The business of climate change

Environmental and sustainability issues are changing the playing field and creating opportunities for CAs in risks, regulations, reporting and other roles

By Julie Desjardins & Alan Willis
Illustration: Gérard Dubois

“Climate change is not only a challenge, it is also an opportunity. A paradigm shift to a low-carbon economy has the potential to drive forward the next chapter of technological innovation. It will require a third — this time green — industrial revolution” (The CEO Climate Policy Recommendations to G8 Leaders, July 2008, page 7; www.weforum.org/documents/initiativesCEO-Statement.pdf).

Risk
Climate change is a global business issue of unprecedented significance, affecting entities of all sizes in all sectors. Unlike the recent recession and financial crisis, from which most economies will gradually recover in time, climate change as a formidable business issue is here to stay. It is multidimensional, evolving and complex, presenting new aspects and challenges as time goes by.

Climate change will increasingly alter the rules for doing business. There will be winning industries and winning companies. There will also be losing ones. Large mainstream investors such as pension funds want to know which companies are the likely winners, and which are the riskier investments in a low-carbon economy.

What are the risks that climate change poses for companies and what are companies doing to manage those risks? As with all types of risks, “enterprises in the same industry, facing similar risks, will often choose different risk management actions because different managements have different risk strategies, objectives and tolerances. Investors need to be aware of these differences,” according to the Institute of Chartered Accountants, England and Wales (Financial Reporting of Risk — Proposals for a Statement of Business Risk, 1998).

Risks related to climate change may be physical, regulatory, reputational or legal. Some companies face mitigation risks related to their obligations and expectations about reducing their emissions of greenhouse gases (GHG). The risks faced by others may be related more to the impact of climate change on their business operations and the need to adapt accordingly (adaptation-related risks). Companies’ effectiveness in identifying and addressing climate change risks (and opportunities) and their implications for business strategy is itself an important and distinguishing competitiveness factor.

For example, what are the risks that a business or its supply chain might be affected by increased frequency of extreme weather events, by sea level changes, or by the availability of water? What financial impact will current and expected climate-change-related regulations have on a company? On its competitors? How might a company’s results be impacted if customers, employees or regulators perceive the company as failing to ad-dress climate change issues?

Might operating approvals be delayed, as in the case of Imperial Oil’s Kearl Oil Sands project in Alberta, or restricted due to legal charges that the company has not adequately considered the climate change impacts of its operations? Might the company’s competitiveness be hurt due to an inability to provide label-ling information about the carbon content of its products? Might the company be subject to US border tariffs because there is a perception that Canadian legislation is not as stringent as that of the US? Might the sustainability of an entire industry, such as the western forest industry or the oil sands, be threatened by climate change issues?

Different industries and different companies within industries will be impacted in their own various ways — some more than others. Financial impacts are inevitable, sooner or later — a reality now evident to investors. It is increasingly apparent to the capital markets that climate change must be factored into investment decision-making.

Families of investment indices are sprouting up to reflect the financial performance of companies with strong carbon management strategies. CIBC World Markets has assessed the carbon impact on entire sectors such as forestry, noting that there is a complex relationship that brings risks and opportunities to the industry. Some individual companies would benefit from a carbon reduction system, some could fare well under a cap- and-trade system, and some could be victims of climate change. New government incentives will enable growth in “clean tech,” renewable energy and energy efficiency.

Climate change will impact finance, financial decision-making and financial results in any number of ways, including:

New capital expenditure considerations: the ability to create and sell emission reduction credits creates a new dimension to capital expenditure decision-making and may make capital investments attractive where otherwise they would not have met hurdle rates.
Increased global operating challenges: companies that operate globally may have to deal with a variety of emissions regulations and emission trading systems, each with different rules, risks and opportunities.
New considerations in mergers and acquisitions: mergers and acquisitions contain another layer of complexity with climate change risk, opportunity and valuation considerations.
Access to insurance: the ability to obtain affordable insurance may impact risk management policies.
Access to capital: increasingly banks are reviewing the climate change risks in their loan portfolios.

What does this mean for the accounting profession?
Whether as executives within the finance and risk management departments of companies or as trusted external business advisers, individual accountants and firms will be inextricably involved, helping to ensure that companies recognize and deal with the new types of risks and opportunities that accompany the paradigm shift to a low-carbon economy. Accountants’ knowledge and skills will need to expand accordingly.

The CICA is supporting business and the profession with a climate change page on its website, continuing education events and publications such as Executive Briefing: Climate Change and Related Disclosures; Climate Change: A Hot Topic for Chartered Accountants; and Climate Change Briefing: Questions for Directors to Ask.

