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Too Early to Pinpoint Accounting Issues on ESG for Private Companies, Panel Says

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

It is still too early to address Environmental, Social, and Governance (ESG) accounting issues for private companies as no prevalent problems have yet been spotted, according to the FASB’s private company advisers.

Private companies have not bumped up against accounting issues related to financial instruments with ESG-linked features, an area the FASB is researching, though there is much buzz around ESG broadly, the Private Company Council (PCC) told the board on April 22, 2022.

So far, the one instance where an ESG-related issue was heard of involved penalties as opposed to an accounting discrepancy, according to the discussions.

“I would say my one experience with it has been with a credit rating agency that did lower a rating on some bonds because of ESG – specifically environment and turnover in lead management,” PCC Chair Candace Wright said. “So, it was the first time I has seen it and that was recent and I’m sure that this is going to become more prevalent, and these types of instruments are going to become more prevalent and trickle down into a lot of the private company space in a relatively short period of time.”

Banks have been discussing the topic of ESG with borrowers and regulatory agencies to gauge how they are thinking of it but view it as an early-stage trend that will quickly develop, PCC discussions indicated.

“This is something we talk a lot about with our borrowers to understand how they’re thinking about it, and then we talk about it with the regulatory agencies because they ask us questions and so far it’s kind of like we’re standing in a big circle and saying ‘I don’t know what ya’ll think,’” said Robert Messer, senior executive vice president, chief financial officer-chief risk officer at American National Bank of Texas. “It seems like it’s emerging, but I don’t know if there’s enough on the ground right now to really set a direction or a set of rules about how we should think about accounting for it. My experience is it’s still in pretty early-stage development.”

Stick with Credits and Debts

The discussions were aimed at gaining insight from the PCC on the prevalence of the issuance or investments of debt with ESG-linked features and whether there were “issues, questions, or concerns related to how those instruments are accounted for.” The panel was also asked to weigh in on whether they are aware of any private company issuing or investing in any debt with ESG-linked features and “any issues, questions, or concerns related to how those instruments are accounted for,” among other related matters.

In general, ESG brings a plethora of issues that might not be relevant to the board’s preview, the PCC’s discussions indicated.

“I think there is more and more interest in ESG reporting, but I think a lot of that may fall outside what I view as the purview of both FASB and the PCC,” Zubin Avari, managing partner at Charter Oak Equity, LP, said. “I think we need to stay focused on if these reporting features have accounting items that we would report on either ESG or other like kind instruments then I think we need to opine on them,” he said. “If they’re not on the debts and credits side but investors are asking for it I think that’s probably in the purview of some other group and not ours and I’d like to suggest that we stay true to our mission.”

The topic was raised as the FASB researching whether to add a project to its technical agenda on financial instruments with ESG-linked features. In December the board added the topic to its research agenda to determine whether standard-setting was feasible after receiving feedback on its June 2021 Invitation-to-Comment (ITC) No. 2021-004, Agenda Consultation, that ESG-related transactions and disclosures should be one of its top agenda priorities.

The most frequently cited challenge by ITC respondents was whether ESG-related provisions within financial instruments are required to be bifurcated and separately accounted for as a stand-alone derivative, according to a staff analysis to the PCC.

Some financial statement preparers said that applying the bifurcation criteria for an embedded derivative to ESG-linked financial instruments is costly and complex. Companies note that ESG features generally meet the bifurcation criteria and, thus, should be separately accounted for as a derivative.

“Certain preparers have communicated that if bifurcation is required, estimating the fair value of ESG features requires significant judgment, and the fair value of such features may not provide decision-useful information to users of financial statements,” the analysis states.

Capital Allocation Issues to Come?

So far academic papers from Europe signal at what could be coming down the pike in the U.S. as those studies reveal there are impacts to capital allocation, according to the discussions.

“he paper showed some banks that chose to make ESG commitments and other banks that didn’t and the paper showed that those borrowers that related to banks that made those commitments had lower growth, lower loans, lower cap X – in other words they were specifically linking capital allocation to these ESG decisions,” Michael Minnis, professor at the University of Chicago Booth School of Business, said. “LPs – keep hearing all the time – are allocating capital to private funds specifically related to ESG types of topics,” he said.


This article originally appeared in the April 26, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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