Climate-related reporting in financial statements

A 2018 report from the Journal of Cleaner Production claims that the pharmaceutical industry emits more carbon than the automotive industry on both an absolute and an intensity basis.

Important reasons for high levels of direct emissions from the pharma companies themselves include their use of water for cleaning and for sterile media, the propellants they use for asthma inhalers, and their energy use to maintain clean humidity- and temperature-controlled rooms through heating, cooling and ventilation. 

The sector is, however, an enthusiastic proponent of targets for carbon reduction, and it provides substantial disclosure of scope 1, 2 and 3 emissions. 

Downstream – many countries’ health systems, including the UK’s NHS, have significant carbon reduction commitments. 

Upstream – the industry also affects its suppliers as it drives carbon reduction initiatives in its value chain. This is a key concern for the industry as company reports show that more than 90% of emissions associated with the industry come from pharmaceutical companies’ value chains rather than from operations within their direct control.

Investor demand and the industry’s enthusiasm for targets result in significant amounts of disclosure in annual reports. The industry has strong credentials in the area but, as for every industry nowadays, the bar is continually raised and demands for data will also lead to further demands for explanation, granularity and verification.

Impact – operations, disclosure and assurance

Operations

Companies’ risk analyses suggest that the direct physical impact of climate change – the risks of more extreme weather, flooding, higher average temperatures and so on – will be relatively manageable, at least for the larger companies. But for companies in the sector, there is much more to do in respect of transition to lower-carbon operations. As noted above, the industry is a substantial consumer of energy. 

Carbon intensity varies substantially within the industry, and it is not clear how much it is driven by relative efficiency and how much by product portfolio (emissions from asthma inhalers for example) or business model (extent and nature of subcontracting). 

Options for managing energy consumption include building intrinsically more efficient operating environments when constructing facilities; retrofitting more efficient environmental control to existing facilities; seeking greener sources of energy; agreeing wider tolerances for temperature and humidity; and finding alternative purification methods for water in products. 

The design of facilities has up to this point prioritised environmental and hygiene control above just about everything else. This makes sense given the primacy of health considerations and the potential consequences of lapses in this area. Changes in this area – such the introduction of new methods of water purification – are likely to have needed regulatory approval. And while the importance of energy and water efficiency may have increased, the potential consequences of problems such as contamination mean that when undertaking process change, pharma companies will have to maintain higher levels of caution than companies in some other industries.

Disclosure

Demands for greater disclosure continue across all industries and in most developed countries. In the UK, listed companies are obliged to report in line with the Task Force on Climate-related Financial Disclosures (TCFD) framework, on their strategy and risks in respect of climate change and carbon emissions. And soon larger unlisted companies will have to do likewise.

The International Sustainability Standards Board has been created, and it issued its first two exposure drafts: Exposure Draft Proposed IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information, and Exposure Draft Proposed IFRS S2 Climate-related Disclosure.

And the European Union has issued a set of 13 exposure drafts of European Sustainability Reporting Standards (ESRSs) for companies located in EU member states, which cover environmental, social and governance matters.

The pharmaceutical sector has relatively high levels of disclosure in respect of carbon emissions. But the sector will doubtless be expected to expand these disclosures further in future years, with clearer methodology, greater explanation of changes and higher levels of granularity.

Current disclosures show the high levels of scope 3 emissions from companies’ value chains, for instance. But, at least in annual reports, these disclosures give little indication of the products or processes with which emissions are associated.

To be aligned with the spirit of the 2015 Paris Agreement, organisations need to set a strategic goal of achieving net zero emissions by 2050. Several of the largest pharma companies have net zero or equivalent targets to be achieved by 2030. AstraZeneca, for example, has unveiled an ambitious programme for zero carbon emissions from its global operations by 2025 and has pledged to become carbon-negative across its entire value chain by 2030. 

Proposed or upcoming regulation and legislation also includes greater disclosure of future plans, particularly in the area of targets, the methods for their achievement, and intermediate milestones. So we can expect to see greater attention given to evidencing progress towards such targets and more detail of the methods by which they are achieved.

In June 2022 the European Council and European Parliament announced that they had reached a provisional political agreement on the Corporate Sustainability Reporting Directive (CSRD). The directive introduces more detailed reporting requirements and ensures that large companies are required to report on sustainability issues such as environmental rights, social rights, human rights and governance factors.  

These EU rules on non-financial information will initially apply to large public-interest companies with more than 500 employees, large companies that meet specific criteria on turnover, total assets and number of employees, and listed companies on EU regulated markets.

For non-European companies, the requirement to provide a sustainability report will apply to all companies that generate a net turnover of €150m in the EU and that have at least one subsidiary or branch in the EU. Application dates for meeting the CSRD requirements vary, with three phases starting from 1 January 2024.

Assurance

With greater focus on disclosure comes greater calls for verification of that disclosure. While there is significant third-party assurance or certification already occurring, to date this is largely voluntary, and standards appear to vary widely. Investor expectations also vary, with some investors demanding more assurance, while others assume it is already in place. 

European legislation provides for mandatory assurance, but auditing standards are yet to be developed for the area. Who should be doing the assurance is still being widely discussed.

CSRD reporting must be certified by an accredited independent auditor or certifier. This independent auditor or certifier must ensure that the sustainability information provided complies with the certification standards that have been adopted by the EU.         

Conclusion

As noted above, the industry is a major emitter. Recent years have seen increasing attention devoted to tackling climate change. Some efforts, such as the purchasing of green energy, can move ahead with little operational impact. But others require careful balancing of the historical single-minded focus on hygiene and the avoidance of contamination against potential substantial gains in energy efficiency.

Efforts will also be pushed out through the supply chain, affecting an increasing number of companies which may be less directly affected by disclosure regulations or investor demands themselves.

All this will require agreement on measurement methodologies, management information systems for measurement and assurance services. This is an important area for development of the audit profession.