Big Four risk losing audit clients over climate accounting failuresby
Against the backdrop of the COP26 environmental summit, a group of investors have threatened AGM revolts against the Big Four unless climate accounting becomes central to the auditing of major corporations.
The Big Four have been warned by blue chip investors that climate risk must be factored into audits of big companies or their future appointments will be blocked.
A group of 24 shareholders, including pension schemes, asset managers Sarasin & Partners, Pictet and Aviva Investors, said they would vote at AGMs to remove PwC, EY, KPMG and Deloitte from auditing the companies they invest in if the carbon footprint of the companies is not thoroughly measured.
The investors, holding around £4.5tn worth of assets, sent a letter to the audit giants as the COP26 global climate change summit in Glasgow began.
First reported by Reuters, the letter states that by glossing over the impact of climate change and policy changes at some of the world’s biggest companies, the Big Four auditors are not providing a complete picture of how environmentally damaging the businesses they audit can be.
Feeling the heat
“Auditors that fail to test accounting assumptions taking these structural shifts into account are, in our view, failing in their duty to shareholders,” the shareholders wrote, noting that more than 70% of assessed audits last year had fallen short of standards.
Deloitte, the group wrote in a letter to the auditor, was responsible for 19 companies, including energy giant BP and miner Glencore, which were flagged in the group’s research.
“While we have identified some welcome signs of leadership, notably at BP,” the investor group wrote, “based on our analysis overall these audits have not met our expectations.”
Just three of the 16 Deloitte audits probed had any reference to climate risk.
“None provides the visibility we seek on the potential financial implications of a 1.5C pathway, which global leaders have committed to delivering,” the group said. A recent study conducted by researchers from the World Economic Forum detailed how the planet was on course to heat by 1.5 degrees, causing floods and unbearable heat unless action was taken to cut carbon emissions.
Paul Stephenson, managing partner of audit and assurance at Deloitte, responded: “We agree with investors that climate-related risks should be accounted for and disclosed appropriately in annual reports and financial statements.”
In the last year, the Big Four have committed more resources to training auditors to assess climate change when they are challenging companies.
If sufficient progress isn’t made, however, the auditors could “increasingly expect to see” investors vote at AGMs to not hire them for falling short, the group wrote.
The same group had previously written to governments to force the auditors' hand in regard to climate risk audits, after a plea in 2019 to increase the pace of green auditing fell on deaf ears.
Investors “cannot afford to wait another three years” for the situation to improve, the group said.
The battle against hot air
The UK government has made a bold promise to decarbonise the City of London, with Chancellor Rishi Sunak unveiling proposals to create the first “net zero” financial centre.
“This means we are going to move towards making it mandatory for firms to publish a clear, deliverable plan setting out how they will decarbonise and transition to net zero with an independent task force,” said Sunak, speaking at the COP26.
It comes on the back of a plan announced recently by the Treasury to force businesses to disclose their emissions and carbon footprint, in a bid to tackle so-called “greenwashing”, whereby a business claims to be more environmentally friendly than it is.
Despite the growing revolt from shareholders, the response from the corporate world to both new green reporting standards and pledges to fight climate change from politicians has been lukewarm.
“The COP26 climate summit is still focused on spin rather than substance,” said Paul Donovan, chief economist at UBS. “Tackling climate change requires public and private sector commitments. For private investors, the lack of transparency and a clear definition of what sustainable investment means remains a significant problem. This lack of focus reduces incentives for corporate action and potentially misdirects private funds.”
Transparency is key in building trust, said Sophie Parkhouse, partner at Accounting Excellence large firm finalist Albert Goodman.
“The plans announced by the government at COP26 requiring net zero plans to be made public for some entities in 2023 is a step towards achievement of transparency in this area,” Parkhouse said. “This is not seen as a positive move by all.”
Some businesses will be resistant, Parkhouse told AccountingWEB, because there are continually new solutions being found to support the achievement of this challenge, making it "feel too early for a plan to be set out as to how exactly we are going to get there".
“Organisations may fear that if the disclosed plan is too fluid and elements of it are later back tracked then this could hinder any trust being built," she added. “The transition to net zero needs a change from the top, and to the culture of the organisation to ensure that it is delivered, and this cannot happen overnight.”
Auditors may also struggle with the new arrangements, said Richard Murphy, tax and accounting professor and author of Tax Research blog.
Murphy said auditors have a duty when issuing reports on financial statements to ensure that “the hard numbers in the back end of those accounts can be reconciled with the soft, narrative driven, statements made by the directors in the front end of that same financial report”.
He said the government seemed unaware of the pressure it would put on auditors to make the sums match given the impact it may have on the business being audited.
“The reality is that once the company has a plan to be net-zero it has, in effect, agreed to close down its existing business model which is, in the case of every large multinational company currently in existence, carbon driven,” Murphy said.
There remains too little incentive for politicians to act, said Peter Miles, co-founder and CEO of agricultural technology firm eHempHouse.
“The impact of climate change is seen as a long-term problem and politicians are rewarded for focussing on delivering short-term benefits,” Miles told AccountingWEB. “For businesses, who are the primary cause of environmental damage, the current situation is even worse. Adopting sustainable practices is usually against their commercial interests.”
Miles suggests the use of carbon markets, where polluting companies can trade carbon credits with businesses who have a net negative impact on the planet.
“A key part of that is setting a ‘carbon price’,” he said. “This puts a price on pollution that reflects the true cost of the product to the environment, which is then passed onto the consumer, or the company has to take it out of its profits, forcing it to become more sustainable to keep the carbon price as low as possible.”
He said the change in consumer behaviour following the introduction of surcharges for carrier bags and coffee cups shows passing on the cost of pollution does have an impact.
“By announcing a carbon price structure, it will signal to the markets a ‘real cost of carbon' and it will provide some impetus behind the creation of an efficient carbon market that will drive many initiatives,” he said.