Breaking down COP26 announcements and their implications

There was a dizzying array of announcements during the two-week UN climate change summit last month. Which ones matter for accounting and finance professionals? Martin Farrar, Ph.D., associate technical director at AICPA & CIMA, breaks down key pledges by governments and businesses, and new requirements on the horizon that accounting and finance professionals should know.

What you'll learn from this podcast:

• Major announcements from COP26 and their contribution to global decarbonisation.
• Implications of the new International Sustainability Standards Board.
• What we know about the UK's new Net Zero-Aligned Financial Centre.
• Impact of net-zero pledges by large businesses on SMEs.
• Useful resources on ESG and sustainability reporting.

Play the episode below or read the edited transcript:

— Contact Martin Farrar, Ph.D., associate technical director of AICPA & CIMA, to share insights or experiences for his upcoming research on accounting for carbon, at Martin.Farrar@aicpa-cima.com. To comment on this episode or to suggest an idea for another episode, contact Alexis See Tho, an FM magazine associate editor, at Alexis.SeeTho@aicpa-cima.com.

Transcript:

Alexis See Tho: Hello, and welcome to the FM podcast. I'm Alexis See Tho, your host for this episode. We have a very special guest with us today, Dr. Martin Farrar. He is AICPA & CIMA's associate technical director for management accounting, and he has written multiple research reports on sustainability and ESG.

As many of you know, COP26, the UN summit on climate change, ended a few weeks ago, and there were many commitments made by countries, by businesses. Today, we're looking at some of those, and what they mean for us in the accounting and finance world.

Martin, welcome.

Martin Farrar: Thank you for inviting me.

See Tho: I know you've been tracking this area of sustainability and climate change very closely for the past one to two years. From the array of announcements we've seen coming out of COP26, which are the ones that you consider the most important?

Farrar: Looking at admissions and the Paris Agreement target, which was to keep temperatures within a 1.5 degree (Celsius) rise, the COP26 didn't work. The country pledges that came out meant that, if we meet those country pledges of COP26, we're going to hit about 2.4 degrees.

That is for me disappointing, and that's why the COP27 in November 2022 in Egypt, the countries are going to have to go back and pledge more ambitious targets for their decarbonisation plans. That was why they were there, and that failed.

I mean, there was a glimmer of hope that for the first time in a COP conference, they talked about reducing use of coal which hasn't been seen before. That's interesting, although the language through the COP was weakened, so it went from phasing out coal to phasing down.

There's a glimmer of hope, but then they don't go all the way. There was also the disappointment around the developing countries pledge and the money that they're looking give to poorer countries to help them switch to greener energy efficient sources and also the effects of climate change, and they missed their pledge, but they're hoping to have something like a trillion dollars in place by 2025.

There's a glimmer of hope there. Fossil fuel subsidies; they've agreed to phase out the subsidies on the price of coal, oil, gas. But there's no date been set. Although they've agreed something, we've got no plan of action of when these subsidies will be phased out.

There was some promise around deforestation, 100 countries have promised to stop deforestation by 2030. And there was also another announcement around cutting of methane emissions by 2030, which more than 100 countries also signed up to.

Especially for the accountants, you've got the establishment of the Glasgow Financial Alliance for Net Zero, which has been christened GFANZ, which is committing over $130 trillion of private capital to help transform the economy to net-zero.

Again, critics for GFANZ are saying that, well, they've only agreed to devote a third of that investment in the next decade to low-carbon, and it reminds me of a quote in Net Positive by Paul Polman and Andrew Winston.

They talk about there, if you commit some percentage of your investment portfolio to responsible investing funds, does that mean that the rest is committed to irresponsible investing? You either go all the way with your low-carbon investing or you can't do 30% and that makes it all right, and 70% is invested in carbon.

My summary overall is I was disappointed. But I think on a good point it promoted that there's a lot of organisations out there pledging to net zero. Though the politicians and the countries may not be having the will to get there yet, there's this bottom-up approach of organisations are driving net-zero targets. That's my takeaway from COP26.

See Tho: Disappointing on some fronts, especially the commitment for decarbonisation. But there were some things that were positive. You mentioned coal and there was a mention of fossil fuel. You made a good point about businesses taking the lead this time, and really for us in finance and accounting, the next step is putting them actually into implementation.

Let's talk about the ISSB, the creation of the sustainability board is probably the biggest news for us in accounting and finance. What do you think are the short term – in next few months, 12 months – to the longer-term implications of this sustainability board?

