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  • “Existing financial accounting rules … may hamper recognition and measurement of long-term sustainability risks.”

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    The EU is currently undertaking a number of initiatives around climate action and environmental policy. They have observed that the “transition to a sustainable economy will entail significant investment efforts across all sectors and will require to manage and integrate climate and environmental risks into our financial system”.

    In order to assist with the transition the “European Green Deal” announced a Renewed Sustainable Finance Strategy to help channel investment into sustainable projects and activities. The EU plans to have a Renewed Sustainable Finance Strategy ready for adoption in the first half of 2021.

    As part of this project the EU has undertaken a range of stakeholder consultation to help it develop policy that will (among other things):

    Strengthen the foundations for sustainable finance by creating an enabling framework to shift the focus of financial and non-financial companies to sustainability and long-term development.” andFully manage and integrate climate and environmental risks into financial institutions and the financial system as a whole.”

    The EU have released a summary of the feedback received, and the documents is a comprehensive 82 pages long, which we don’t plan on summarising here. But what we think is particularly interesting, given the IFRS Foundations’ current interest in Sustainability Standards, is the discussion around whether or not current accounting standards support sustainable finance.

    The report notes that “of those respondents who had an opinion” the majority felt that “existing financial accounting rules … may hamper recognition and measurement of long-term sustainability risks.” Specific areas identified included:

    • Impairment and depreciation rules: Respondents indicated that IFRS depreciation rules do not fully (or at least explicitly) reflect climate risks. Some recommended that companies should disclose the (key) assumptions used for impairment and depreciation charges and align these with the Paris Climate agreement.
    • Provisioning: Several respondents pointed at the importance of adequate provisioning for climate change impact, with some noting that that IFRS rules on provisioning for future risks are too strict to allow sufficient
      provisions for things like “repairing”.
    • Contingent liabilities: Most stakeholders highlighted the need for additional emphasis on significant climate-related contingent liabilities.

    The report notes that some stakeholders felt that a short-term focus on cash flow generation in the Standards negate longer term sustainability issues and make it unlikely accounting can capture all sustainability risks in financial statements. Though some respondents considered that existing IFRS can adequately capture the financial implications of sustainability risks but more guidance is needed on this.

    Our view

    There is no reason the IFRS Standards can’t address these concerns, if they genuinely do represent short comings in the Standards. As the IASB itself has already pointed out, IFRS Standards do require the consideration of a wide range of risks when preparing financial statements, and though not explicitly mentioned climate risk should be key among them. That being said, bringing sustainability into the IFRS fold via a Sustainability Standards Board, even though independent from the IASB, is likely to have a positive impact, raising awareness of key issues that will need to be considered when developing financial accounting standards.

     


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