Impact of Climate Change on Business, Reporting & Tax- Part 1
This is the first post of a two-part series that looks into business mindset change, regulatory reporting on climate change and exploring potential tax issues yet to come.
One of the most significant and equally misunderstood risks that the world face today relates to climate change. It is accepted that continued emission of greenhouse gases will cause global warming resulting in both economic and socialite consequences. Reduction in greenhouse gas emissions means moving away from fossil fuel energy- coal, oil and natural gas. The mitigation away from climate-related risks and transitioning to a lower-carbon world will affect most industry sectors, where they will need to reflect on their new climate operating model. Moreover, it will also create opportunities for those organisations focused on both change mitigation and reengineering solutions. In 2015, Economist Intelligence Unit estimated that the total global stock asset value, as a value at risk measure ranged from $4.2 trillion to $43 trillion between now to the end of the century.
Currently, new and unprecedented steps will force businesses to act after 1st January 2021, especially those companies with the first annual financial reports subject to these new climate change. With COVID-19 pandemic still onset to stay until Q2 2020, I suspect there will be some organisations who will be under extreme pressure to deliver compliance statements, disclosures consistent with Taskforce on Climate-related Financial Disclosures and Sustainability Accounting Standards Board’s target KPIs and metrics, otherwise they will need to provide an explanation why they have not done so.
As a tree hugger and a fellow of the Royal Society of Arts, I see this as a real positive fundamental shift towards making a difference to the climate change agenda, but alas only when the hand is forced. Nevertheless, as a consultant I like to take part in topical and current issues, and one thing that echoes in my thoughts is “why is the front end of the financial reporting statements on climate change, if anything, non-existent at the back end?”.
There is a wind of change coming, where only strongest will thrive and weakest will struggle- not to sound too melodramatic. So, Business leaders (CxO’s) what do you need to do, what’s the road map? Well-read on…
Future Target Operating Model (TOM) with Climate Change Milestones ¹
A thought struck me the other day- in that wouldn’t it be a revolutionary idea if organisations included in their future business target operating models some of the climate change solutions specifically facing them as a positive step forward towards a carbon neutral footprint?
To explain, an operating model is both an abstract and visual representation of how an organisation delivers value to its customers or beneficiaries as well as how an organisation actually runs itself. How your business works today versus what is necessary to put in place as a next-generation target operating model that will sustain new levels of carbon neutral footprint, speed, agility, efficiency and precision will require a three-pronged approach, with a slight twist…
For more reading on evolving the TOM, refer to my article on… Organisational Change during a Pandemic- Part 2 ¹
The illustration below is not a Climate Target Operating Model (CTOM), but a pictorial representation that depicts the interaction of key influences, subject areas, opportunities, risk/ issues and various stakeholders, in a visual format. I’m not going to get too hung up about if I have not pigeon-holed labels into the right place. I believe the most important thing here is that all key items are reasonably presented in this holistic environmental climate eco-system, which I will further elaborate in detail in part 2 and in part below.
Some questions business leaders (CxO) need to ask themselves on climate change:
How do we actually build it and what does the roadmap actually look like?
What is our end journey and what initiatives will deliver the most value?
Do we have the right mix of capabilities and skills to meet our climate TOM?
How do we set up teams to be successful under the new climate TOM?
How can we scale and sustain the operating model across the entire group?
How do we put in place and embed the new skills, technologies, processes and ways of working?
For sure, these are not simple questions to answer, but they are the right ones to ask the Board where it is for business leaders (CxO’s) to answer them and even request help in getting there².
Regulatory Bodies- sending a wind of change
In June 2017, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (Task Force or TCFD) released its final recommendations (2017 report), that provides a framework for companies and other organisations to develop more effective climate related financial disclosures through their existing reporting processes.
In November 2020, the Financial Conduct Authority announced that, for periods beginning 1 January 2021, premium listed companies will be required to report on a ‘comply or explain’ basis against the Taskforce on Climate-related Financial Disclosures (TCFD’s) framework. At the same time, the Financial Reporting Council (FRC) issued its thematic review inspection report on climate change, advocating the 1 January 2021 date and also encouraging companies to report against the TCFD and the Sustainability Accounting Standards Board (SASB) metrics relevant to their sector.
There are also two further requirements, for those premium listed companies….
Disclosures are also required where the CEO has voluntarily committed to implement universal sustainable principles and to take steps to support the United Nations (UN) goals under the Global Compact framework to advance societal goals. This Global Compact charter of universal principles cover off disclosures concerning human rights, labour, environment and anti-corruption.
Another requirement is to report on the Global Reporting Initiative (GRI) which has the same aims as the United Nations Environment Programme (UNEP). In this report, companies are required to compare GRI standards and provide factual proof by way of appropriate disclosures on how they meet those standards.
I know that “premium listed businesses” have been mentioned, but Private-Equity backed investors need to also ensure their investees’ comply too. I’ll explain this in more detail in part 2 of this two-part article.
Calling on all Accountants… the CFO especially
The IASB has not mentioned climate change- nor do they need too. Nevertheless, upon close examination, IFRS Standards do actually address issues that relate to climate‑change risks and other emerging risks, where it is updating its non-mandatory guidance on management commentary, where it would expect companies to address material environmental and societal issues, complementing what companies have in their financial statements.
Note, that climate change financial issues require sound judgement concerning decisions about recognition, measurement, presentation and disclosures. To avoids rehashing IFRS standards here, I would strongly suggest that the “Definition of Material- amendments to IAS 1 and 8” is read thoroughly as it uses utilises the IASB’s practice statement ¹.
