By Eric Israel, Skytop Contributing Author July 14, 2021

Eric is the world’s first sustainability chartered accountant. He was the independent assurance leader for Royal Dutch Shell’s first global Sustainability Report in 1997. Eric is the co-founder of KPMG’s Global Sustainability Practice and PwC’s Conflict Minerals Practice. He was the U.S. Director for the Global Reporting Initiative (GRI) and is passionate about coaching the new generation of professional accountants on applying integrated thinking within new and emerging reporting frameworks.


Climate Change Battlelines Drawn

It is D-day at the C-Suite for many multinational companies. The butterfly effect of global warming is starting to have an impact on company’s business models and a perfect storm is in the making because of decades long climate change negligence and miscalculations. Recently a Dutch court found Royal Dutch Shell responsible not only for its own direct emissions but also those of consumers burning fossil fuels. 

The court ruled that Shell has a duty of care to reduce carbon emissions beyond their current reduction plans. As a result, the court ordered Shell to cut its carbon emissions by net 45% by 2030 compared to 2019 levels instead of the net 20% stated in Shell’s plan they presented to its shareholders earlier this year. Although this is a significant increase to reduce their carbon emissions, Shell’s internal plan did anticipate a reduction of net 45% by 2035 so they will need to accelerate their efforts. 

It is expected that this court order opens the door to similar challenges for other energy-intensive sectors and beyond. Ironically, or maybe because of what just happened to Shell, a few hours after the Dutch court order, an environmental activist investor won three seats on Exxon Mobil’s board. This investor was supported by large investors such as BlackRock, who continue to be concerned about the company’s strategic direction and the anticipated impact on its long-term financial performance and competitiveness. 

Long Term Investors Leveraging Capital in Exchange for Remedial Action

Climate change research conducted by BlackRock, the world’s biggest investor with almost $9 trillion in assets under management, concluded that key U.S. industries are vastly underestimating the economic dangers posed by the transition to a low carbon economy, which is a material investment and regulatory risk. And, shortly after Exxon Mobil shareholder’s meeting it was Chevron’s turn where shareholders voted in favor of a proposal to cut emissions generated by the company’s products, so-called “Scope 3” emissions, as another sign from investors to push for carbon emission reduction. These three companies have all been struggling to regain their footing as industry leaders even before the pandemic crushed demand for oil and gas and the support for change shows investor’s growing frustration with companies that are not doing enough to mitigate climate risk.

The good news is that these companies have been preparing for this day for the last two decades. They published various corporate responsibility reports with Shell starting this trend in the late 1990’s. These reports provide a lot of climate risk insights including a license-to-operate to further grow their business. However, it should be noted that despite increased reporting, carbon emissions have continued to rise, and environmental damage has further accelerated. 

In Come the Regulators and the Auditors

Predictably we see a lot of regulatory attention for climate and other corporate responsibility related disclosure from the new U.S. Administration. President Biden’s day-one action to rejoin the Paris Climate Agreement has started a fast-track of corporate responsibility disclosure initiatives.

 Among many other initiatives, this includes the SEC’s recent statement to move forward with rulemaking on climate, human capital and other ESG disclosures. Another initiative is President Biden’s Executive Order directing all government agencies to develop a strategy for identifying and disclosing climate-related financial risks to government programs and assets. A significant development for companies is The House Financial Services Committee’s Climate Risk Disclosure Act that will require disclosures to climate change for public companies. This was further underpinned by the support from the SEC and the U.S. Secretary of the Treasury for the creation of the International Sustainability Standards Board (ISSB).

In response, and to ensure that companies’ numbers can be relied on, the world’s largest audit firms published a commitment to play their part in stepping up to the climate crisis. Recently EY and Deloitte made disclosures in their respective audits of Royal Dutch Shell and BP. Both auditors included climate risks and the energy transition in their so-called “Key Audit Matters” and provided their view as to whether the assumptions aligned with the goal of limiting global warming to less than 2 degrees Celsius above pre-industrial levels. As to be expected, they clearly struggled with the companies’ climate commitments. 

When asked whether Shell is on the way to net-zero carbon emissions by 2050 and is acting in accordance with the Paris Climate Agreement, EY replied that the company will not achieve that target with the current policy. Statements like this provided some headlines saying that auditors hold the key to this climate crisis. 

