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Accounting for Net Zero: The Role of Audit Institutions

Climate change, biodiversity loss and pollution pose an existential threat to life on earth. The UN’s Intergovernmental Panel on Climate Change has warned that without immediate and deep emissions reductions across all sectors, limiting global warming to 1.5°C is beyond reach. One million of the world’s estimated eight million species of plants and animals are threatened with extinction, and extinction rates are accelerating. Environmental pollution - pollution of air, water, and soil - compounds both biodiversity loss and climate change. UN Secretary-General Antonio Guterres has warned of a “code red for humanity”.

Addressing this triple challenge carries a huge cost. Global investment needs are estimated at USD 125 trillion by 2050. Europe alone will need an estimated €350bn in additional investment per year over this decade to meet its emissions-reduction target in energy systems alone, along with €130bn for other environmental goals. The scale of investment needed is well beyond the capacity of the public sector. This means that private investment must be re-prioritized to finance sustainable growth and to reduce companies’ direct and indirect carbon footprint to net-zero. Although some public and private investors already support the transition by means of their Environmental, Social and Governance-based investments (ESG), many others still lag. 

At the heart of efforts to generate the sustainable investment needed to create a net-zero economy is a set of initiatives to promote relevant and comparable sustainability data. Such data transparency is essential to monitor progress and to counter efforts at ‘greenwashing’.

In the US, the Securities and Exchange Commission is finalizing a rule for audited emissions data to be included in corporate financial reports. In Japan, the Financial Services Authority will introduce mandatory climate risk disclosure for Japan’s biggest firms. The EU is taking four data transparency initiatives: a classification system of sustainable activities (taxonomy); a disclosure framework for financial and non-financial companies; benchmarks, standards, and labels; and mandatory corporate sustainability reporting.

However, one key element of this drive towards accountability for net-zero emissions is still missing. The capstone of financial accountability, state-of-the-art external audit, is not yet in place. Although commercial audit firms are building expertise, most national audit offices – often called supreme audit institutions (SAIs) - have yet to do so. To support the transition to sustainable finance SAIs must widen the scope of their audits to include the emissions reporting of state-owned enterprises (SOEs) and state pension funds.

SOEs operate in almost every country in the world, where they often dominate industries such as energy, telecommunications, transport, and banking. At USD 45 trillion in 2018, SOE assets are equivalent to 50% of global GDP, the IMF has found. In countries such as China, India, Indonesia, Russia, and Saudi-Arabia, SOEs constitute one-third or more of the largest firms.

SOEs are significant sources of greenhouse gas emissions, and progress towards net-zero targets remains slow. Only a few SOEs, such as Singapore’s Temasek, are implementing ESG policies. One important step would be for SOEs to report on their carbon footprint in line with the OECD Guidelines on corporate governance, which require SOEs to disclose material financial and non-financial information. Through their audits, national audit offices can help to improve the accuracy, consistency, comprehensiveness, and timeliness of these disclosures.

Public and private pension fund investments can also have a significant negative carbon impact. Some leading public sector pension funds have committed to cutting their total carbon emissions to net zero by 2050. These include the United Nations Pension Fund and funds such as KLP (Norway), ABP (Netherlands), MP Pension (Denmark), ERAFP (France), and the 12 leading public and private UK pension funds convened by the Church of England Pensions Board. Some funds, however, remain hesitant. Auditors should remind them that the fiduciary duties of investors require them to incorporate environmental, social and governance concerns, as UN’s Principles for Responsible Investment and UNEP have confirmed.

Many national audit offices have a mandate to audit SOEs and state pension funds. It is time for them to modernize their audit practices and consistently include climate change risk management in their reports. State auditors could verify, for example, if SOEs and state pension funds (1) report publicly on the size, composition and development of their carbon footprint; (2) have adopted a net-zero carbon emissions target for 2050 at the latest, and set interim targets; (3) have specified the extent and impact of any policies to offset rather than reduce carbon emissions; (4) support one or more of the international financial alliances to limit climate change; and (5) report on progress transparently and reliably in their annual reports.

Global standards invite national audit offices to “make a difference in the lives of citizens”. The existential risks of climate change, biodiversity loss and pollution should lead these influential bodies to upgrade their audits and join the global net-zero coalition.