United States: Former SEC Commissioner And Carbon Tracker Initiative Submit FASB Request On Climate Risk

Last Updated: January 22 2014
Article by D. Cameron Prell

A lot has been reported and discussed over the past few years on the concept of "unburnable carbon" and the digestion by capital markets of the inherent financial risks associated with climate change. There are myriad things to discuss on the topic, but for the moment I'd like to highlight something that was missed recently just before the holidays. A request to the Financial Accounting Standards Board (FASB) was submitted on December 10, 2013 by the Carbon Tracker Initiative and a former SEC commissioner arguing that financial disclosure of carbon content should be required for companies with significant fossil fuel reserves.  As the request states "As astute [carbon bubble] observers recognize, there is an increasing probability that some governments will embark on regulatory action to limit carbon dioxide release. Such action could have a major impact on the value of fossil fuel reserves as well as the capital investment in exploring and developing reserves. In our view, investors would benefit from sensitivity analyses against low demand or price scenarios that could capture the future potential emissions constraints and their potential impact on the quantity and the net present value of reserves. ... We are not requesting that the Financial Accounting Standards Board pass judgment on the future viability of fossil fuel reserves. Rather, we urge the FASB to recognize the need for disclosure sufficient to permit investors to make this determination for themselves."

It is unclear what FASB might do with this request, but a number of points in the request are worth noting.  For example, the request cites FASB Statement 33, Financial Reporting and Changing Prices, issued in 1979 to "address the need for information on current costs given the rampant inflation of the time."  The request goes on to state:

"In [its excerpted explanation of Statement 33 below], FASB considered the consequences of not having reliable access to such information. If we replace the highlighted words 'changing prices' or 'inflation' with 'carbon emission restrictions', that summary paragraph would apply to the constraints of the carbon budget that affect us today.

The Board believes that this Statement meets an urgent need for information about the effects of changing prices. If that information is not provided: Resources may be allocated inefficiently; investors' and creditors' understanding of the past performance of an enterprise and their ability to assess future cash flows may be severely limited; and people in government who participate in decisions on economic policy may lack important information about the implications of their decisions. The requirements of the Statement are expected to promote a better understanding by the general public of the problems caused by inflation: Statements by business managers about those problems are unlikely to have sufficient credibility until financial reports provide quantitative information about the effects of inflation.

Therefore, there is precedent for requiring supplementary information – even extensive supplementary information – to more accurately depict a rapidly changing economic environment. The logic of this FASB statement applies with equal vigor to the rapidly growing and increasingly recognized global threats of anthropogenic climate change.

Without benefit of information concerning the carbon content of fossil fuel reserves, investors are deprived of key information having a direct impact on a company's exposure to the risks of the carbon budget and, thus, on its ability to create and sustain value. Carbon disclosures represent information about events and conditions that are not yet recognized in financial statements but that affect the company's future net cash inflows. As FASB Statement No. 33 wisely forewarned, insufficiently complete information risks the misallocation of resources. This risk is especially true for the many fossil fuel companies that, following long outdated business models, continue to expend vast amounts of corporate wealth – on which shareholders hold the residual claim – in searching for new fossil fuel reserves, despite the severe limits the carbon budget will, if implemented, impose on existing reserves."

Again, it is unclear what FASB might do with the request.  However, it is yet another example that the sand is really beginning to shift on financial carbon accounting and corporate disclosure of climate risks, and that 2014 may see a great deal of discussion on these and other related topics.  If carbon-intensive companies are required in the future to conduct some form of climate risk sensitivity analyses for project investments, and publicly disclose such information or share it with investors, what might that do to the investment attractiveness and value of low carbon technologies or project alternatives?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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