IFRS

Climate reporting – responding to market expectations

Mark Hucklesby
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A common question in board rooms around the world is how well are large and complex companies responding to market and regulatory expectations on the consequences of climate change in their audited financial statements?
In this article

To answer this question Grant Thornton in France recently completed some research on 45 issuers (mainly CAC40 and SBF 120 French stock exchange) with 31 December 2021 reporting dates to see how much attention they have given to climate reporting.[i]

Their results, based on reports that were released during the first quarter of 2022, are both fascinating and insightful, and we summarise our key findings below.

Climate change is now being recognised

The first two matters we considered were ‘how and where is climate information being presented in financial statements?’

We were encouraged to see that 84% of the companies we selected presented some climate related information in the notes to the financial statements.

Drilling down into that headline statistic of who made disclosures on climate change we found that 16% of those companies provided a note that was specifically dedicated to climate issues within the financial statements. This provided a ‘one stop shop’ for their climate disclosures. Whether this was in response to climate reporting expectations set out by the European securities regulators prior to 31 December 2021 will require some further research, but to us it’s interesting that a note addressing all aspects of disclosure in one place was used.

For those that did not put all their disclosures in a single note we found that 71% presented their climate information in a basis of preparation of financial statements note. So, in more than half of the companies we sampled included a note that was ‘dedicated’ to disclosure of climate related matters. Those companies that did not adopt one of these two approaches presented their climate related information in various notes to the financial statements (such as for goodwill, estimated lives of property, plant and equipment etc).

What was disclosed?

Almost two thirds of the companies in our sample provided an initial assessment of climate change on their financial statements and/or their business activities. However, many did not explicitly indicate whether this had, or would have, a material or significant economic impact on their year-end and future financial statements in relation to the valuation of assets and liabilities, nor on their expected short and medium-term financial performance.

When the International Accounting Standards Board (IASB) published some educational material on the effects of climate-related matters on financial statements in November 2020 they included a non-exhaustive list of possible impacts (eg inventory valuation, fair value measurement etc). Our research revealed that one quarter of the companies specifically mentioned the uncertainties inherent in the estimates they used to prepare their 31 December 2021 financial statements. From a technical perspective this was an encouraging disclosure to observe.

How much detail is being provided on recoverable amounts?

To our surprise we found considerably more detail than we expected.

Of the companies that presented some climate information in their financial statements (84% of our sample) we assessed whether consideration of climate related issues had changed the assumptions used to determine the recoverable amount of assets. What we found was 59% of companies indicated the assumptions they had changed as a result of taking climate into specific consideration (eg CAPEX, production costs, sales etc), with 41% mentioning specifically the extent of that impact (eg providing the amount of CAPEX to be incurred).

We also found 21% of them disclosed a cost per tonne of CO2 amount in their cash flow projections while 10% of them provided detailed information on the key long-term assumptions used and how they were determined (eg long term price trajectories, external sources and climate scenarios used).

Our research in this area triggered two further observations that might be of interest to standard setting. The first was the amount of disclosure made, strongly correlated to the industry the company was operating in. Companies operating in industries that polluted the environment the most, disclosed not only considerably more than those that did not, but also disclosed a lot more longer-term information. The second was those companies reporting on the short and medium-term impacts of climate change appeared to put their focus on updating the assumptions they had used in their three-year business plans.

But the story does not end there. In our sample, approximately one in every five companies reflecting the effects of climate change made changes to certain financial assumptions (for instance, by revising the perpetual growth rate used to determine terminal value or by incorporating a risk premium in the discount rate) and slightly more than one in five (ie 21%) adapted their sensitivity analysis to take into account climate risks (eg changes in the costs per tonne of CO2 or regulatory changes).

What components are being reported on?

When it came to consideration of climate change on the assessments of the useful lives of fixed assets, half of the companies disclosed they had addressed the potential impact of climate change, and 11% of them provided quantitative information of the impacts of the changes they had made. This was encouraging given that some of the companies indicated they clearly had significant exposure to polluting assets.

When evaluating future or continued investment in an entity, analysts and investors closely scrutinize the environmental provisions made and its contingent liabilities. In our sample, 50% of the companies made specific mention of environmental provisions and contingent liabilities. In addition, 24% of the companies in our sample made specific mention of the impact of climate related matters on the provisions and contingent liabilities they disclosed.

Among these companies, 67% mentioned the existence of uncertainties inherent in the valuation of these provisions and the existence of contingent liabilities (such as changes in environmental regulations). 33% went on to disclose either the impact of climate change issues on the estimation of these provisions (eg the alignment of industrial scenarios) or assumptions that made with following on from statement commitments to decarbonation (which will impact schedules for dismantling and renovation work to be carried out).

Other ESG matters

To round out our research we considered two final questions. The first was 'did the financial statements mention green financing?' and 'did the companies have long-term compensation plans with indexation to ESG factors?'

A third of companies (34%) indicated they did have green financing (ie financing to fund green projects) but almost half (44%) of the companies indicated they had financial liabilities and long-term compensation plans with ESG-linked features.

What can we take away from our research?

The first is companies in France have clearly heeded expectations set by both investors and regulators. They have assessed what is material and/or significant and disclosed the financial consequences of climate change that exist. However, in making this observation the sample we used involves some of the largest companies in France, many of whom making no secret of the fact they are significant polluters and hence having a direct impact on climate change. They also can martial and pay for the resources needed to compile these results.

From here it will be interesting to see if in the next set of annual financial statements they prepare, additional disclosures will be made given the requirements set out in IFRS. With the International Sustainability Standards Board now up and running and its connectivity to the IASB, we hope there are considerably more disclosures on climate related matters made by every company, not just the most significant polluters.

Secondly, the educational material issued by the IASB setting out the disclosures it believes should appear in financial statements has also been heeded. However, the follow-on question is will it be sufficient to satisfy investor and regulatory expectations in the longer term, given our findings have revealed a bias towards short and medium-term impacts? A combination of commentary in the business press on the quality of climate related disclosures alongside regulatory feedback on assessed compliance with what IFRS requires in this area is going to be fascinating.

And finally, while directionally significant progress has clearly been made in France over the last 12 months to reflect in the financial statements the effects of climate change, more refinement and detail is likely to follow as companies carefully assess and hopefully look to bridge the expectation gaps that will always exist between investors and regulators.

If you would like to discuss this topic further then please let me know, or speak to your local Grant Thornton member firm.

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i. www.grantthornton.fr - Prise en compte des enjeux climatiques dans les états financiers - 17 May 2022