The net zero future: environmental accounting

Mark Stewart

Mark Stewart

Edinburgh Office Head & Corporate Finance Partner

This article first appeared in the Spring 2022 edition of Scottish Land & Estates LandBusiness magazine.

The focus on mitigating the climate crisis has prompted the introduction of several schemes to help businesses achieve net zero targets (including not adding new emissions to the atmosphere). In the rural sector, for example, we have seen initiatives such as the Woodland Carbon Code and the Sustainable Agriculture Capital Grant Scheme.

These schemes are excellent in their intent but come with the backdrop of largely ineffectual COP26 pledges and increasing global warming. October’s United Nations announcement revealed that current global climate plans would allow up to 2.6 degrees of global warming, warning that emissions must fall 45% this decade to limit disastrous global warming.

In addition to encouraging businesses to make use of net zero schemes, another way to induce an eco-friendly economy is by making businesses report on their environmental activities. Since 1 April 2019, large entities have been required to disclose their energy use and carbon emissions as part of their financial reporting. Whilst these obligations include providing intensity ratios and information on any energy efficiency measures implemented, for now, Scope 3 emissions generated by sources connected to business (supply chain emissions) are excluded.

Fundamental to this new era of green accountability is the introduction of International Sustainable Accounting Standards and, in time, a standardised ESG reporting framework to allow comparability and consistency in climate reporting. Additional regulations have been introduced which require more than 1,300 UK public interest entities, AIM companies, high turnover companies and LLPs to make financial disclosures in relation to their climate-related risks in respect of any financial year commencing on or after 6 April 2022.

Climate reporting does not only affect the ‘front-end’ of the accounts. In a 2020 Open Letter on Accounting Standards, major investor groups representing global assets worth over $103 trillion stated that, whilst most companies assumed business as usual in their financial statements, the focus of their investment will be on those businesses that are more likely to thrive in a carbon-constrained future.

Funders are already starting to ask for ESG strategies as part of the credit process, whether applying for funding, extending loans or refinancing. Those who cannot demonstrate ESG credentials will find funding more expensive and, in the extreme, not available.

Organisations across all industries can expect to be held to higher standards when it comes to sustainability, and this may be the case for the rural sector in particular, equipped as it is to play a key part in the race to net zero through carbon capture and adopting more sustainable practices.

Regulators have already pointed out that climate-related risks and strategies should be factored into the numerical side of the financial statements by reviewing assumptions for going concern, impairment testing, fair value accounting and provisions. The Capitals Coalition, a global collaboration aiming to harmonise approaches to managing all forms of capital, proposed the creation of asset and liability types to reflect debts to nature and efforts in enhancing natural capital. The recently created International Sustainability Standards Board has published draft environmental accounting standards which are yet to be finalised and endorsed by individual countries.

What remains to be seen is whether the current energy crisis will impact upon the proposed timelines for achieving net-zero. Progress continues to be made, albeit slowly, towards global net zero pledges, but the energy crisis has necessitated a huge shift back to coal and fossil fuels, as energy security becomes a critical factor to consider in the mix.

Time will tell whether the goalposts are moved in terms of the deadlines, but regardless, net zero and decarbonisation must remain a priority. It is therefore only a matter of time before environmental reporting requirements are extended to smaller businesses. Business owners of all sizes need to consider how their existing operations are going to fit into the future net-zero economy, so they stay ahead of the competition and set themselves apart.

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