As ESG begins to shift under the finance chief’s purview, CFOs have begun to think about how to finance that ambitious net-zero plan handed to them by the sustainability department. Entering the carbon credit market has become an appealing prospect, if you can get past the accounting barriers, experts tell CFO Brew.
Zoom out: Carbon credits, while a market was officially created under the 1997 Kyoto Protocol, gained corporate interest after the 2015 Paris Agreement was adopted. In the years that have followed, many companies have publicly issued net-zero plans, or commitments to reduce their operations to be environmentally neutral.
Carbon credits are purchasable through the cap and trade market, also referred to as emissions trading systems, which ensures environmental certainty, or if the carbon credits are really doing what the corporates purchase them for: reducing carbon. The cap-and-trade market is overseen by governments and is considered a “market-based” program, similar to that of a traditional trading market, according to the EPA.
And not to be confused—despite the word credit being in the name—carbon credits have nothing to do with tax credits, Eric Knachel, a partner at Deloitte, told CFO Brew.
The appeal: Whenever you hear the word “credit,” it’s appealing to CFOs, Frank D’Amelio, Deloitte’s CFO-in-Residence and former Pfizer CFO, told CFO Brew. CFOs are always looking for ways and opportunities to improve their results, D’Amelio remarked, and the ability to tap into a credit market could appease their stakeholders, who are increasingly demanding ESG progress. Also, the carbon markets serve as a way for companies, who had pledged to reduce their carbon footprint, to make progress.
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Accounting headache: One of the biggest issues facing the carbon credit market for corporate finance is how to line-item the costs into the balance sheet, Knachel said.
Knachel isn’t the only one hearing from companies that some standardization would be nice—the World Business Council for Sustainable Development (WBCSD) wrote that “there is a strong desire in the international business community to develop a widely recognized, commonly used, global accounting mechanism” and that also allow stakeholders “to track aggregate corporate progress on the net-zero targets,” in a report released last fall.
Many are looking for the SEC’s climate change proposal, set to be announced in April, to give some clarity around categorizing carbon credits, but, currently it’s a “crystal ball” on if or how the topic will be addressed, Knachel said—especially considering there are rumors of reeling the proposal back.
“Regardless of that rule, if companies enter into different transactions involving environmental credits, they actually need to account for it, and report for it in their financial statements,” Knachel remarked. Currently, the transactions have been relatively small compared to the company size, allowing them to categorize the investment as insignificant or immaterial to the company. Although, the market is increasing as companies attempt to fulfill their net-zero plans, currently creating an accounting headache.
“If there’s one thing to kind of take away, it’s that environmental credits will likely be part of the climate strategy going forward, and so companies need to start thinking about how they will account and report for those,” Knachel said.—KT