Regulation
Climate change policy and regulations place a price on carbon that, along with the costs of adapting a company’s business to climate change impacts, directly affects the bottom line of many companies.

We are seeing new regulations and economic instruments internationally and domestically — carbon taxes, cap-and-trade systems, new building codes, and fuel emission standards — that affect the operations of businesses and the competitiveness of companies’ products and services.

Companies are increasingly using scenario analyses to understand the strategic and risk management issues related to current and possible new regulations. Companies will want to identify and act upon strategic opportunities as well as prepare for meeting compliance and reporting obligations.

Currently in Canada, leadership in climate change regulations is coming from the provinces. For example, BC has instituted carbon taxes and has mandated new water and energy efficiency building codes. Public sector organizations in BC are required to be carbon neutral by 2010. BC, Manitoba, Ontario and Quebec have joined the Western Climate Initiative, a regional cap-and-trade program. Alberta enacted climate change regulations effective July 1, 2007, setting emissions intensity limits on GHG emissions of certain facilities.

At the federal level, signs are that Canada may follow the lead of any US national system. The American Clean Energy and Security Act of 2009, referred to as the Waxman-Markey bill, proposes a cap-and-trade regime for entities that emit more than 25,000 tons per year of carbon dioxide-equivalent GHG emissions. Those entities that are not covered by the cap may be able to create offset credits for eligible emissions reduction projects that can then be sold for compliance purposes into the covered sectors. While there would be many advantages (including a much more liquid market) to a harmonized or at least linked emissions trading system with the US, the Canadian and US economies are quite different and may require thoughtful and divergent economic policies.

International trade will be impacted by national governments putting a price on carbon. There will increasingly be the prospect of border taxes or similar trade measures for those countries perceived as not having sufficiently robust carbon regulations in place and therefore perceived as having a competitive cost advantage, absent the trade measures.

This month, international talks take place in Copenhagen to negotiate a framework to limit GHG emissions for the years after the first commitment period of the Kyoto Protocol, which is due to expire at the end of 2012. The Copenhagen discussions will be complex, and it will be critical to have the US, China and India as signatories of any new framework. The world’s poorest people have contributed little to global GHG emissions but are the most vulnerable to the impacts of climate change. They expect the developed nations, responsible since the Industrial Revolution for the majority of global GHG emissions, to bear the economic brunt of whatever needs to be done to reduce GHG emissions and stabilize global warming this century.

Canada contributes about 2% of global GHG emissions, but on a per capita basis Canada’s emissions are seventh in the world. Alberta, Saskatchewan and Ontario account for about 70% of Canada’s GHG emissions. Alberta’s emissions have been rising due to increased production of petroleum products for export. Currently, Alberta accounts for about one-third of Canada’s GHG emissions and 40% of industrial emissions. It is projected that Alberta’s contribution will increase in coming years. Part of the issue is that oil sands development produces more GHG emissions than conventional oil production. Canadian oil sands producers are feeling the heat. International civil society campaigns, ethical investors, banks and insurance companies are all keeping a keen eye on the sustainability of oil sands development and its impact on Canada’s GHG emissions.

What does this mean for the accounting profession?
Members of the accounting profession will be called upon to assess the financial impacts of existing and potential new regulations associated with climate change and climate-change-related regulations on companies, industries and governments. As for other economic instruments such as taxes and incentive programs, professional accountants will have to be thoroughly familiar with new regulatory policies and schemes, whether to support company compliance or advise on strategic options to minimize the operational and financial impacts of climate-change-related regulation.

The CICA has been active in commenting on government discussion papers and draft regulations, as well as providing technical input to government departments about the tax, accounting and assurance implications of possible and proposed regulatory schemes.

Reporting
Climate change confronts companies and their accountants with new measurement and reporting challenges. These include measuring and reporting company GHG emissions, accounting for the financial implications of climate change transactions that occur under regulations and emissions trading schemes, devising and implementing new performance metrics (key performance indicators) and making sure that disclosures to capital markets include all material risk and performance information. Management and boards of directors need reliable performance metrics and reporting to support informed decision-making and oversight about climate change issues and their future bottom-line impact. Investors increasingly seek reliable disclosures about climate change risks and material bottom-line impacts, beyond what securities regulators currently call for in periodic corporate filings.

There is significant uncertainty or lack of precision in the measurement and reporting of GHG emissions. There is also generally a lack of good information systems, processes and controls to ensure that data collected is reliable. Given this, it is particularly important that independent verification is carried out to provide reasonable assurance as to the reliability of GHG emissions information reported to regulators and investors. As a risk management strategy for the credibility of a government’s GHG inventory and/or cap-and-trade and offset programs, independent verification of inventories and project baselines and emissions reductions seems essential for ensuring compliance with regulations and making sure that tradable credits are issued only as appropriate.

