ESG is arguably the hottest topic in business and with ESG and climate risk concerns set to increase, the role of the audit committee is being watched closely by investors. We convened a panel of experts to explore the role of audit committees in ensuring ESG is implemented at the heart of the business. Here are the key takeaways.
- Natural remit - Audit committees have a natural remit over ESG (environmental, social and governance) issues. Audit committees have oversight of risk management and internal controls while also acting as “guardians” of financial statements and the audit process. ESG is, and will be, a central element in the running of a company and that places audit committees in a vital position to ensure it is integrated into all those areas.
- ESG oversight - Many investors prefer audit committees to oversee ESG issues, rather than specialist committees because they are so closely related to risk management and corporate disclosures.
- Right skills - Audit and risk committees need to ensure they have the right skills to judge what are clearly complex issues, including the risk of greenwashing. Investors and financial institutions are looking to see the right knowledge and capability are in place throughout an organisation. Specialist expertise may not be necessary on a board but all boardroom members need “climate literacy”, a minimum appreciation of what the stakes are and an understanding of where to turn for expertise. This may mean placing board members through dedicated training.
- Reporting obligations - There are a number of big projects underway to give companies new reporting obligations. The biggest to watch out for is the International Sustainability Standards Board (ISSB), an offshoot of the International Financial Reporting Standard Foundation (IFRS), and efforts in Brussels with the Corporate Sustainability Reporting Directive (CSRD). It’s important to avoid seeing these as competing reporting standards, but as compatible pieces of work: ISSB’s standard is aimed at financial implications of climate risk while the CSRD takes a broader view of reporting, including societal impacts. Both can be expected to evolve and potentially converge over time.
- Increased contact - This all means investors are watching audit committees closely, with sustainability and climate risk potentially prompting increased contact between them in the future. Investors are keen to know how audit committees have assessed the risks they face and whether they are capable of challenging management. In short, investors will seek reassurance that financial statements really do reflect the material concerns of a company.
- Assurance - If a company has ESG targets, financial and non-financial, then assurance, whether internal or external, will be essential. And that hands audit committees another important role in overseeing the process. But this is emblematic of another trend: a widening remit for audit committees to oversee the total framework of risk and controls. All parties will need to accept that assurance of ESG factors, whether internal or external, is an imperfect science at the current time without universal standards. Many companies don’t even bother. Metrics and data to measure and monitor ESG are still developing: companies are on a journey.
- Investor research - Even if there is assurance, investors consider it a starting point only. They will still do their own research. Worth bearing in mind that Europe’s CSRD, when implemented, will require an external audit of ESG information.
- Social impact - So far most attention has been on the “E” (environment) in ESG. However, there is growing interest in the “S” (social) impact of businesses. Covid has accelerated this focus, with many investors realising that the “S” is a key success factor. This throws up a whole new challenge for audit committees as they consider how to measure the social impact of organisations.
- E, S and G - However, social is not a separate issue from climate. Companies considering action on climate change must also consider the impact on communities and employees. E, S and G are interlinked.
- Irrelevant information - There is much talk of “greenwashing” in discussions of ESG. What concerns observers most when looking at financial reports is the provision of a large volume of information that is either immaterial or irrelevant to a business while remaining silent on key issues. One approach mentioned by experts is if faced with an accusation, to “lean in” and find out what the concern is, because there is a good chance something has been overlooked. It might be an uncomfortable conversation, but good may well come out of it.
Panel participants involved in this discussion were:
- Chair - David Prosser, Associate Editor, Board Agenda and former Business Editor, The Independent
- Dr. Hans‑Christoph Hirt, Executive Director, EOS at Federated Hermes
- Shonaid Jemmett-Page, Audit Committee Chairman and Board Member
- Leila Kamdem, Head of Climate Risk, HSBC
- Maud Gaudry, Global Co-Head of Sustainability, Mazars.
You can read a full account of the panel discussion here or watch the discussion on demand.
This article was first published in Board Agenda.