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​Internal Audit: Are You ESG Ready?

Blogs Jim Pelletier, CIA Jun 05, 2019

​Internal auditors can help ensure their organizations provide the reliable and accurate environmental, social, and governance reports that investors increasingly demand.

Expectations of investor groups around the world continue to shift toward environmental, social, and governance (ESG) reporting. While ESG isn't a new topic, the pressure for organizations to provide more ESG reporting continues to grow, and there are more calls for the underlying data in these reports to be scrutinized. This presents an opportunity for internal audit to address a key risk area that is increasingly on the board's radar.

A recent Forbesarticle included these insights from Tim Mohin, chief executive of the Global Reporting Index:

"In the past decade there has been a tremendous upswing in interest coming from the financial sector. With over 90% of the largest companies now filing sustainability reports (85% of the S&P 500), the data is plentiful. But that is not new. What is new is the interest in using the information for investment decisions. A recent study from Oxford University found that more than 80% of mainstream investors now consider 'ESG' — environmental, social, and governance — information when making investment decisions. And the numbers are compelling — globally, there are now $22.89 trillion of assets being professionally managed under responsible investment strategies, an increase of 25% since 2014. This number is so large it needs context — it exceeds the gross domestic product of the entire U.S. economy."

This shift in thinking isn't limited to investors. At least in part, the rapid growth in ESG reporting reflects shifts in consumer and general public expectations. I can foresee two scenarios that could lead to significant reputational and financial consequences for organizations: failing to provide adequate ESG reporting and publishing ESG reports that are incomplete, inaccurate, or unreliable. In both cases, internal audit can and should play a significant role in preventing such undesirable scenarios.

As the name suggests, ESG covers three broad categories:
Environmental – risks and opportunities around greenhouse gas emissions, water usage, and waste and pollution. This category focuses on both the outputs (what and how much the organization produces) as well as the inputs (the sustainability of the resources the organization needs to feed its processes). For example, a beverage producer may be concerned with sufficient, long-term availability of fresh water while also being aware of any environmentally undesirable byproducts of its production processes.

Social – risks and opportunities around employee relations, diversity, health and safety, and community support. Are employees, including those working for third parties, treated fairly? Are they paid fair wages? Are work conditions safe and free of unnecessary hazards? How does the organization impact and/or support the local community?

Governance — risks and opportunities around shareholder rights, board diversity, ethical decision-making, and deterring corruption and bribery. More and more, activist investors are looking for organizations that make money while maintaining transparency and high ethical standards. Global organizations such as the United Nations (UN) and the Organisation for Economic Cooperation and Development are particularly focused on mitigating corruption and bribery around the world.

How can internal audit build awareness and get involved? Two resources that have gained traction in recent years offer opportunities to learn why ESG has become a frontline concern for many investors.

The United Nations'Sustainable Development Goals, "recognize that ending poverty and other deprivations must go hand-in-hand with strategies that improve health and education, reduce inequality, and spur economic growth — all while tackling climate change and working to preserve our oceans and forests." The goals are a culmination of decades of work by UN member countries, and organizations are encouraged to examine how they contribute to the goals.

Standards developed by the Sustainability Accounting Standards Board (SASB), whose mission is to help businesses around the world identify, manage, and report on the sustainability topics that matter most to their investors, provide a second source. The SASB has developed a set of77 standards to "enable businesses around the world to identify, manage, and communicate financially material sustainability information to their investors." The standards include both technical protocols for compiling the data needed for appropriate disclosure as well as accounting-based metrics for each topic within the standards. The SASB also works directly with the investor community, guiding them with questions to consider when evaluating a company's sustainability efforts.

I found that combining the UN's broader goals with the SASB's more detailed standards delivers an effective way to get grounded in this topic. However you choose to familiarize yourself, it is important that internal auditors understand the state of their organizations' ESG efforts, particularly how those efforts align with board expectations and each organization's unique circumstances in relation to changing expectations in the investor community. Seize the opportunity to build your ESG awareness and understanding and be part of your organization's ESG dialogue.

Jim Pelletier, CIA

Jim Pelletier is Vice President, Portfolio Strategy, at The IIA in Lake Mary, FL.