To every accountant, climate change should be very important, or I hope so, in that if the business has non-green/ non-climate friendly assets that is being used and depreciated over its useful economic life beyond the target climate change date- as set by the Paris Agreement (on 12 December 2015 and entered into force on 4 November 2016- aims explained below). Then the asset needs to be impaired immediately.
Note, I am not for one minute suggesting that if the useful economic life is below the target agreement date, you do not do nothing either to innovate, adapt or evolve your non-climate friendly assets! This is just one very small example of climate change impacting financial reporting.
Financial implications arising from other climate-related and other emerging risks include the following that need to be carefully considered ¹:
The aim of the Paris Agreement is to limit global warming to below 2, preferably to 1.5 degrees Celsius, compared to pre-industrial levels. To achieve this long-term temperature goal, countries need to reach global peaking of greenhouse gas emissions as soon as possible to achieve a climate neutral world by 2050.
I personally feel that 2050 is too long and know of some clients’ aiming to achieve a net-zero carbon footprint as early as 2025 to 2035!
Non-Green Taxation ¹
By non-green taxes I mean, for the avoidance of doubt, taxation on non-environmentally friendly activities.
Rishi Sunak, the chancellor, is exploring potential options for raising taxes from this year in response to record public sector net cash requirement (PSNCR) incurred during the Covid-19 pandemic, where the gap between government spending and tax income is on track to hit almost £400bn deficit!
When natural disasters strike, government intervenes, spending billions of taxpayer monies on disaster relief and recovery and shoring up infrastructure to guard against future events- this is the proper role of government. However, policy makers can no longer afford to ignore the underlying reasons for the increase in the number and severity of natural disasters. To do so jeopardises the UK fiscal future, particularly given the severity of climate risk. If we don’t change course, wide-scale government interventions will increasingly add to the PSNCR, which will hamper growth and competitiveness while siphoning off public monies that could be spent in other critical areas.
As a pragmatic economist and tax practitioner, the only way to raise some serious tax revenue is from income tax, national insurance contributions, or VAT, which is a political choice, if and when there are tax rises. Let’s face it, total UK Government revenues from petroleum revenue taxes (PRT) were £863m in 2019-20, a drop of 26% on the previous year, due to falling oil prices, increases in tax deductible expenditure and green-energy incentives that has contributed to the fall- which is all set to further decline over the future coming years for obvious reasons.
Whatever way you look at it, to tax or not tax non-green related goods and services, if there is such a precisely defined definition of this, there will also be counter-arguments and also competing companies who will always be light years ahead of the others on addressing climate related change within their organisation right the way through their value supply chain and supplier management.
Using the doctrines of Adam Smith’s four cannons (principles) of taxation (equity; certainty; convenience and efficiency) as a potential policy guidance framework and perhaps stress-testing to find the optimal implied rate of tax whilst setting target tax revenue over a period of time using the Laffer curve could provide valuable insights on tiered tax rates. Moreover, the key takeaway in all this is that non-green taxes should not create a disincentive affect and most importantly be equitable in nature, without over burdening the UK tax system with compliance complexities, but to also promote an efficient and effective mechanism of optimal tax revenue collection so as to avoid a redistribution of income, say via: Universal Credits, if people are extremely very lucky to get anything; Tax Credits, just as good odds as winning £5 on a scratch card; or Personal Allowance, always an election voting smoke and mirrors tactic, to appease the general public- or at least that’s what the government thinks.
As a chartered accountant, I am of the opinion that Mr Sunak has some “hard choices” to make on tax and spending to recover both the Covid-19 funding gap and inevitable fall of fossil fuel driven tax revenues to balance the UK tax books ahead of him.
I guess the real question now remains as to what actual tax levers will the Chancellor start pulling on and when, without stifling UK growth and prosperity, whilst maintaining his “Zero to Hero” status. In the series Spitting Image, there is a sketch called “Helping Us All”, that hilariously shows an element of truth of what is yet to come from Rishi. See YouTube link: https://www.youtube.com/watch?v=LLbNtou1CuI
On that light-hearted note, I now leave you with two thought-provoking quotes on climate change:
“Saving our planet, lifting people out of poverty, advancing economic growth… these are one and the same fight. We must connect the dots between climate change, water scarcity, energy shortages, global physical risks and health, food security… and labour empowerment.
If we can’t all swim together, we will eventually sink, for sure. There is no plan B, because we have no planet B”.
Ban Ki-Moon, former Secretary-General of the United Nations (2007-2016)
So, Business leaders (CxO’s)… what are you waiting for, time is ticking, do you really want to sink, or swim?
In part 2, I will examine various operational and stakeholder risks and why stakeholders are pushing for climate change and how companies can adapt and evolve. Click link here.
Dee Singh Kothari is a senior partner in Kothari Partners
¹ Ideas expressed in this article are solely of the authors. The author nor Kothari Partner’s accept any liability for the incorrect application of these ideas either used by companies, employees or other individuals alike. ² At Kothari Partners, we have worked with various UK and overseas listed and PE-backed clients across various industries to consider how their business and finance services can bring them both cost reductions and performance improvement. Our approach is to help our clients understand their current situation, identify the value and decide on the scope, vision and set of strategies for what they could achieve for their business. We help plan their implementation and support them and deliver the solution/ change needed, so it is properly and permanently embedded in their organisation. We aim to help past and future clients by delivering high-quality work to their organisation, generate real efficiencies and free up time to support better business decisions. For a confidential discussion please free to contact us, via our corporate website: https://dipakagkothari.wixsite.com/website