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Stern stuff
| by Richard Young 31 Jan 2007 Topic: Environmental accounting, The profession |
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’Sustainability’ is one of those true ‘motherhood and apple pie’ concepts that no one disagrees with. Read any report on the subject and you will find business leaders and politicians falling over themselves to explain how they have always embraced the principle. No one admits to acting in an environmentally unsustainable way; everyone wants to spin what they already do as being sustainable. The problem is that public relations – hot air, you might say – will not reduce greenhouse gasses. And if we keep pumping more CO2 into the atmosphere, nothing about human life as we know it is sustainable. Fortunately we now have official confirmation of the cost of not acting on CO2 emissions. The Stern Review, published at the end of October, makes it a lot harder to spin on the subject – and, by attaching real numbers to the effects of excessive carbon emissions, it pushes accountants into the spotlight as agents of real change. Even Prince Charles agrees. In a speech last year, he spelled out the problem. ‘If environmental sustainability is the aim, how will we monitor progress and measure success? And how will we know whether our prosperity and quality of life today are being achieved at the expense of our children and grandchildren? In a world of scarce resources it is essential that we secure the best value for money over time.’ ‘There are certainly aspects of this debate where our profession can make a major contribution,’ says Roger Adams, ACCA’s executive director responsible for establishing global technical policies on a range of issues including sustainability and corporate governance. ‘From an accountancy point of view, the message is one of market failure – perhaps the biggest we’ve ever seen. Which begs the question: how do you set about correcting that failure?’ The second half of the Stern Review explains how this market correction might come about. ‘Policy to reduce emissions should be based on three essential elements: carbon pricing, technology policy, and removal of barriers to behavioural change,’ it says. So attaching a cost to carbon – through taxes or regulation – is essential. ‘We’re seeing a lot of support for that route – including, for example, the shadow chancellor George Osbourne’s backing for carbon taxes,’ says Adams. It also means both management and financial accountants are going to have to learn to factor that cost, however it is measured, into their planning and reporting. And by articulating the real costs of carbon emissions – whether that is in hard numbers from carbon taxes or clear risk assessments of non-financial metrics – accountants are also crucial to enabling and driving the behavioural changes among their fellow managers that Stern warns are so crucial. Prince Charles himself set up the Accounting for Sustainability Group two years ago to look into this very challenge. ‘[We wanted to] see, in particular, what could be done to encourage longer-term and broader perspectives in decision-making, which are, of course, the essential prerequisites to ensuring that we live and work more sustainably,’ he said. ‘A new accounting and forecasting system is needed to ensure that the longer-term and broader consequences of our actions are taken into account more effectively in decision-making.’ Of course, accountants have been measuring aspects of sustainability for some time. ‘For example, we’ve been working with FTSE Group to make an assessment of the carbon disclosures that are finding their way into company annual report and accounts,’ says Adams. ‘It’s part of our 2007 Awards for Sustainability Reporting being held on 1 March, and we’ve had over 100 entries – so we think companies in the UK are already starting to do a good job on this.’ And it is not all altruism. According to the International Federation of Accountants’ (IFAC) report on sustainability published in August, BT’s 2003 sustainability report highlighted £600m in savings over 10 years from its environmental programme, which includes energy efficiency and fuel savings. ‘BT also pointed out that its strong focus on social and environmental issues has been a crucial factor when it comes to bidding for new contracts: £900m in their 2004 financial year,’ it says. ‘We did some work with a major tour operator to look at the consequences of climate change on the net present value of several of its holiday destinations,’ says David Bent, principal sustainability adviser at Forum for the Future, a sustainable development charity. ‘As Stern shows, climate change is very unpredictable, but by running different scenarios through this company’s value-at-stake models, we were able to show how its market cap could be hit significantly, thanks to factors such as the price of air travel rising and adverse climate effects, if it did not respond. So you can use accounting tools to make a business case for not doing nothing.’ In fact there is an emerging discipline – sustainability accounting – that strives to introduce methods for evaluating social and environmental impacts that are normally not included in traditional financial accounting. The movement has some serious weight behind it. For example, Bent sits on the ICAEW’s Corporate Social Responsibility committee and his colleague David Aeron-Thomas on ACCA’s Social Environment Committee, both of which are working towards better, more explicit ways of handling sustainability in an accounting context. But it is not even just about accurately measuring true outputs and compliance with new regulations such as emissions controls and trading. Accountants can support another crucial component of Stern – the profits from sustainability. ‘Because Stern is a respected economist and his work has the backing of the Treasury, the Review has gravitas. There’s now a compelling case for change,’ says Bent. ‘The transition to a low-carbon economy will create huge opportunities and will drive a response from business. For example, the Stern Review estimates that developing countries alone will need to spend at least £20bn, and up to £30bn, each year on renewable energy.’ A flood of investment in companies developing alternative energy sources – Venture Business Research says that investment in clean technology firms by US venture capitalists has gone from $500m in 2004 to $2bn this year – shows this process has already begun. The Stern Review itself calculates a global upside of actions that would deliver stabilisation of the concentration of CO2 in the atmosphere of 550ppm (it is currently about 430ppm): ‘The excess of benefits over costs, in net present value terms, from implementing strong mitigation policies this year, of shifting the world onto the better path… would be of the order of $2.5 trillion. This figure will increase over time.’ In other words, adopting a more benign long-term strategy, mapping the outcomes and establishing the net present value and risk factors of investments – all core skills of the accountant – are a brilliant way of driving realistic, sustainable change. That blended approach – demonstrating profits while enforcing regulations – is already working. The Environment Protection Agency in Victoria, for example, has a Greenhouse Program that requires big energy users to go through a consumption review. They audit greenhouse emissions and other environmental impacts, then subject the resulting review recommendations to traditional accounting payback models – it is a legal requirement to put in place any project with a payback time of less than three years. It works for the companies because these are, by definition, cost-controlling measures with quick returns. ‘The law is constructively forcing improvements where accounting measurements show there’s an economic benefit,’ says Adams. ‘And accountants at businesses in Victoria also work these issues into any capital planning they do for future initiatives. So it’s doubly beneficial.’ Missed opportunity Ultimately, if the accountant’s reaction to Stern ends up being solely about tax mitigation or clever wording in the Business Review, we will have missed a huge opportunity. ‘That’s a key challenge for accountants,’ says Adams. ‘If we are to be enablers of new ways of working, we need to adopt a holistic approach. We must work with everyone in our organisations to deliver improved systems and processes that will create a positive impact in the areas flagged up by Stern.’ It feeds directly into broader debates about the profession, too. The emergence of fair value accounting, for example, is already forcing accountants to look forward and make more calculated assumptions. ‘And since the response to climate change is to radically alter your activities, you can’t just apply historical costs,’ says Bent. What Stern does is make climate change a strategic driver of business which undermines the ‘business-as-usual’ assumptions in valuation models. The debate is no longer about the impact of business on society, but the impact of climate change on business. A lot still rests on the Government’s shoulders. A number of institutional investors have used their influence to encourage companies to improve disclosure and management of CO2 emissions, as well as engaging – both individually and through collaborative initiatives such as the Institutional Investors Group on Climate Change (IIGCC) – directly with policy-makers on issues such as the European Union Emissions Trading Scheme. But businesses need clarity in the sustainability framework to commit to real change. Governments, both nationally and globally, need to lay out their response to Stern and guarantee a degree of certainty around taxes, incentives and regulations if businesses are expected to plan and invest in CO2 reduction projects. If the profession can shape this debate and produce even better ways of describing the true costs of climate change – organisational P&Ls to Stern’s macroeconomic outlook, if you like – then there is a chance we might be able to develop carbon mitigation systems that can deliver the right outcomes for the planet in the sort of time-frame that Stern says is quite simply critical. ‘The bottom line from Stern is: doing nothing is not an option,’ Bent concludes. ‘There’s no debate now about the science of climate change; and Stern has given us a clear view of the economic impact. The question now is whether business does something itself to address the problem – or whether we wait for Government to come in with a big stick.’
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