representing over $9 trillion in assets to 36 of Europe’s largest companies requesting that companies and their auditors consider material climate risks in forthcoming financial statements. In addition, letters were also sent to the UK’s largest audit firms in December 2022, following letters sent in November 2020.

In its 2020 letter to IASB, the GPPC said that welcomed guidance from IASB and the IAASB on how climate-related risks should be reflected in accounting and audit and promised to “play [it’s] part” in driving improved transparency.

In addition, the GPPC stated that “All GPPC networks will provide technical communications to audit partners and professionals on the recent IASB and IAASB developments and engage with companies and other stakeholders to encourage greater transparency on the impact of climate-related matters on companies’ financial statements”, noting that “Individual GPPC networks and/or their member firms may also be taking additional actions”.

Yet as far as we are aware, the GPPC has not publicly articulated its position on these issues since.

What does this failure mean for companies?

Recent company assessments published by investor climate coalition, Climate Action 100+, show that the largest corporate emitters and their auditors are still largely failing to fully consider climate-related matters when preparing and auditing the financial statements, or if such matters are considered, they do not explain how this was done, depriving investors of much-needed transparency.

This is despite guidance from accounting standard setter, the IFRS Foundation, and audit standard setter, the International Auditing and Assurance Standards Board, stating that more transparency is already required under their standards. Failure to address this challenge means that companies are unprepared for the risks they face, and investors face exposure to deeper climate risk than they can carry.

ClientEarth lawyer Robert Clarke said: “Despite promising to drive improvements to how climate risk is reported in financial statements and audit reports, the auditors’ position on this crucial issue remains worryingly unclear.

“The largest audit and accounting firms have a huge sphere of influence over the crucial issue of how climate risk is reflected in financial reporting and audit, yet it is hard to discern any meaningful leadership from the GPPC when it comes to climate change. We urgently need to see the auditors’ thinking on how financial reporting must be improved and ClientEarth is urging the GPPC to publish and develop its position as financially material climate risk continues to escalate.

“Investors are repeatedly demanding better reporting. Standard setters have already said this is required under existing rules. It’s time the auditors step up and drive the necessary change.”

Why is the role of audit firms so important?

Accounting and audit are crucial for managing climate-risk in the financial world. As far back as 2021 ClientEarth lawyers warned the world’s four largest audit firms – Deloitte, EY, KPMG and PWC – that they risk failing to fulfil audit standards and their core legal duties by not adequately considering climate risk, threatening the integrity of the market and leaving them open to legal challenge.

Accounting and audit experts have expressed concern over the positions attributed to the GPPC in the letter, and the implications not only for investors but for a sustainable climate.

Climate Accounting and Auditing Project member and visiting Cambridge University fellow David Pitt-Watson said: “This is the elephant in the climate reporting room. Standard setters have issued clear guidance on the need for transparent disclosure of material climate risk in accounting and audit, but this appears to not be implemented in practice.

“So, for example, we will have fossil assets which are overvalued, and companies not providing for clean-up costs, creating the sort of financial risks which accounting and audit aim to protect against. The challenge in this letter from ClientEarth, is that it appears auditors’ interpretations in effect will turn a blind eye to existing standard setter guidance. They may seem nerdy, but if we don’t follow existing rules, we are in trouble. That is especially true when we are writing new ones.”

SGV Take

It is deeply concerning that there is no clear position from the audit community on how to articulate climate risk within company financial reports. While there may be a range of guidance that is building up, without clarity from these groups it is difficult to see where the pressure for changing economic behaviour is going to come from.

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