Cleaning up their act

DONALD RUMSFELD, US defense secretary until 2006, memorably classified intelligence in three ways: known knowns, known unknowns and unknown unknowns. If we can thank scientists for dragging greenhouse gas emissions from the last category into the second, we probably need to rely on accountants and statisticians to take them from the second to the first. And if mandatory reporting is introduced – as the government suggested this summer as part of a consultation required in the 2008 Climate Change Act – finance directors will need to polish up their carbon accounting. Among many things, the government proposed the use of a reporting standard, obligatory reporting for quoted companies and obligatory verification.

However, many reported emissions at the moment fall into an awkward fourth category: unknown knowns. Reporting is widespread, but the number crunchers often betray a lack of familiarity with their data. As Stefano Dell-Aringa, research manager at environmental data provider Trucost, puts it: “There are some very junior mistakes and a lack of attention.” According to an Environment Agency study published last year, 67% of FTSE All-Share companies reported quantitatively in 2009-10 on their environmental impacts, which represented a significant rise from 42% in 2006.

Some 36% of annual environmental disclosures were made in the audited sections of companies’ reports and accounts and 57% in business reviews, while 62% of companies produced quantitative information on climate change and energy use, a 112% increase on 2006. The European Emissions Trading Scheme and other policy tools are, of course, partly responsible for the increase. Yet the Environment Agency found only 22% was in accordance with government guidance.

Many reports are full of potholes. But the reader will not know what unknowns a company is leaving out, because it does not usually state the limits of its disclosure. Worryingly, Trucost analysis reveals some glaring errors among big emitters. For instance, it reports that the German utility company RWE had in 2009 overstated its own carbon dioxide (CO2) emissions by 70 million tonnes – equivalent to the annual greenhouse gas emissions of Denmark – because of a classification mistake. Research by Trucost also reveals an airline reported sulphur dioxide (SO2) emissions higher than the whole of the EU at 6,421,000 tonnes in 2005. It got the zeroes muddled up, but reported a less surprising figure a year later of 6,856 tonnes.

Trucost has also drawn attention to a mix-up at a major cement company, which in 2008 confused SO2 with the greenhouse gas nitrous oxide (N2O) and accidentally switched the two figures.

Aside from clerical errors and ignorance about pollutants, it is also easy to deliberately understate emissions. One company reported a 25% emissions reduction from freight transport over a three-year period, a figure arrived at by comparing CO2 tonnage per £m sales. But that figure might well drop if the company’s sales were to increase significantly.

“It happens very often that companies, just to look better, disclose their environmental performances normalised by revenue, employee or floor space,” explains Dell-Aringa. “In this way, it might seem that performances improved even if absolute emission increased over the years.”

Fiddly work

There is also the issue of defining and disclosing in the business review the principal risks facing the company, as required by the Companies Act 2006. Outraged by tar sands plans, Co-operative Asset Management, the WWF and other stakeholders challenged BP to disclose information about greenhouse gas emissions and tar sands risks at the 2010 AGM and were rewarded a few months later. BP’s latest annual report and accounts contains 23 references to oil sands – an alternative term – compared with just three in 2009. However, the WWF wants oil companies to go further and start to disclose potential future carbon costs associated with tar sands.

“These liabilities don’t exist until given values and so it’s difficult to bring them in the financial accounts, but they can be put in where considering risk – in the narrative section,” argues Sue Charman of the WWF, referring to carbon pricing.

Regulations and reporting standards might still have to come into the picture. UK government guidelines include use of the Greenhouse Gas (GHG) Protocol, a standard developed by the World Resources Institute and the World Business Council for Sustainable Development. The use of a single standard under a mandatory regime would, presumably, cut the confusion and errors caused by the dozens of reporting methods used. Some of these methods are very similar – but not identical – to the GHG Protocol, which creates fiddly work for analysts. The GHG Protocol defines the limits of scope 1 (direct emissions controlled by the company), scope 2 (emissions from energy bought by the company) and scope 3 (indirect emissions from, for instance, transport of fuels bought by the company). Mandatory reporting would probably cover scopes 1 and 2.

Mandatory cheer leaders

Quite a few big hitters certainly number among the supporters of mandatory reporting, including the Association of Chartered Accountants (ACCA) and the CBI. These organisations see a mandatory regime as preferable to the current muddle.

“Improved consistency and completeness need a mandatory reporting environment,” warned ACCA in a position statement on making reporting mandatory. “The issues are too urgent to give the opportunity to businesses to avoid regulations.”

Mandatory reporting makes companies more likely to pay attention to the issue and spend more time learning the difference between SO2 and N2O. As Stefano Dell-Aringa points out, mistakes are made because of “a lack of internal quality checks… among companies that do not disclose environmental information, some can’t be bothered and some have no idea”. But reports will mean nothing without accuracy and verification.

Companies need to steel themselves for a potential change in the law that could require some of them to address the issue for the first time. “For a lot of companies [mandatory reporting] would be quite a struggle,” says Dell-Aringa. “But it would be a very good initial step.”

Of course, it would present no ready solution to every problem. As the Environment Agency has found, plenty of companies continue to dodge the issue, and arguing that environmental issues are not material to the business is one way of avoiding disclosure.

But it does not end there. As Donald Rumsfeld once quipped: “The absence of evidence is not evidence of absence.” ?