Farrar: Well, if we look at what's in place before the announcement, I think what we've got is a very crowded and fragmented alphabet soup of sustainability reporting. There's lots of slightly different terms, inconsistent language and various measures. You never know whether it's mandatory or voluntary, and organisations can be using multiple reporting frameworks at the same time.

The Carrot & Sticks website, they've identified 614 sustainability reporting requirements amongst 80 countries. The International Financial Reporting Standards (IFRS) Foundation announcement about the establishment of the global sustainability Standards Board, ISSB, is a welcome move. Its ambition is to create a climate standard based on the TCFD, the Task Force on Climate-related Financial Disclosure recommendations, and have something in the marketplace by the second half of 2022.

That's positive, and I should also recommend if you go to the IFRS website, you can check out the prototypes that were released on the day of the announcement. There's a prototype on climate-related disclosure requirements and a prototype on general requirements for disclosing on sustainability. That will give organisations and accountants an understanding of where it's going and what's likely to come in the next year or two.

They also announced the consolidation of the Climate Disclosure Standards Board and the Value Reporting Foundation into the ISSB to drive the harmonisation in sustainability standards and the settings space. That's a positive.

I think, what we must also acknowledge that there was some notable silences. One was from the US Securities and Exchange Commission, the SEC, on the announcement. They haven't issued a press release on it. There's a consensus that they're looking at issuing a climate- related disclosure rule in possibly January 2022. It's not as they were all going through a global standard when the SEC will be issuing a possible standard next year. That's going in at the same time.

Then you've also got the EU is continuing with their proposal for a corporate sustainability reporting directive that will amend the existing reporting requirements in the non-financial reporting directive. You've got that going on at the same time as the SEC and what the ISSB are doing.

It's still not black and white and we don't know which standards will prevail as the top one that organisations will need to use. It's also interesting that the announcement didn't articulate a role for the GRI standards, the Global Reporting Initiative, and KPMG in research in December 2020 noted that the GRI standards are the world's most widely used for sustainability reporting.

They're outside the ISSB tent at the moment, and will they move into that? I think what's also interesting for accountants is that within the next two to three years, mandatory sustainability reporting will be in place across multiple jurisdictions.

That means the profession must step up. Because once this information is being used to make economic decisions, there's going to be a demand for insurance and audit. We need to be ready as a profession with the sufficient resources, capability, and competency to be able to undertake the sustainability assurance work.

It also means that we need to upscale on training and understand that there's going to be hyper demand for sustainability information in the next two to three years. What we also need to make sure is that although these reporting standards come in, it doesn't then become a tick box exercise and end in greenwashing.

We'll also need to make sure you've got that integrated thinking and it's embedded across an organisation through the governance, through the strategy, through the risk management process, and also through the targets and metrics.

See Tho: It seems like we have ISSB but at the same time, you made a really good point there, SEC will have their own and the EU is already pushing forward with their own. It might still look quite like an alphabet soup there, maybe in the short term.

One other announcement from COP26 was the UK's Net Zero-Aligned Financial Centre. Could you tell us a bit more about that and the implications of it?

Farrar: To be honest, at the moment, it feels very much like style over substance. It's very much just slogan. We're still awaiting the depth from the UK government. What I understand is that most big firms and financial institutions will be forced to show how they intend to hit their climate change targets.

But we don't have the detail on how that's going to happen. Supposedly an expert panel will be set up to work on standards that will be used to enforce and what will be benchmarked against. But they're not due to be released until the end of 2022.

At the moment, we know we're going to have to do something about publishing our transition plans, but we didn't have the detail about what that means. There's also, I will say from the end of 2022 we'll have to start publishing transition plans in 2023.

We don't know how we'll assure these plans because although you have to publish them, there's no mandatory process or how you will deliver them. It's confusing at the moment.

Well, what we do know is that the UK is not moving to firms having to commit net-zero targets. There's no mandate behind that. You're not being mandated or forced to commit to net-zero targets. We also know that the investments in carbon-intense activities will still be allowed under this system.

We also know that at the moment there's no commonly agreed standard of what 'good' looks like for a transition plan. If we're going down this route, I don't know how you're going to find out what a 'good' looks like. Maybe talk to people in your industry, other sectors to see what the leading companies are doing. We don't yet have that vision.

