The global economy may be humanity’s most powerful invention. Not only has it enabled 8 billion people to exist at once and nearly double our average lifespan, but we've made it possible for one person to personally own a quarter of a trillion dollars and plausibly entertain visiting Mars. But the global economic system's short-term lens, and insensitivity to the well-being of communities or ecosystems have caused it to rout our planet’s life support systems and leave 15 of every 100 people in poverty worldwide. And if you're reading this, we know you're interested in evolving it.
At the highest level, impact management is an ambitious effort to enhance how we perceive the effects of our economic activities to better align those effects with what we individually and collectively care about.
Still, companies and investors face mixed incentives, and actors that wish to stymie decarbonization are getting better all the time at kicking up media and legal discomfort for companies which act.
It’s important that company directors feel that they will not be penalized for addressing companies’ carbon footprints, and hopefully that they will be rewarded for doing so. In service of this goal, we are watching with great interest two converging events.
One is the new legal opinion that has been issued in the UK articulating the basis upon which existing financial accounting standards support incorporating sustainability-related information into published financial statements. The opinion speaks to the requirement of a company’s accounts to reflect a “true and fair” representation of the company’s financial position and:
affirms directors’ existing legal responsibilities to be mindful and ‘exert themselves’
highlights relevant accounting standards in the context of sustainability e.g. asset impairment and constructive obligations
reflects on the appropriate disclosure which could be as a note to the accounts
states that company directors may deliberately choose to structure commitments in such a way as to create constructive obligations which impact upon the accounts
Why does this matter? Enter the second event: clarification of public climate-related goals as constructive obligations.
Under International Financial Reporting Standards (IFRS), a constructive obligation is “an obligation that derives from an entity’s actions where; by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.” – Paragraph 10, International Accounting Standard 37 (IAS 37)
When a company creates a constructive obligation, it must record it on its balance sheet as either a liability or an asset. In the case of climate emission reduction targets, expenditures made to achieve that target could be transformed from expenses, which is how they are currently treated, into capitalizable assets: investments to achieve a valued goal.
IFRS is meeting later this month to clarify whether and when companies’ publicly stated goals around climate emission reductions constitute constructive obligations under IAS37. If this happens, it could remove one of the major systemic disincentives for companies to act.