Originally posted on Business Post 13 June 2021.
Corporation tax might be dominating the headlines now, but environmental matters are of more long-term importance to international finance.
Ideas for what constitutes sustainable behaviour change over time too. Over a decade ago, motor tax on diesel cars was reduced here to reflect lower greenhouse gas emissions
From the headlines you could be forgiven for thinking that the G7 finance ministers discussed nothing but multinational corporation tax last week. Accounting standards rarely deserve such coverage, but the G7 statements about how businesses should account for their environmental behaviour will have repercussions long after the tumult over tax has subsided.
The fundamental issue considered by the G7 finance ministers is that there is no universally accepted standard to measure claims by a business that it is conducting itself in a sustainable way. Misleading impressions are getting created.
When it comes to food, for example, there is much talk about the environmental impact of shipping produce from far afield. Yet, as the chief executive of Bord Bia pointed out last week, transport accounts for only about 3 per cent of the carbon footprint of Irish produce. This figure is undoubtedly valid, but without agreed standards, her counterpart in another country may be doing the same calculation a different way and getting a different result.
Ideas for what constitutes sustainable behaviour change over time too. Over a decade ago, motor tax on diesel cars was reduced here to reflect lower greenhouse gas emissions. Now there is a pushback from some quarters on the role of diesel cars on the grounds of high particulate emission.
If all this confusion makes sustainable consumption choices difficult for the consumer, the problems are even greater for fund managers looking to make planet-friendly returns on behalf of the individuals, unit trusts and pension funds for whom they act. These investment choices are really what prompts the G7 concerns over the lack of generally recognised accounting standards.
The idea of obliging companies to report on their sustainability agenda activity is not new. Since 2014, an EU directive on non-financial reporting has required large businesses to report not only on their financial results, but also on things like their approach to human rights, steps to take against corruption and their promotion of diversity in the workforce.
It is estimated that perhaps 20,000 companies across Europe have been including this material in their published reports and accounts, some of whom volunteer to do so.
The system is not without its drawbacks. It is only a legal requirement for the very largest businesses and it allows companies to choose whatever reporting standards they feel appropriate. This makes it difficult to form objective comparisons between companies. Nevertheless, the directive has promoted the key idea that sustainability reporting needs to be seen in two ways.
First it has to show how sustainable conduct contributed to the value of the business – the euros on the balance sheet. Then it has to show what impact the company’s performance has on the broader environment. This idea is known as “double materiality” in the jargon.
Persisting with the notion of double materiality will be crucial to any fair measurement of a business in terms of its environmental impact. There are already at least five voluntary consortiums involved in devising reporting standards and the EU now wants to establish yet another standard for itself.
The G7, however, seem to be saying that the work should be given to the International Financial Reporting Standards (IFRS) Foundation, the organisation which sets the existing accounting standards to calculate profits, losses and balance sheet values.
That approach seems logical, but it is also problematic. The IFRS Foundation will have to develop expertise in sustainability matters. It took well over a decade to devise the current financial reporting regime, but that kind of timeframe surely cannot be repeated if proper sustainability reporting is to be part of a meaningful response to the climate change crisis.
These initiatives will affect more than just large multinationals. To be credible, larger entities will have to be able to show that their supply chain also operates with good sustainability credentials. That in turn means that smaller enterprises will have to develop similar credentials to secure their position in supply chains, even if they are exempt from formal reporting themselves. All this will come at a cost.
Currently, the relatively modest requirements of the EU non-financial reporting directive drive average costs per company of some €150,000 a year. While such costs would be only a tiny fraction of the total operating costs of a large manufacturer or insurer, they are certain to become proportionately higher as the reporting requirement increases.
In addition, there will be training costs for staff, and new systems to be implemented. It's one thing to meter the number of items processed on a production line, but quite another to meter, for instance, the energy consumption per item.
The piece missing from the G7 approach is that it is all very well for them to mandate more regulatory change cross their own industries in their own territories, but climate change is a global problem. Regulatory compliance is not always a top priority in every country across the world.
The current tax proposals have teeth because the US is threatening to discriminate against countries that don’t apply the proposed 15 per cent minimum rate. There will have to be similar sanctions for countries where their major industries do not have to account for what they are doing to the planet.
Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland
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