Muck and money: estimating the risks
Cliff Warman, a senior manager at Deloitte, addresses UK companies on the liabilities and financial aspects of contaminated land management
Current estimates suggest there are thousands of sites in the UK that are either known to be, or have the potential to be, contaminated. This fact infers considerable environmental liability on the current or previous owners, or the current occupiers of these sites. The overall scale of the financial burden on UK companies could realistically run into billions of pounds.
Liability of this scale would represent a measurable proportion of the current market value of all commercial property in the UK and as a consequence, in recent years the financial management of contaminated land has been elevated as a corporate issue requiring proactive management. The financial and legal implications of contaminated land will impact the majority of businesses at some time, be it during acquisition, divestment or as a going concern and could represent a key business risk for companies operating in specific industrial sectors.
Recent trends towards the promotion of good corporate governance and ensuring businesses become more ‘transparent and accountable’ when communicating environmental concerns to stakeholders, have greatly increased the pressure on companies to obtain accurate estimates of their contaminated land liabilities.
There are distinct business reasons why a company should be proactive in estimating and managing the financial risks associated with contaminated land exposures, especially when you consider that the cost of contaminated land liability through assessment, clean-up, aftercare and asset revaluation, may be significant.
When embarking on a contaminated land remediation project, the management should consider more than just the costs of achieving legal compliance. By promoting good corporate governance, including meeting the increasing societal expectations of this type of work and providing a sustainable solution to the remediation, the company could see wider benefits from the expenditure incurred. Such additional considerations are especially important where a number of options for remediation are being considered.
Under the contaminated land management framework provided by the Environment Act 1995, remediation can take the form of either the removal, isolation or detoxification of the source, the breaking or removal of a particular problematic exposure pathway or the protection or removal of the sensitive receptor which is deemed to be at risk. As a consequence, the final decision on which remediation option best fits requirements of the land and the company will ultimately depend on a complex interaction between the technical requirements of the clean-up, the cost, the long-term environmental objectives and the appetite to retain residual liability post-remediation. All of these factors should come into play when estimating the scope of the work to be undertaken and therefore the financial implications to the business.
There are a number of discrete accounting and tax reasons why the financial magnitude of contaminated land remediation work should be considered early in the business planning cycle and why obtaining accurate estimates for the work makes good business sense. Financial Reporting Standard (FRS) 12 (to be replaced by International Reporting Standard (IAS) 37) enforces/allows companies to make a provision for future expenditure where a contingent liability currently exists. Decommissioning costs, legal and constructive remediation costs and aftercare/monitoring costs for landfills will all come into this category. Where the liability can be realistically estimated, a provision could, and in many cases should, be made.
FRS 11/IAS 36 look at the impairment of fixed assets. This may occur when a property asset is found to be contaminated and therefore the value of the asset is diminished, or indeed uplifted when property value is enhanced post-remediation. In addition, the Finance Act 2001 offers significant tax-related benefits for companies cleaning-up third-party pollution. The benefits of obtaining tax relief in the context of the remediation/redevelopment expenditure, can be considerable.
The American Society for Testing and Materials (ASTM) recently derived a framework within which environmental liabilities can be scoped. They promote a hierarchical scheme for setting a preference on the type of estimates that should be employed. The lowest priority estimates, above having no estimate of the scale for the liability whatsoever, is having an understanding of the Known Minimum Value (KMV) that the liability could take. In preference to using the KMV, the Most Likely Value (MLV) or having an overview of the Likely Range of Values (LRV) the cost profile could take, should be used as an estimate for the liability. By far the most preferable estimate is the Expected Value (EV). Here, consideration should be given to the amount of information needed, and the depth of
the technical and business-related decisions to be taken, in order that the scope of the remediation can be defined and the cost for the work accurately estimated.
Funding the remediation
In order for a business to commit to any form of financial investment an assessment of the overall benefit of the project will need to be undertaken with a view on defining the return-on-investment. The management, funders and wider shareholders alike will all want to assess the environmental credentials of the investment to ensure value is obtained from the proposed financial expenditure. Taking account of uncertainties and building realistic contingencies into the budgeting for contaminated land remediation is critical. The uncertainties in any contaminated land clean-up programme will, by definition, always be large. It is impossible to know everything about a certain contaminated land issue prior to undertaking the remediation work and experience shows that where over-runs on remediation projects do occur, they are likely to be material with respect to the scale of the originally planned expenditure. It is also important the management team remain flexible during the period when the remediation work is being undertaken, as when new information does become available, rational business and environmentally-focussed
decisions on the implications can be made.
Managing the costs
Few companies are good at accounting for the costs associated with everyday environmental management and the costs of undertaking environmental improvement projects in a comprehensive way. Management and staff will often be forced to use standard expense codes to collate the resources and capital costs of the environmental-related activities. As a consequence, the true costs of undertaking contaminated and remediation projects are often lost in the general accounting processes. In these cases, it can also be difficult for a company to pin-point where cost-saving opportunities may exist, especially in terms of issues such as resource use, or over-use, as the data required to assess potential wastage is seldom available in real time.
Companies that have implemented improved environmental data quality handling processes have shown the ability to interpret cost data in real time during the projects and have experienced real cost-saving and economy of scale saving opportunities. In addition, the quality of cost-related data for the purposes of developing a comprehensive contaminated land tax relief claim at the end of the tax year, or on the sale of the site, can reap major financial benefits to the business.