The fact Shell’s latest annual report included a striking new warning on the value of its natural gas assets may not seem like headline news. But given the IPCC has issued its ‘bleakest warning yet’ on climate change, the need for concerted action to reach the goals of the Paris Agreement has never been so acute. A critical step towards meeting these goals and securing a net-zero future is undoubtedly transforming financial statements – and ensuring annual reports reflect climate risks, as Shell’s now does, must become the norm.
See also: – IPCC: New fossil fuel investments must be stranded for 1.5°C world
The purpose of financial statements is to provide a full picture of a company’s financial health so shareholders and other stakeholders can assess how the company is performing and understand any risks that might impact the value of their investment. Financial statements also act as the nerve centre for decision-making on capital allocation. Where reported returns are highest, capital flows. Where the accounts show losses, capital is withdrawn.
Some of the most significant assumptions carbon-intensive companies make in their accounts surround the long-term prices of oil, gas and materials. This is because they are key to the value of their largest assets, underpinning reported capital, profit and dividends. However, no one knows for sure what future energy or material prices might be – imbalances in the market can lead to sharp changes in energy and material prices, while policy measures that aim to decarbonise the economy will result in reduced demand for fossil fuels and products with high embodied carbon, causing downward pressure on prices. Demand will also fall as cleaner alternatives become cheaper and more accessible.
Ignoring the realities of decarbonisation is potentially making a wide range of entities look more profitable than they really are. This results in fresh capital flowing into potentially impaired businesses whose continued operation is not compatible with a net-zero pathway. However, through voting at company meetings, shareholders have several powerful levers at their disposal to drive climate-conscious accounting and contribute meaningfully towards delivering net zero.
Instruments for influence
One way shareholders can give corporations a firm nudge towards more concrete action to combat climate change is through voting for or against the appointment of audit committee directors, whose job is to oversee the accounting processes. Already, investors representing more than $100trn in assets have called for all carbon-intensive companies to align their accounting with a sustainable planet. Shareholders must vote against audit committees that fail to respond.
Second, shareholders can vote for or against reappointing an external auditor. The auditor’s job is to ensure accounts present a true and fair view of the entity’s financial position, and they are required to call out misrepresentation. Investors have sent public letters to the ‘Big Four’ audit firms in the UK, US and France, setting out their expectation for auditors to act. Shareholders should vote against the reappointment of auditors that fail to sound the alarm.
A third tool also exists. Shareholder resolutions have been filed asking for audited accounts of the financial implications of a 1.5°C pathway. Although this would sit outside routine financial statements, it would force company executive boards to confront the financial reality of decarbonisation, providing vital insights to investors.
Acting together
Engagement requires a large body of shareholders to make a difference and shareholders are much more effective when we act together. We recently voted against reinstating the accounting and auditing practices of global mining giant Rio Tinto, and we will do the same at building materials company CRH’s upcoming AGM.
See also: – abrdn abstains from approving Rio Tinto accounts over sexual harassment and racism
As a leading global construction materials manufacturer and supplier, CRH is a highly carbon-intensive business, with its cement production accounting for nearly 60% of its total emissions across scopes 1 to 3. As countries transition to net zero, the demand for carbon-neutral construction will only intensify. CRH has stated it is committed to driving this transition and published a science-based target to reduce group-wide scope 1 and 2 emissions by an absolute 25% by 2030. It is also aiming for 50% of its revenue to come from products with sustainability attributes by 2025.
To support CRH’s transformation, we and other investors set out our expectation that its accounts provide visibility for the financial implications of a 1.5°C pathway, in line with the Investor Expectations for Paris-aligned Accounting paper released by IIGCC in November 2020. This sets out five expectations for disclosures in the financial statements, and four expectations for auditor disclosures in its report to shareholders.
However, we were disappointed to find CRH’s recently published 2021 accounts and its auditor Deloitte Ireland’s audit failed to meet these expectations. As such, we will be voting against reappointing CRH’s current audit committee chair, against reappointing Deloitte Ireland as its auditor, and against approving its financial statements.
Similarly, we did not approve Rio Tinto’s auditing committee chair, auditor, or financial statements at its most recent AGM. The company’s 2021 accounts did not provide disclosures on its quantitative assumptions, visibility on how it will be impacted if its own stated goal to be 1.5°C-aligned is achieved, nor any clarity on how the costs of achieving its ambitious 2030 and 2050 carbon commitments will be incorporated into its accounting practices.
Shell shows how shareholders are heard in the boardroom and reflecting climate risks in the accounts makes a remarkable difference.
Related: Asset managers’ net-zero targets not showing real-world impact – [Research]
