Balancing climate and financial reporting
Milton Friedman stated that a company’s only corporate social responsibility is to maximise profits. While we can’t agree that this is the only responsibility, we see that initiatives such as carbon management enable companies to reduce operating costs, increase revenue streams and satisfy investor requirements.
Financial and carbon accounting have more in common than we are led to believe, as both drive how companies stay competitive and develop viable business models.
What do financial and carbon accounting have in common?
In the UK, nearly 75% of publicly traded companies report against parts of the TCFD framework or plan to do so in the future. The adoption of standards aiming to increase climate-related financial disclosures signals that the financial world is integrating financial and non-financial data to mitigate risks and maximise opportunities.
To be effective, carbon accounting should be conducted with the same rigour and standards of financial reporting, ensuring it is:
- Transparent: In the same way that investors would investigate financial assumptions and audit methodologies, companies should clearly state the boundaries, scopes and methodologies relevant to preparing their greenhouse gas emissions assessment.
- Consistent: To best leverage the data, companies should collect comparable monthly or quarterly data for emissions analysis, applying consistent calculation methodologies throughout the reporting period.
- Relevant: In carbon reporting, companies should indicate how carbon reduction targets would impact the business, what risks and opportunities would arise, and how material this would be for its stakeholders. Projects should be costed, with ROI calculated and targets set with clear timelines.
Financial and carbon management must abide by the above principles for companies and investors to leverage data effectively for decision-making. When done correctly, diligent carbon management can further enhance and drive your corporate strategy.
How are regulations driving the need for audit-ready emissions data?
While emissions data has been voluntarily reported by companies striving to stay ahead of the regulatory curve, a wide range of organisations will be impacted by new regulations making carbon disclosure a requirement.
The United States Securities and Exchange Commission (SEC)
Last year, the SEC made headline news with their proposal of new rules requiring all public companies registered with the SEC to disclose a complete emissions assessment covering scopes 1, 2 and 3. Additionally, companies would need to report the risks posed by climate change on their business.
The emissions data and environmental risk management would be submitted alongside annual reports, with the SEC progressively requiring data to be assured by third parties. While still in development, this regulation would send shockwaves in the US sustainability reporting environment, inevitably requiring global supply chain partners to disclose their greenhouse gas emissions data.
The European Union’s Corporate Sustainability Reporting Directive (CSRD)
On the other side of the Atlantic, the European Union’s proposed CSRD could strengthen and broaden sustainability reporting rules impacting 50,000 companies.
Those impacted are publicly listed companies in EU markets and large companies, defined as those with more than 250 employees, revenues over €40 million and over €20m in assets. Beyond European companies, CSRD would also impact non-EU companies with revenues over €150 million operating in the European Union.
These companies will need to disclose their scope 1, 2 and 3 emissions with some assurance from third-party auditors. They will also need to demonstrate how their business model and corporate strategy are compatible with the world’s transition to Net Zero emissions by 2050 and limiting global warming to 1.5°C.
More widely, the CSRD is mandating a digitalisation of sustainability reporting to reduce costs and ensure that the data is easily accessible and comparable. In this world, companies like Emitwise are well-positioned to drive the adoption of technology for carbon management, from data collection to reporting.
Upcoming regulations such as the SEC’s disclosure requirements or the EU’s CSRD are setting a new standard for companies to prepare auditable greenhouse gas emissions reports and proactively manage their risk exposure to climate change.
How are companies integrating emissions data into financial reporting?
When publishing their annual sustainability reporting, companies have historically separated it from their broader financial reporting commitments. More recently, companies are combining their financial reporting with wider Environmental, Social and Governance topics for shareholder transparency.
In 2020, the automotive manufacturer Audi released its first combined annual and sustainability report. Recognising that its business is being impacted by global regulations and legislation on vehicle emissions, Audi ties its success as an organisation to proactive carbon management.
Strategic decision-making regarding emissions data will be easier for leadership when the financial implications are identified and linked to the company operations and supply chains. Such analysis is more accessible when a monetary value is given to environmental externalities, which is precisely what the luxury group Kering has done.
To quantify the financial impact of its emissions and other environmental impacts, Kering has developed an Environmental Profit and Loss statement. Starting by measuring the emissions across their operations and value chain, the company then assigns a monetary value to the greenhouse gases emitted.
By integrating emissions data into financial reporting and even going as far as assigning a monetary value to emissions, companies can reap the following benefits:
- Shareholder transparency: Companies transparently disclose how their financial statements are connected with their environmental impact, making it possible to compare cost centres.
- Risk management: Sustainability teams can prioritise projects based on the significance of environmental costs, proactively addressing reduction initiatives in carbon hotspots to shield the company from future carbon pricing mechanisms.
- Budget justification: If a procurement team can demonstrate how initiatives, such as replacing materials with recycled alternatives, can generate cost savings on an Environmental Profit & Loss statement, senior leadership will likely approve it.
By driving the convergence of financial and carbon reporting, companies like Kering highlight the close link between environmental management, cost reductions and profit generation.
What does auditability mean for carbon accounting?
A financial audit is successful when a company’s financial records are well structured, the information shared is complete, and communications with the auditors are transparent, providing evidence wherever needed.
The comprehensive examination of your company’s emissions assessment will rely on similar principles. The main objective of auditing in carbon accounting is ensuring that the statements prepared are free from material misstatement, whereby a company might be under or misreport its emissions.
The auditors will source evidence to ensure that the greenhouse gas assessment is complete and accurate, in line with the temporal boundaries of the reporting period and that double counting is prevented.
Significant attention will be given to the end-to-end process of calculating emissions, from initial data calculation to your emission factor selection strategy. Auditors will examine which emission factor database you have leveraged and ensure that the year of the emission factors is consistent with the period you are reporting against.
Auditing emissions data is streamlined when relevant evidence and transparent documentation are provided. To ease the process for both companies and auditors, Emitwise prepares the following reports:
- Emissions calculations reports: Such a report will create an audit trail, mapping input data such as electricity consumption (kWh) and CO2e outputs (kg or tCO2e) to emission factor databases and the chosen year of the emission factor (e.g., DEFRA 2022).
- Methodology reports: Additional to the data, qualitative explanations can be provided on the scope and boundaries of the assessment, data quality and completeness, as well as emission factor selection strategies.
By treating carbon accounting with the same rigour and professionalism as financial data, companies are positioning themselves to satisfy regulatory requirements with auditable emissions data and to identify opportunities to manage and reduce costs.