Expert comment

The urgent priority of carbon reporting

Triggering climate change and potentially devastating economic effects, the greatest issue of our time is global warming. The corporate sector is at the heart of this issue; it is a major contributor to global warming and is also greatly exposed to the effects of climate change.

We remain resolutely focused, however, on quarterly earnings as an indicator of corporate performance. While sustainability accounting and reporting is increasingly common, it is also marginal, and largely inadequate for investors’ decision making.

Global corporations cannot be held to account in the absence of effective accounting. This is well understood for earnings, the measurement of which is standardised, and audited. Accountability needs to be equally well understood for greenhouse gas (‘carbon’) emissions, the reporting of which is currently voluntary, incomplete, lacking in comparability, largely unverified, and inadequately linked to science-based targets for carbon reduction.

Fortunately, of all the many and varied environmental, social and governance (ESG) metrics, carbon emissions are the easiest to deal with. For the most part, we measure them already, according to a generally accepted protocol. They are also straightforward to audit.

Equally fortunate, there exists a political and institutional framework for making carbon reporting mandatory. The EU has the will and the statutory authority, and while it does not have expertise in setting accounting standards, nor credibility with investors in that regard, it can achieve both by partnering with the International Financial Reporting Standards (IFRS) Foundation. This is the very same partnership that led rapidly to global financial accounting standards. With modest increment to IFRS structure and funding, it could lead equally well - and even more rapidly - to a global standard for the reporting of carbon emissions.

The call for action here is simple. It needs to be. The EU and the IFRS Foundation should collaborate, urgently, to set and mandate a carbon accounting standard in Europe.

One benefit of a carbon focus is that, at least for now, time spent on developing the reporting of non-carbon ESG issues is a distraction. ESG is a very broad concept, embracing issues ranging from toxic waste to income inequality to board structure. Most of these do not come close to the existential, urgent threat posed by climate change, and the associated need to meet Paris climate targets; a simple, topical example is that the loss of all ice on Greenland would raise sea levels globally by 7 metres, enough to transform coastlines and dislocate major populations. Moreover, most other critically important ESG issues would become even more important if the threat of climate change is not averted; the poorest countries in the world would be those most badly affected, the already cataclysmic loss of biodiversity would accelerate, while flooding, extreme weather events and reduced access to water would cause unprecedented and unmanageable levels of migration. Climate change is the logical priority.

A second benefit is that comprehensive, standardised and reliable information is an essential prerequisite for change in investment decisions, government policy, consumer behaviour and, ultimately, corporate action on climate change. Corporate reporting is not in itself the answer to anything, but it matters. Imagine capital markets without earnings. Imagine climate adaptation without carbon data.

A third benefit is that the objective mandatory reporting of carbon emissions (‘how much has the activity of my business contributed to global warming?’) would complement the subjective voluntary reporting of climate-change risks and opportunities (‘how is my business affected by climate change?’). The former question concerns performance measurement, while the latter is the subject of Michael Bloomberg’s Task Force on Climate-related Financial Disclosure, and it concerns strategy, risk management and governance.

If we can’t set reporting standards for carbon emissions, then we have no hope of doing so for more complex issues such as social capital and natural resources. Carbon is the low-hanging fruit, and so it offers the institutional mechanism to get started, and so ultimately a vehicle to expand into other areas of ESG. Bear in mind that financial reporting is relatively easy, because it is based upon recording financial transactions in markets, and yet it has taken decades to develop. ESG reporting is more difficult, and also much more varied. It makes no sense to say ‘it took ages to do the easy bit, now let’s tackle all of the difficult stuff in one go.’

The call for action here is simple. It needs to be. The EU and the IFRS Foundation should collaborate, urgently, to set and mandate a carbon accounting standard in Europe. Global adoption will follow. Investors, policymakers and others should resist the distraction of other ESG issues, and focus their pressure and voice. For economic, scientific, political, institutional and practical reasons, ‘it’s the carbon emissions, stupid!’

green sprout

This comment is the first update to his whitepaper, with Robert Eccles, discussing the future of corporate reporting, which is designed to be added to as important events occur, and progress is made in establishing standards for nonfinancial information.