See Tho: It sounds like it's still very much up in the air, but something that companies should definitely look out for by [end of] 2022. There should be something, hopefully more clarity on that. One of the implications, I think, and also from speaking to other finance professionals, is that even though a lot of the net-zero targets by businesses are announced by really large businesses, but they will impact, SMEs.

If a smaller company is part of a supply chain of a company with net-zero targets, there will be implications. Could you share a bit more on what you see?

Farrar: I think it's going to be a huge impact. The UK government has asked from April 2022 that UK-registered companies will have to disclose within the TCFD recommendations on a mandatory basis. The TCFD recommendations ask organisations to understand their Scope 3 emissions. Scope 3 emissions are all the indirect emissions that occur in the supply chain of that reporting company and that's upstream and downstream.

That means the large companies with these requirements to disclose more, will pass it on to SMEs and the businesses in their supply chain. You may think, "I'm a small business, it doesn't affect me." But if you're in a supply chain with a large company that's got to report on the TCFD recommendations in the UK, it's likely to be passed down to you to talk about your emissions in what you do and what you produce.

There's a trend in leading businesses that they're developing systems to gather information on GHG, greenhouse gas emissions, of the goods and services they're purchasing from the supply chain.

They want that information from you, the small SME now. There are also incorporating GHG emissions into tendering and procurement processes. If you want to be working or in partnership with a larger organisation, it's likely in the tendering process that you're going to need to provide that information anyway.

My recommendation is to start looking at the TCFD recommendations now and understanding your emissions and how that interacts with Scope 3 emissions.

See Tho: Whether you're a large business, small business, whether you have a net-zero [target] or not, if you're part of a supply chain of such companies, then we need to start looking at how to meet those new requirements.

My last question to you, Martin, is could you share a bit about the work that you've done? The CIMA research reports on sustainability, on ESG. If I'm somebody who is new to this, or just know a little bit about [sustainability] reporting or just thinking about ESG and strategy, where should I get started?

Farrar: In the last year, we've started a sustainability in business thought leadership series. You can find that on CGMA.org resources. There's a whole series there that will help you take your ESG, your sustainability journey.

But in light of COP26, I'd recommend our summary on the TCFD recommendations and start using that to experiment of how you might first look at how you might do it internally, to then think about how you externally report later.

Also on the TCFD recommendations in January 2020, we issued a report called Accounting for the Climate Horizon, and it was a study on the implementation of TCFD by companies. That was written by the University of Sydney and it's on the CIMA global site under research and development.

Read the summary, then read how companies have been implementing TCFD. You'll be fully up to speed when you need to bring it in. Then to get the bigger picture, there's introductory guides to ESG, is the Putting the E in ESG, Putting the S in ESG, and Putting the G in ESG.

Although they're separate, read them together and understand the whole. Because if you do something in E, it has implications and trade offs in S and G. You need to understand the whole picture, not just one bit of it.

Two weeks ago, we released Accounting for the SDGs. That's a good place to start to understand how the whole of ESG works together, so use that. I'm currently working on a report accounting for carbon, which is going to be released early next year.

If any listeners have stories or experiences to share that I can use as examples in the report, contact me and that's going out February next year.

See Tho: Thank you, Martin, for sharing those resources. If you are hoping to find the reports that Martin just mentioned, don't worry about having to write them all down. We will provide links to them in a transcript of this podcast page.

If you're listening in through Apple podcast or Spotify, go to our website, click the podcast tab find this episode and you'll see the transcript with the links. Now Martin, before we wrap up our podcast episode, any last words?

Farrar: I talk about the whole and that's about systems thinking. But we need to recognise that the planet is being impacted by; it's a three fold crisis. It's a climate emergency. It's dramatic nature loss, and it's rising social inequality and you need to understand all three of them.

If we just look at providing efficiencies in climate change, you could negatively impact nature loss or rising inequality. You've got to look at all three of them. With that in mind, watch out next year. It's the UN's Convention on Biological Diversity COP15 in April, May 2022 in China. You need to be thinking about biodiversity loss and how accountants impact that next year.

Then finally a book recommendation, which is Net Positive by Paul Polman and Andrew Winston. I had been working in the background on the AICPA and CIMA's net-zero commitment. The week that commitment was launched, Net Positive was published. For me, reading that book was a eureka moment because net zero has a focus on being less bad when actually organisations need to create more good.

That means not stopping when you reach your zero point, but crossing over into positive territory and keep going. We need to move from net zero to being net positive. As finance professionals, we need to be driving organisations to become net-positive businesses.