There is a yawning gulf between audit of emissions and audit of financial statements, and this could be very bad news for the trees and the animals that dwell amongst them.
Financial audit is increasingly rigorous, because there is a balance of interests – very strong interests – ensuring an auditor’s impartiality. If the auditor allows profits to be understated, he will get it in the neck from buyers, since their stock will be undervalued. If he allows profits to be overstated, he will get it in the neck from sellers, whose short strategy will be foiled. And then when the truth comes out, the existing shareholders will get their knives out too. These shareholders are financial institutions with lots of money to spend on the best lawyers that money can buy – where best means very vindictive and nasty. When shareholders have supped of the auditor’s blood, a policeman will scrape up the body and throw it into the clink for good measure.
These days no-one wants to be in the business of signing off on phoney numbers. The auditor is quite blasé at the thought of being sacked by his client for refusing to turn a blind eye to a misstatement. Better to be sacked than spend ten years on bread and water.
Sadly it is not the same with verification of emissions. The auditor – or Designated Operational Entity in the street-wise slang of the UNFCCC – gets paid either by the project developer or the buyer of the credits. It is the project developer’s interest to get as many credits as possible for his project. Funnily enough, it is in the buyer’s interest also to get as many credits as possible from the project. So either way, the auditor’s paymaster wants to maximise the quantity of carbon credits. Similarly in the case of the EU Emission Trading Scheme, the installation wants as few emissions as possible to come out of his verification.
Say the auditor allows his judgment of the hypothetical counterfactual to be influenced a little bit by a fee-paying client who knows a darn sight more about his own business and industry than the auditor ever will, and who can be very convincing indeed about what he might or might not have done if things had been different … it could just be that emissions are a bit understated and credits overstated.
The trouble is that there is no counterbalance against this interest. There are no injured shareholders who can sue the auditor for allowing misstatement. Because the injured shareholders are not me and you or Goldman Sachs or the Bank of England. The injured shareholders are their grandchildren, polar bears, and baby hedgehogs. Hedgehogs don’t make it to court. They don’t even make it across the court’s carpark.
Audit of emissions and carbon credits will only work properly if the auditors can end up in jail and penniless if they get it wrong. They need to be regulated based on this premise. This means some major rethinking of the system. And hedgehogs need to start learning English quick.