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On the Frontlines: Internal Audit's Role in Tackling Climate Change

On The Frontlines Cátia Silva Sep 27, 2022

Corporate action on climate change gained momentum following the United Nations Climate Change Conference in Glasgow in 2021, and it is becoming imperative for organizations to examine how their actions are influencing global warming and extreme weather events. Internal audit can add significant value by providing assurance over the identification, mitigation, and management of risks, as boards may not always be aware of the wide range of impacts emerging from climate change risk. Internal audit's holistic understanding of risks is crucial in providing confidence and trust to stakeholders.

Organizations are likely to be impacted by transition risks arising from policy and regulation changes, new technologies and markets, and reputational effects based on how they transition to a low-carbon economy. Moreover, organizations and governments are increasingly at risk of potential legal actions if they fail to take steps to mitigate climate change or if they take actions that undermine the safety and livelihoods of their workers and citizens. For example, a company with high greenhouse gas emissions may be sued because its operations pollute the surrounding regions, endangering the health of local communities. In fact, the threat of litigation poses a real financial and reputational risk to organizations, which needs to be weighed against the risk of continuing with business as usual. Organizations that understand the risk of inaction will be better positioned to thrive in a net-zero economy.

What Internal Audit Can Do

Climate change mitigation initiatives include measures undertaken by governments, businesses, regulators, and individuals to proactively combat the causes of climate change, by reducing or preventing further greenhouse gas emissions. Emissions need to be rapidly reduced and policies need to be created and implemented to manage the transition toward a net-zero future. By giving assurance on greenhouse gas emissions, internal auditors can contribute directly to the organization's competitive edge by influencing brand reputation, helping build stronger risk management and corporate governance structures, helping lower energy costs, increasing resilience against future regulation, increasing investor confidence, and promoting a stronger focus on innovation.

To provide assurance on climate change, internal auditors should be innovative, have a deep knowledge of climate change risks that are impacting their business, and able to warn management and the board about the urgency for change. For example, in measuring an organization's carbon footprint, internal audit can help the board and executives gain a better understanding of the impact the business is having on climate. Internal auditors also should ensure that climate-related risks are embedded into every audit engagement.

Robust disclosures build strong confidence about the accuracy and reliability of information revealed to investors. Internal audit is best positioned to independently validate the effectiveness of these disclosures. However, disclosure is only valuable if it leads to action and absolute reduction in greenhouse gas emissions over time. Measuring and reporting data is a critical fist step. But if data is to have any value, it needs to be used to inform decisions and drive strategic, tactical, and operational changes. Internal auditors can provide value by auditing their organization's sustainability report and reviewing whether the business strategy aligns with current regulatory environment requirements. They could also evaluate if management has established benchmarks, metrics, criteria, key performance indicators, and leading practices. Therefore, it is important that climate change and environmental matters are incorporated into board committee structures, and that internal auditors have an ability to advise senior management about the importance of executive incentives aligned to climate change and sustainability-related targets.

Agents of Change

Internal auditors also are in a unique position to discuss the importance of climate governance with government bodies by reinforcing the need for setting climate-related policies and complying with global targets. For example, internal auditors could recommend compliance-based carbon pricing mechanisms that include carbon taxes and emissions trading schemes. Carbon taxes are set by governments and consist of a predetermined, fixed price on carbon that is paid by the producers or consumers of high-emission goods or services. These taxes are intended to provide a price signal that incentivizes emission reductions and increases consumption of low-carbon alternatives. Alternatively, internal auditors could discuss with governments the possibility for cap-and-trade systems, where the maximum level of permitted emissions is set by the government.

Internal auditors should keep in mind that the modern internal audit function is pivotal in advancing the climate change journey. However, it is critical that chief audit executives equip their teams thoughtfully, with relevant expertise, and that internal auditors are willing to adopt a future-focused, insightful, and proactive attitude.

Cátia Silva

Cátia Silva is the environmental, social, and governance manager at Sands China, Ltd. in Macau.

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