New research from financial think-tank Carbon Tracker highlights significant jurisdictional disparities in the extent to which companies and auditors inform investors about whether they are reflecting the impacts of climate-related financial risk and the energy transition in their reporting.
Covering 97 Climate Action 100+ (CA100+) companies across Australia, the European Union, Japan, the United Kingdom, and the United States, the report underscores the crucial role of regulators in driving high-quality financial statements and audit reports that investors, regulators and policymakers can rely on for decision making.
The report, Flying Blind: Accounting and Audit Regulation – Regulatory activity and its role in exiting the holding pattern, finds that:
- Evidence of, and transparency around, consideration of climate-related matters in financial statements and audit reports vary significantly across jurisdictions. This is despite the similarities in existing reporting requirements.
- The EU and UK lead in transparency and disclosure quality, while Japan and the US lag. Australia sits in between. The relative positioning of these jurisdictions (refer Fig 2, p6) reflects the extent of regulatory activity and reinforces the link between reviews or enforcement and better practice.
- Disclosure in audit reports across jurisdictions often lag those in financial statements, even in the EU which is a leader in company reporting and regulatory activity.
- Regulators play a key role in monitoring and enforcing existing financial reporting and auditing standards that require companies and their auditors to assess the financial impacts of climate risk and the energy transition on financial statements. In some jurisdictions, their activities are falling short.
Implications for investors and market stability
The report also finds that with global investors increasingly exposed to financial risks related to climate change and the energy transition, inconsistent supervision, monitoring and enforcement of existing reporting standards can undermine investor confidence and market stability.
If regulatory gaps persist, investors and lenders may be forced to apply different risk premia, including adjusting the cost of capital to reflect varying degrees of financial statement transparency and uncertainty.
Greater reporting transparency needed
“Our latest research reinforces the urgent need for regulators worldwide to step up, enforce existing reporting standards, and ensure that companies and auditors evidence their consideration of financial impacts of climate change and the energy transition”, Carbon Tracker senior analyst Sepi Roshan said.
“The global financial system must transition from “flying blind” to full transparency and accountability around reporting of financial risk.”
The Flying Blind series warns that without transparency regulators may become limited in their abilities to pick up signals and warnings that can increase market instability and systemic risk. The market may experience a potential ‘climate Minsky moment’ which is a downward correction of asset prices/values resulting from re-evaluation of climate-related risks.
Additionally, policymakers may miss information about material financial impacts of climate-related matters and ways to facilitate an orderly transition (i.e., by introducing and gradually tightening policies for reducing emissions and directing economic activity towards lower emissions activities).
Lastly, investors are limited in their ability to use financial statements for decision making.
Regulators, auditors and policymakers urged to act
Carbon Tracker has urged regulators, auditors and policymakers to take the following steps:
- Prioritise supervision/monitoring of climate-related risk in financial reporting and audit to ensure evidence of, and transparency around, consideration of such matters in financial statements and audit reports.
- For lagging jurisdictions like Japan and the US, prioritisation and enforcement of existing financial reporting and auditing standards is particularly pertinent for enhancing reporting quality and transparency.
- Greater collaboration among global bodies to create regulatory consistency.
- Improve auditor accountability by ensuring audit reports evidence consideration of climate-related risks in audits as required today.
- Without decisive regulatory action, investors, regulators, and policymakers will remain in a “holding pattern,” unable to make informed decisions and exposed to undisclosed or underestimated financial risks.
Carbon Tracker is an independent financial think tank that carries out in-depth analysis on the impact of the energy transition on capital markets and the potential investment in high-cost, carbon-intensive fossil fuels.