However, in response to the key steps investors expect auditors to take based on the Institutional Investors Group on Climate Change (IIGCC), EY mentions that “It is not within our professional remit, responsibility or expertise to disclose in our audit opinion what we would consider to be reasonable assumptions taking the net-zero transition into account, and the impact such assumptions might have on Shell’s financial statements”. In addition, EY notes that “the audit procedures were performed principally by the audit engagement team with the assistance of EY auditors with expertise in climate change”. 

In other words, it seems that professional accountants are not the subject matter experts we can rely on where it involves technical analysis of climate risks.

Notwithstanding all these inherent limitations, accounting firm PwC recently announced that it will invest $12 billion over five years to create 100,000 new jobs aimed at helping their clients grapple with climate and diversity reporting. To give PwC’s new global strategy some perspective this job creation is more than a third of PwC’s current total number of global employees. In addition, the firm’s global chairman mentions that every employee of PwC must be familiar with ESG. 

If all this sounds too good to be true let’s listen to what BlackRock’s former global chief investment officer for sustainable investing, Tariq Fancy, recently said after he left that company in September 2019. In an interview with Forbes, he expressed his doubts about the value of ESG data. 

More specifically he mentioned, although a good ESG rating sounds good, it is not that profitable to be responsible. As a believer in free markets, he acknowledges that markets have limitations and when there are market failures these will need to be fix. According to Fancy, one of the ESG market failures is that the incentives for ESG are not set up correctly. Although the current ESG investment approach is well marketed there is no evidence that it is going to help stop the harm. He acknowledges that “ESG measurement is helpful, however, Wall Street will currently incentivize companies to take what they are already doing and slap a green label on it”. 

Fancy believes what needs to happen is for the government to act and he compares the ESG investment dilemma with the systemic challenges caused by Covid, that require solutions with input from the government.

Leveraging existing regulatory reporting frameworks may be harder than we think. For example, within the SEC there is currently no consensus if the SEC should require ESG metrics. Hester Pierce, one of the SEC commissioners noted that common disclosure metrics would lead to homogenized capital allocation decisions and impede creative thinking, stifling innovation. Recently she said that “unlike financial accounting, which lends itself to a common set of comparable metrics, ESG factors, which continue to evolve, are complex and not readily comparable across issuers and industries”. ESG professionals familiar with the GRI Sustainability Reporting Standards and the Sustainability Accounting Standards Board (SASB) would immediately acknowledge that. 

Customization and Materiality

Even more to the point, celebrated investors like Warren Buffett argue that Berkshire Hathaway’s decentralized business model makes it unreasonable to have one-size-fits-all standards for its operating units on climate change and diversity. Buffett, one of the world’s biggest philanthropists, told investors during a shareholder meeting that requiring ESG reports from all the subsidiaries would be “asinine,” because many of them are small and Berkshire Hathaway allows them to run independently. He also said he does not like making “moral judgments” on businesses, and it is “very tough” to decide which one’s benefit society.

Although it is expected to hear this from an investor with a limited time horizon, many ESG supporters are expecting more from Buffett as a philanthropist and are accusing him of showing a lack of leadership calling him the Platitude instead of the Oracle of Omaha.

So, What’s Different this time? Ask the Accountants

Maybe nothing and this will only lead to just more data that will be used to further delay the reforms we need. After all, businesses are built to generate profits and they prefer to maintain the status quo if it serves their legacies. 

What is also not different is the desire for continuous economic growth and CEO compensation growth, which unfortunately has always supported the growth of carbon emissions. Most people understand that this time it will need to be different. But we need real change and right now the messages coming out of businesses are delaying real changes and that is a recipe for disaster. 

As a professional accountant I always believed that reporting is not just the report itself. Rather it is a management tool that is the nervous system handling all data to support an organization’s vision. What can make this different is to have accountants with a different mindset, accountants who understand how value can be created. If you are a professional accountant and never heard of ESG, TCFD, double-materiality, non-financial reporting, and assurance you should now invest in learning these subjects. 

A war for data has started and this may be your most important investment.

The Financial Report is Dead, Long Live the Financial Report!