There are a number of issues related to GHG emissions verification. Verification of GHG emissions will generally require a multidisciplinary team of professionals (perhaps CAs, engineers, professional foresters). Accreditation of verifiers should therefore be at a firm level; the process for accreditation should reflect a team-based approach to verification, be robust, internationally consistent and acceptable, and should reflect the need for verification teams to apply professional standards, principles, judgments and competencies. Verification standards need to be robust in providing the needed assurance about emissions information and be internationally recognized.

Government regulations and related market transactions will create new liabilities, assets, revenues and costs to report in financial statements, and companies will require accounting standards guidance on how to account for these new transactions. For example, auctioned allowances and those provided free of charge will result in different accounting in company financial statements, with gratis allowances possibly recorded as government grants (with income measurement consequences). There is currently a lack of clear guidance on how to account for GHG transactions under emissions trading systems, leading to the use of a variety of accounting approaches. Inconsistency in accounting practices, depending on materiality, may be problematic for internal and external users of financial statements in evaluating cash flows, reported earnings and financial condition.

Effective management of climate change issues calls for reliable information not only about actual GHG emissions, but also for the design and use of other relevant and reliable performance metrics or key performance indicators (KPIs) to track progress over time against targets. For example, KPIs might measure GHG emissions per unit of output (intensity), energy consumption, technology-related R&D expenditure and investments in new energy technologies. As they say, what gets measured gets managed.
Climate change presents new external reporting issues in both mandatory and voluntary disclosure channels. There are two main categories of mandatory reporting: continuous disclosure reporting to capital markets and required filings under governmental climate change regulation. Many companies voluntarily provide information beyond that required by securities regulators or other government departments and agencies. Voluntary information may be reported in responses to surveys such as the Carbon Disclosure Project (it collects climate change information from corporations worldwide; for more information see www.cdproject.net/canada.asp) in separate corporate sustainability and climate change reports and on corporate websites.

Information disclosed in all these reporting channels needs to be consistent; material information in voluntary reports also needs to be disclosed on a timely basis in mandatory reports; and voluntary external reporting needs to be reliable and comply with applicable Canadian Securities Administrators’ requirements about forward-looking information.

There are developments in the US affecting securities regulators that may impact Canadian companies listed in the US. In June 2009, 41 signatories, including public pension funds, state treasurers, controllers, asset managers, foundations and other institutional investors with approximately US$1.4 trillion in as-sets under management, sent a letter to the US Securities and Exchange Commission (SEC) requesting that it address corporate disclosure of climate change and other material environmental, social and governance risks in securities filings. The letter followed the release of two reports that showed that S&P 500 companies — including those with the most at stake in responding to the risks and opportunities from climate change — are providing little climate-related disclosure to investors. The letter is but the latest of several attempts to engage the SEC on this issue, and finally there are signs of the SEC giving these disclosure needs serious consideration.

Meanwhile, on March 17, 2009, the US National Association of Insurance Commissioners approved a mandatory requirement that insurance companies disclose to regulators and investors the financial risks they face from climate change, as well as actions the companies are taking to respond to those risks. All insurance companies with annual premiums over US$500 million will be required to fill out an Insurer Climate Risk Disclosure Survey every year. This US initiative may impact insurance costs going forward that could affect Canadian companies.

In Canada, some securities regulators have signalled their intention to pay closer attention to environmental disclosures in continuous disclosure reviews but so far have not introduced specific climate-change-related disclosure rules beyond those already embedded in current Annual Information Form and Management’s Discussion & Analysis (MD&A) requirements. To date, institutional investors in Canada have not submitted letters and petitions similar to those submitted to the SEC. In April 2009, however, a private member’s resolution was approved unanimously in the Ontario legislature. It called for the Ontario Securities Commission to review its disclosure rules regarding environmental, social and governance factors and report by January 2010 what actions it might take to improve such disclosures.

A key stumbling block to date in external reporting to capital markets about climate change has been the lack of an internationally developed framework for climate change disclosures in companies’ mainstream annual reporting. In 2007, a multistakeholder Climate Disclosure Standards Board (CDSB) was established by the World Economic Forum and several other international bodies to promote and advance climate-change-related disclosure in mainstream reports through the development of a global framework for corporate reporting on climate change. The requirement to adopt and follow such a framework, modelled with the adoption of international financial reporting standards in mind, could then be legislated in any jurisdiction worldwide — say, in Canada, as an add-on to MD&A reports. The CDSB issued its first exposure draft of such a framework in May 2009; it is too soon to assess the outcome of this bold initiative.

