FMA expectations on climate risks and audit files

  • Legal update

    28 October 2022

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The Financial Markets Authority (FMA) published its expectations on the impact of climate risks in financial reporting (Expectations Document) yesterday.

The Expectations Document highlights that consideration of climate risks and impacts is not only a matter for the approximately 200 climate reporting entities (CREs) that will be subject to New Zealand’s mandatory climate-related disclosure (CRD) regime (see our most recent update on this regime), but also all financial reporting entities under the existing Australian and New Zealand Accounting Standards.

Who needs to read it?

Directors and senior management, and preparers and auditors of financial statements for businesses with financial reporting obligations.

What does it cover?

Some of the FMA’s key expectations of directors and management, as well as those charged with governance and auditor reporting, are summarised below.

We recommend you read the Expectations Document in its entirety.

  • Strong recommendation that management and directors consider climate risks throughout their risk assessment process and look at how this impacts the preparation of financial statements (and for CRD reporting entities, climate statements).
  • The FMA acknowledges that while accounting standards do not refer explicitly to climate-related matters, it expects that entities must consider these matters when they are material in the context of the financial statements as a whole. Information is material if omitting, misstating, or obscuring it could reasonably be expected to influence decisions made by primary users of financial statements and climate statements.
  • Entities should focus on providing information in a clear, concise, and effective way, so material information is not lost in lengthy explanations of circumstances and financial impacts. This includes disclosing any sources of estimation uncertainty and key assumptions that underlie asset values, impairment and relevant provisions that may be materially impacted by climate risks.
  • Expectations when documenting and supporting climate risk disclosures in financial statements:
    • prepare high-quality technical papers for all material areas impacted by climate risk. This includes materiality assessments and accounting considerations of decisions made to support financial statement disclosures; and
    • provide adequate documentation for board minutes and audit committee meetings, like discussions, analysis and conclusions for accounting areas impacted by climate change.
  • The above documents will be critical for the entity to maintain proper accounting records to support the material disclosures in the financial statements. Where decisions are made that items are deemed immaterial, these decisions should also be included in the documentation.
  • Expectation that entities should also consider how their information and communications related to climate change comply with laws and regulations, and if their messages align across their various communications including the messages in the financial statements. Auditors will be looking at areas of non-compliance with laws and regulations, including assessing matters referred to in other information accompanying financial statements.
  • Expectation that there should be discussions with management and directors on how climate change-related laws, environmental regulations, and fair dealing rules may impact what statements an entity makes (e.g., about climate change and net zero emissions targets), the entity’s operations and consequences of breach, and how compliance is managed.
  • Expectation that as part of identifying and assessing the risks of material misstatement and potential climate change impacts, an entity should note (and the auditor should check that an entity does) the following:
    • document how it assesses how climate change may impact its business;
    • understand how its business model may be impacted by climate change (e.g., subsidiaries in other jurisdictions) and auditors are expected to challenge business models;
    • consider how climate-related laws and regulations could affect the way business is conducted and the impact on financial statements (e.g., a requirement to become carbon neutral may mean the entity needs to invest in cleaner production methods and existing equipment becomes obsolete); and
    • assess whether other external factors impact the entity (e.g., consumer preferences for green products, bank lending restrictions).
  • Expectation that when considering materiality, look at disclosures that could be reasonably expected to influence the economic decisions of users (e.g., investors placing importance on climate-related issues), based on financial statements as a whole, not just quantitative disclosures.
  • Expectation that if climate change risk could have a material impact on financial statements, design procedures to respond to these risks and obtain sufficient evidence to address them.
  • Expectation to establish a clear link between material climate risks and the impact on assumptions and methods used in assessing accounting estimates (i.e., are estimation models fit for purpose to capture climate change effects, and is data provided relevant and reliable). Auditors are expected to document evidence obtained to challenge the assumptions used in management’s estimates.
  • Expectation that auditors pay attention to the following when evaluating misstatements of an entity identified during the audit in relation to climate-related risks:
    • whether errors and omissions in areas like financial position, financial performance or the entity’s cashflows are arising from inadequate assumptions or failing to disclose key considerations when assessing estimates; and
    • whether the entity has made, or left uncorrected, departures from NZ IFRS to achieve a particular presentation of the entity’s financial position, financial performance or cashflows.
  • Expectation to have going concern assessments and ensure that it contains all relevant information in relation to climate-related risk (e.g., significant litigation claims that may impact ability for entity to continue operations for foreseeable future, or changes in regulations prohibiting the entity continuing its current business).
  • Expectation that there should be a link between assumptions used for impairment assessment and the budgets used for going concern assessments.
  • Expectation that disclosures of the effect of climate-related risks and impact in the financial statements are appropriate (including in relation to accounting policies and whether information disclosed is sufficient), adequate, free from material misstatements of fact, and free from material inconsistencies between the financial statement and any climate-related information contained in other documents.
  • Expectation that auditors maintain communication with those charged with governance and explain how any material climate risks have been addressed in the audit.
Our view

While the Expectations Document is drafted primarily from the perspective of the FMA’s expectations on preparers and auditors of financial statements, it includes useful insights as to what the FMA is wanting auditors to check in relation to an entity’s financial statements. These expectations should form the basis of an entity’s internal monitoring, audit or review processes so come the time of external audits, the financial statements should be in a good form.

What next?

Yesterday’s publication follows the FMA’s initial monitoring approach to climate-related record keeping in September 2022. For those captured under the CRD regime, it seems the next content we should expect from regulators is the External Reporting Board’s final climate standards in December 2022. Next year, the Ministry of Business, Innovation, and Employment is hoping to publish its exposure draft of record keeping regulations for consultation in February 2023, and in June 2023 the FMA is looking to publish detailed record keeping guidance.

If you have any questions in relation to the Expectations Document or CRD regime, or what it means for your business, please contact one of our experts.

This article was co-authored by Shaanil Senarath-Dassanayake, a Solicitor in our Financial Services team.