ESG: Time for clarity and action
Today, how an organisation’s products and services contribute to sustainable development is high on everyone’s agenda. However, ESG statements of intent are no longer enough and internal auditors have a vital role to play in ensuring that commitments are turned into action
Mention ESG and historically climate change would spring first to mind. Its negative impact on biodiversity, rising green house gases emissions, melting ice around polar regions and wild fires all hit the headlines on a regular basis. These are all important issues but as Sonia Shah, the Financial Regulation - ESG and Climate Risk Lead at Grant Thornton, points out, there are others, including environmental waste, depletion of resources and air and water pollution.
Speaking at the recent ACCA virtual Internal Audit Week, she alerted her audience to the wide range of issues falling under the ESG umbrella. “Alongside the environmental considerations, there are also a wide range of social matters, such as human rights, impact on local and indigenous communities, employee relations and up-skilling of employees,” she said. “All of these are of interest to a wide range of stakeholders in ESG.”
ESG structures are being created across every board and every industry but Sonia said that all organisations need to consider what is actually relevant to their business. Last year was “the year of ESG”and this was evidenced by a whole host of documentation coming out and discussions taking place around them. What was previously perceived as good for business is now a necessity for long-term sustainable growth.
In 2015, 193 member states of the UN General Assembly signed up to a 15-year plan to fight poverty and inequality, end injustice and protect the planet. Lying at the heart of the plan are 17 Sustainable Development Goals, including action on climate. The same year saw the Paris Agreement, which initially set a goal to limit temperature rises to two degrees celsius, although this has now been reduced to 1.5 degrees celsius.
Meanwhile, the UK task force of regulators and government departments are considering how the expectations in the Green Finance Strategy can be met, while the Task Force Climate-related Financial Decisions (TCFD) has been developing voluntary climate-related financial disclosures that will be useful to investors, lenders and underwriters in understanding material risks. The latter’s final report sets out overreaching recommendations in the areas of governance; strategy; risk management; and metrics and targets.
UK takes the lead
The financial sector in the UK is leading on putting ESG frameworks in place, although other countries, including the USA and China, are also getting involved. Meanwhile, non-financial services across the board are playing an enormous part in actually applying ESG across their decision-making, according to Sonia.
There are many plans for how firms can invest in the UK’s green finance strategy, as well as a number of frameworks in place which address ESG risk. Firms are signing up to those which are suitable for them and the industry they are in. “There are different potential mixes for building an ESG Framework, so look carefully at what your organisation needs to report on,” Sonia advised. “Look at what stakeholders are asking for. This will drive what framework is suitable for your firm. There will never be one size fits all.”
A firm’s wider remit over E, S and G need to be considered as a strategy is evolved. “It’s very important to have this clearly defined because without it what, as an auditor, are you going to review?” Sonia asked? “One aspect of sustainability, for example, might be more important to one firm than another.” Overall, her message was clear: in order to retain a competitive edge, all firms should be embracing ESG as a strategic business imperative.
Everyone, including customers, need to be involved in creating an organisation’s sustainable strategy. The board is important in driving conversations on social and environment issues and will no doubt play a part in designing the strategy. The business mission statement will change as well and it ism possible that the whole business model may need to be adapted and redefined. Questions to be asked include: What gaps are there that need to be filled? What are the opportunities and vulnerabilities we need to focus on?
“There will be a need to oversee ESG goals and identify relevant metrics to measure objectivity and reliability,” Sonia said. “Goals should be qualitative and quantitive and leaders need to ensure that agreed plans are embedded in a firm’s workforce, with a timescale agreed on.”
Making commitment a reality
Sonia emphasised that the time for simply making statements on ESG is over. “As auditors, we need to be aware that if our firm has made an ESG commitment, stakeholders will want to know what frameworks are being set up and what is actively being done in terms of identifying material risks and growth opportunities ,” she said. “Paying lip service to ESG is no longer acceptable.”
All organisations need to know what impact they are having on the environment. “I can’t emphasise disclosure enough because everyone is going to be looking at this,” Sonia pointed out. “What’s more, failure to disclose can have a hugely negative effect on the reputation of a business.”
Risk management is very important for the wider ESG framework and boards need to sign off on risk appetite and tolerance levels against the various risks identified. They need to be familiar with the risks modelled and how they effect the long-term horizon.
So how are risks being captured, monitored, managed and mitigated? These are all familiar terms to Internal Auditors. The tools needed to capture risk include data and there is a lot available. Meanwhile, in terms of governance, it is important to remember that there is no need to try to create a new framework but simply to extend it to include ESG risks. “You need to assess what kind of reporting is required and what challenges need to be made,” Sonia concluded. “All three lines of defence have an important role to play.
“This is a journey for organisations and internal auditors have a key role to play in it.”