What does this mean for the accounting profession?
The International Accounting Standards Board and the US Financial Accounting Standards Board are jointly conducting a project to develop comprehensive guidance on accounting for emissions trading schemes.

The International Auditing and Assurance Standards Board (IAASB) is developing relevant assurance standards for engagements on carbon emissions information. It is expected to issue an exposure draft in 2010 that will address the issues of uncertainty, risk and the impact of internal controls on assurance work. It is expected to highlight key elements of the professional code of conduct requirements under which members are bound, including issues of independence and conflicts of interest.

Accountants within companies have to grapple with new measurement and reporting challenges. The roles and services of accounting firms as accounting and reporting advisers and as providers of independent assurance take on new dimensions as well as new opportunities to apply traditional skills.

Auditors of financial statements may have new transactions and associated professional risks to address in the course of auditing companies’ financial statements.
The major accounting firms are building their client service practice units to meet the needs of businesses for climate-change-related reporting and assurance services, as well as strategy and risk management advisory services.

As can be seen in the time line summarizing CICA’s involvement in climate change issues since the mid-’90s, the CICA has been an extensive contributor to measurement, reporting and verification issues. The CICA has participated in the setting of International Organization for Standardization standards 14064, 14065, and 14066 regarding measurement, reporting and verification of GHG emissions. The CICA is a contributing member of the project advisory panel of the IAASB assurance standard. In 2003, the CICA and the American Institute of Certified Public Accountants jointly issued a practitioner’s guide to providing assurance about GHG emissions information. In 2008, the CICA published Building a Better MD&A: Climate Change Disclosures to assist MD&A preparers. The CICA is an active participant in the Climate Disclosure Standards Board Technical Working Group and contributor to the May 2009 exposure draft (which refers extensively to the CICA’s 2008 guidance on MD&A disclosures regarding climate change).

Roles
The roles and responsibilities of boards of directors, CEOs, CFOs and internal and external auditors all take on new dimensions to address the impact of climate change on the companies they serve. To carry out their oversight role, directors not only need a thorough knowledge and understanding of the company’s busi-ness but also how it might be impacted by climate change. In particular, they will want to enhance their understanding of:• the business issues arising from climate change;

how these business issues influence a company’s risk management and strategy;
the impact of these issues on a firm’s financial performance;
the external communications necessary to inform investors about these matters; and
the adequacy of the company’s information systems and related internal controls for managing climate change issues.

CEOs and CFOs need to take concrete steps to address the implications of climate change and related regulations for the company’s strategies, risks, opportunities and financial performance. They also need to provide appropriate and reliable information to capital markets to meet securities regulators’ disclosure requirements (including certification of filings) and satisfy investors’ expectations for such information.

Within companies, the lexicon of climate change must become an everyday feature of the language of business for effective interdepartmental dialogue. A 2001 CICA report, Environmental Performance: Measuring and Managing What Matters, about managing environmental performance, identified the need to improve communications between environmental and financial executives. Climate change issues make this even more a necessity.

A significant infrastructure build will be required of auditors. Internal auditors increasingly will be called upon to assess the reliability of GHG emission information and the underlying systems, processes and controls. External auditors will need to ensure that they have the appropriate skill set to perform verifications of GHG emission information and the financial statement impacts of climate-change-related transactions.

The accounting profession itself needs to continue to support in various ways the transition to a world of business, capital markets and professional services shaped by climate change issues and policies. Since the ’90s, the CICA has been at the forefront of worldwide accounting profession initiatives related to climate change; through its strategic and operational cooperation with provincial institutes of CAs, the CICA will remain so.

Bottom line
“Businesses succeed when they innovate and when they adapt to new market opportunities. The scale of new technologies, practices, services, products and innovations that will be required to address climate change is large. The business of addressing climate change and the rapid shift to a low-carbon economy that lies ahead have the potential to drive forward the next chapter of technological innovation” (The CEO Climate Policy Recommendations of G8 Leaders, July 2008, page 9).

Climate change inescapably transforms the context for doing business and impacts companies’ bottom-line results sooner or later. There will be winners and losers. Investors are already looking to differentiate between them, although company disclosures don’t make this easy. In this new low-carbon economy, the CA profession has a great opportunity to help businesses, investors and regulators meet the challenges of climate change.

Initiatives regarding climate change

Julie Desjardins, CA, and Alan Willis, CA, are independent consultants in sustainability and business reporting. They have been involved in all the CICA publications and initiatives on climate change since 1997