Climate Change, Finance and the Circular Economy

Aligning the Role of the Accounting Profession in a Climate Emergency to Create a World of Strong Economies

This article was originally published on the Institute of Chartered Accountants of England and Wales website as a contribution to the Energy and Natural Resources (ENR) Community (with thanks to Bill Roberts, chair of the ENR Advisory Group, for his input).

There’s a transformation taking place in the financial sector. Investors and asset managers are starting to understand the implications of making the wrong decisions around businesses exposed to the climate change. In line with the science, the UK government, EU and others have made policy commitments to achieve net-zero emissions by 2050. The policy clarity, often enshrined in law, is changing outlooks. These shifts are moving investors from Mark Carney’s tragedy of the horizons – the mismatch between the timescale for financial decisions and for building a sustainable future - to new expectations.

Those businesses that are most exposed to climate change own vulnerable assets and infrastructure which may not be viable on net-zero pathway. These businesses together with those which face disruption to supply chains, logistics and customer demand face greater scrutiny and risk of divestment. Investors and asset managers seek greater assurance and are reconfiguring portfolios. Realignment is driving down the share prices of the least resilient businesses. There’s now a race to make sure businesses have sustainable strategies and a coherent story for investors.

Consistent with the role of accountants through history, transparency, assurance and accountability are central to the transition. Initiatives like Taskforce for Climate-Related Financial Disclosures (TCFD) and carbon pricing are starting to give investors the information they need to make decisions that better align short-term interests with long-term responsibility. The Financial Reporting Council is looking into how businesses and auditors meet reporting standards and react to the risks posed by global warming. It’s also very positive to see the call to action in response to climate change from the chief executives of accounting bodies representing 2.5 million accountants and students globally. The call to action recognises that the accountancy profession can play a significant role in achieving both climate change mitigation and adaptation at individual business, industry sector and economy-wide levels.

There is also a very active debate around Environmental, Social and Governance investing which goes to the heart of the question of what businesses are for. The emerging consensus that businesses need to do more than maximise profit can help create a more sustainable future.

One of the ways that businesses can participate in a positive change in the system is by adopting circular economy principles - keeping products and materials circulating within the economy at their highest value for as long as possible, through re-use, recycling, remanufacturing, delivering products as services. This approach is a key differentiator in the battle to convince investors that medium-term business models are viable.

The necessary transition to a zero carbon, circular economy isn’t straightforward. Convincing investors that moving from a production-based model where performance is measured by units sold and margin to a leasing model where success is evaluated on the value customers place on services and long-term relationships has a whole series of challenges.

So, the question for CEOs and FDs is whether a circular economy strategy is more attractive in the face of a different type of appraisal from investors. That’s why, according to ING research, 16% of US firms are implementing a circular economy strategy and two thirds are developing one. Accelerated adoption will create the transformation which is necessary not only to make the transition to a net zero carbon world but also to deal with hard to reduce consumption-based emissions.

Measurement and assurance are at the heart of the accountancy and audit profession. For members of the Institute, we can facilitate the shift in financial flows by giving investors the information and assurance they need in a reconfigured financial system. There are also opportunities for Chartered Accountants in their role as advisers to small and medium sized business. These businesses can harness the opportunities of the current transition. Those successful organisations which adopt circular economy principles will create the business models of the future.

The ICAEW has many initiatives of its own. But are these initiatives well enough co-ordinated and ambitious enough to accelerate the shift in the system? For the profession as a whole, the imperative is to be on the right side of history. Financial information needs to reflect long-term liabilities and vulnerabilities so that investors can make better decisions in the face of climate change and systemic change in the economy. 

There is much to do to create the reporting, accounting, and assurance architectures to facilitate these changes. Do we have the right definition of going concern in the face of a climate emergency and what really is true and fair when thinking about circular business models, potential stranded assets and vulnerable infrastructure? The answers to these questions will show whether the profession really is prepared to lead and create a world of strong economies.