Regulator seeks enhanced transparency, more useful information on firms’ activities.

The European Securities and Markets Authority (ESMA) has issued new guidance for issuers on accounting for their carbon trading activity in their financial statements.

The regulator published a report setting out its recommendations for documenting and disclosing carbon allowances under international accounting standards. The guidance aims to enhance transparency and ensure that investors get more useful information on firms’ activities in carbon markets.

Among other things, the guidance — which focused on the European emissions trading system — highlights the accounting standards that could be affected by carbon allowances.

ESMA doesn’t prescribe how these activities should be addressed in financial statements, but highlights considerations for issuers and auditors.

The regulator said it aims “to raise issuers’ awareness regarding a topic whose relevance in corporate reporting has increased in recent years and is expected to continue to gain further attention as the targets set out in the 2015 Paris Agreement draw closer and issuers may need to consider carbon allowances to compensate greenhouse gas (GHG) emissions.”

Given the lack of a specific accounting standard for carbon allowances, the regulator called on issuers to provide investors with information on the accounting policies used for the recognition, measurement and presentation of carbon pricing programs.

“Disclosures should specifically explain how these allowances impact the financial performance, financial position, and cash flows, indicating which line items in the financial statements are affected,” ESMA said.

Looking ahead, ESMA said regulators will continue to monitor the work of accounting standards setters in this area, as well as the progress of issuers at documenting and disclosing these exposures in their financial statements. It will also consider whether further guidance is needed to address firms’ carbon market activities.

The new guidance comes on the heels of ESMA’s first report on the European emissions trading system’s performance in 2023.

That report noted that carbon prices have been falling since the start of 2023. After breaking the €100 price barrier for a tonne of carbon dioxide-equivalent emissions (tCO2) in early 2023, prices fell back to less than €70/tCO2, ESMA said.

“This was due to a combination of lower demand for emission allowances from weak industrial activity, falling natural gas prices and decarbonization of the European energy sector, along with increased supply,” the report said.

It also found that the vast majority of emission allowance trading in secondary markets takes place through derivatives.

Secondary market trading activity “was broadly stable” in 2023, the report said, with 9.3 billion tonnes of tCO2 exchanged on European trading venues in 2023. Over-the-counter trading was much smaller, at 864 million tCO2.

ESMA said banks and investment firms “dominated both the on- and off-exchange markets,” accounting for 56% of total trading volumes, with non-financials responsible for 25%, and investment funds (12%).