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New carbon accounting standards needed to scale climate investment

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Specific accounting standards are urgently needed for new asset types such as certified carbon offset credits, according to a new report from Imperial College Business School.

  • Research from Imperial College says new carbon accounting standards are necessary to match changes in the changing climate investment landscape.
  • With the new rules for international carbon trading agreed upon at COP26, there will be an increasing focus on accounting for different approaches to emissions reduction and removal.
  • The current range of methodologies, standards and approaches must be standardised to facilitate carbon markets at scale.

The report Financial Accounting for Carbon Finance: A New Standard for a New Paradigm, from Imperial’s Centre for Climate Finance & Investment, shows how emerging global carbon markets and new investable assets make the need for new accounting regulations in the fight against climate change.

Authored by Raúl Rosales, a senior executive fellow at the Centre for Climate Finance & Investment at Imperial College Business School and María Angeles Peláez, global head of accounting & regulatory reporting at Spanish bank BBVA (NYSE:BBVA), the report assesses the current accounting framework for global carbon markets under IFRS, the global standard-setting in accounting, and makes several policy recommendations.

Transparency on offsets is needed if the mandatory and voluntary markets are to thrive

New accounting standards will be a major step towards achieving “transparency” the researchers noted, pointing to the need for openness in accounting practices ahead of the 27th United Nations Climate Change Conference (COP27) which opens on 6 November in Sharm el-Sheikh, Egypt.

The report coincides with the new sustainability reporting standards being developed by the International Sustainability Standards Board (ISSB). It is crucial to develop new financial accounting standards alongside these, to achieve global harmonisation. Dr Rosales said that the International Accounting Standards Board is “the most qualified international body to address this”.

Carbon offset market is growing rapidly

Despite the lack of clarity around accounting standards, in 2021 global carbon markets grew to a record €760 billion ($851 billion). With discussions around greenhouse gas emissions reduction set to continue at COP27, the report proves timely, with accounting standards – particularly around carbon credits – widely considered crucial to scaling up carbon markets and achieving net zero by 2050.

In particular, certified carbon offset credits (also known as carbon offsets) – measurable emissions reductions from certified climate action initiatives –  remain misunderstood as financial instruments, which creates a barrier to standard setting in this space.

Lack of clarity on carbon offset accounting is a risk for banks

Dr Rosales noted that the current lack of clarity and guidelines around carbon markets’ financial accounting and risk management has significant implications for banks’ regulatory capital requirements, as they act as intermediaries in the emissions trading system.

According to the report, accounting standards need a change that amplifies the importance of developing a new category of financial instruments at fair value. reflecting the management and goals of financial entities in their financial statements.

Achieving all of this, Rosales noted, starts with re-thinking the definition of carbon offsets. Rather than being classed as intangible assets or inventories, carbon offsets should be considered investable assets used as part of a bank’s offering to corporate clients, both for ‘offsetting’ and ‘hedging’ purposes.

The report was created with the support of the Singapore Green Finance Centre, which is co-managed by Imperial and Singapore Management University, and strategic insights from financial firms, banks, asset managers, and senior officials from policymakers.

Reflecting on the report, Dr Rosales said: “We need accounting standards that reflect both the market at present as well as the direction that it is going in. With such markets evolving rapidly, there is an urgent need for the establishment of a carbon instruments accounting project in the near term.”

The IFRS launched the ISSB at COP26, now it is time for implementation

The report is published a year after the IFRS Foundation’s unveiling of the ISSB at COP26, which took place in Glasgow in late 2021. Aware of this timeline, Dr Rosales added: “Last year, we witnessed a major milestone moment: the announcement of the ISSB at COP26. A year later, now is the time to build on that development.

“As this report highlights, markets are changing. As such, standards too are evolving. This report offers policymakers and those operating within the industry a number of valuable recommendations to ensure that, amongst all of this change, transparency remains.”

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