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New carbon accounting standards crucial in matching changing climate investment landscape

November 1, 2022

Specific accounting standards are urgently needed for new asset types such as certified carbon offset credits, according to a new report from Imperial College Business School.

The report shows how emerging global carbon markets and new investable assets make the need for new accounting regulations more pressing in the fight against climate change.

New accounting standards will be a major step towards achieving “transparency” the researchers note, pointing to the need for openness in accounting practices ahead of the 27th United Nations Climate Change Conference (COP27) which opens on 6 November in Sharm el-Sheikh, Egypt.

Despite the lack of clarity around accounting standards, in 2021 global carbon markets grew to a record €760 billion ($851 billion). With discussions around greenhouse gas emissions reduction set to continue at COP27, the report proves timely, with accounting standards – particularly around carbon credits – widely considered crucial to scaling up carbon markets and achieving net zero by 2050.

According to the report, Financial Accounting for Carbon Finance: A New Standard for a New Paradigm, from Imperial’s Centre for Climate Finance & Investment, the changing investment landscape demands new accounting standards. In particular, certified carbon offset credits (also known as carbon offsets) – measurable emissions reductions from certified climate action initiatives – remain misunderstood as financial instruments, which creates a barrier to standard setting in this space.

Authored by Raúl Rosales, a Senior Executive Fellow at the Centre for Climate Finance & Investment at Imperial College Business School and María Angeles Peláez, Global Head of Accounting & Regulatory Reporting at Spanish bank BBVA, the report assesses the current accounting framework for global carbon markets under IFRS, the global standard-setting in accounting, and makes several policy recommendations.

Dr Rosales, via the report, notes that the current lack of clarity and guidelines around carbon markets’ financial accounting and risk management has significant implications for banks’ regulatory capital requirements in their role as intermediaries in the emissions trading system.

According to the report, a change in accounting standards that amplifies the importance of developing a new category of financial instruments at fair value that reflects the management and goals of financial entities in their financial statements is needed.

Achieving all of this, Rosales notes, starts with re-thinking the definition of carbon offsets. Rather than being classed as intangible assets or inventories, carbon offsets should be considered as investable assets used as part of a bank’s offering to corporate clients for ‘offsetting’ and ‘hedging’ purposes.

The report was created with the support of the Singapore Green Finance Centre, which is co-managed by Imperial and Singapore Management University, and strategic insights from financial firms, banks, asset managers, and senior officials from policymakers.

Reflecting on the report, Dr Rosales says:

“We need accounting standards that reflect both the market at present as well as the direction that it is going in. With such markets evolving rapidly, there is an urgent need for the establishment of a carbon instruments accounting project in the near term. This report is timely as it coincides with the new sustainability reporting standards being developed by the International Sustainability Standards Board (ISSB). It is crucial to develop new financial accounting standards alongside these, to achieve global harmonization. The International Accounting Standards Board (IASB) is in our opinion the most qualified international body to address this.”

The report is published a year on from the IFRS Foundation’s unveiling of the ISSB at COP26, which took place in Glasgow in late 2021. Aware of this timeline, Dr Rosales adds:

“Last year, we witnessed a major milestone moment: the announcement of the ISSB at COP26. A year later, now is the time to build on that development.

“As this report highlights, markets are changing. As such, standards too are evolving. This report offers policymakers and those operating within the industry a number of valuable recommendations to ensure that, amongst all of this change, transparency remains.”

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