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December 20, 2021

Big Four auditors risk legal challenge on climate failings: ClientEarth

By Zoya Malik

ClientEarth lawyers have warned the world’s Big Four audit firms that they are failing to fulfil audit standards and their core legal duties by not considering climate risk, threatening the integrity of the market and leaving them open to legal challenge.

In letters to PwC, KPMG, Deloitte and EY, the lawyers stress that there is little evidence that any of the firms are taking climate risk into account when reviewing company financial statements, despite existing requirements to do so.

Analysis of the 2020 financial statements and audit reports of more than 100 carbon-intensive companies by Carbon Tracker and the Carbon Accounting Project found that 80% of auditors provided no clear indication of whether, or how, they had considered material climate-related matters.

ClientEarth lawyers are now putting the Big Four on notice, warning that their insufficient audit practices put them at risk of breaching legal requirements and investor expectations, and are starkly at odds with their own public climate commitments.

ClientEarth Climate Finance Lawyer Rob Clarke said: “Emissions reduction targets, regulatory changes, and declining product demand all present significant risk to businesses’ financial health, yet auditors are continuing to wave through company financial statements that appear to ignore these impacts.

“When climate risk does not factor in audit reports of the most climate-exposed companies in the world, investors are left in the dark about potentially enormous risks to their capital.

“Auditors are legally required to consider material climate risks. Failing to do so puts them at serious risk of legal and regulatory challenge, and undermines their public commitments to take action on climate change.”

ClientEarth found that all four audit firms had publicly claimed to have extensive awareness of climate-related risks and their implications for financial reporting, raising questions over the legitimacy of their position on climate.

Specifically, ClientEarth lawyers found that:

  • PWC openly acknowledged that “climate change isn’t a challenge for tomorrow, it needs to be tackled now”.
  • Deloitte said that finance professionals should drive their businesses to prepare Paris-aligned accounts in order to provide the “quality information” investors need “to shift capital flows towards activities aligned with the Paris Agreement”.
  • KPMG recognised that “Climate-related risks and strategic decisions could impact [companies’] financial statements – and KPIs”.
  • EY stated that “ignoring climate change risks and stakeholder concerns around these issues is no longer an option” and “climate change remains top of the public, regulatory and investor agenda.”

Each of the Big Four audit firms has joined the Net Zero Financial Service Providers Alliance, which commits them to align all relevant services and products with net zero by 2050 or sooner. This includes incorporating Paris Agreement-alignment into the core of their respective business. But their auditing practices paint a different picture.

Climate change has clear implications for the accounting estimates and assumptions used by carbon-intensive businesses, such as the long-term oil and gas prices used by fossil-fuel companies.

If these assumptions are not properly tested by auditors, there is greater risk of companies making material misstatements and misleading investors about the safety of their investments.

ClientEarth lawyers are calling on the Big Four to ensure they are prepared to address material climate risk when conducting audits for financial statements from 2021 onwards, and to alert the companies they audit of their intention to apply existing audit standards more rigorously.

“Investors and shareholders need to be able to trust auditors’ opinions on corporate reporting: if not, it threatens the integrity of the market as a whole,” said Clarke. “Audit firms need to get their head out of the sand and play their part in moving the financial system towards net zero.”

In a review carried out earlier this year of the largest 250 UK-listed companies’ 2019 reporting, ClientEarth found that only 4% of audit reports provided a clear explanation as to whether auditors considered climate-change related factors.

Following this research, ClientEarth reported technology firm Just Eat Takeaway.com and cruise travel company Carnival to the UK’s financial services regulator for failing to report on climate change risk to their investors.

Lawyers also put the companies’ respective auditors, Deloitte and PwC, on notice for failing to flag the omission of climate risk in their audits of the two firms’ financial statements.

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