Audit committees and ESG: ‘It’s a difficult journey to navigate’

The rise of ESG as an investor concern is creating new demands of audit committees. Our recent Centre for Audit Committee and Investor Dialogue (CACID) live panel debate examined at the challenges, exploring the work of audit committees, the nature of their responsibilities, how they engage with stakeholders and the role assurance can play in the implementation of ESG and sustainability reporting. This article – first published in Board Agenda and featuring comments from the panellists – details the discussion.

Watch a recording of the full, live event here.

In case there were any doubts about the role of audit committees in the implementation of ESG, stewardship and governance expert Hans-Christoph Hirt dispels them in a few short words.

Hirt says ESG is now an integral part of risk management and financial statements. And that places the subject firmly in the realm of the audit committee. “Absolutely, there should be a role for the audit committees overseeing ESG,” he says.

Hirt, executive director of EOS Federated Hermes, was speaking at the latest Centre for Audit Committee and Investor Dialogue (CACID) panel discussion, organised by professional services firm Mazars. The topic: the role of audit committees in environmental, social and governance (ESG) policies.

ESG has become a major issue for companies as they implement policies designed to help tackle the climate crisis and respond to calls for a societal purpose rather than simply pursue profit. The importance of ESG was further underlined by the pandemic as companies moved to support the welfare of employees hit by lockdowns.

The panel explored the work of audit committees, the nature of their responsibilities, how they engage with stakeholders and the role assurance can play in the implementation of ESG reporting.

Addressing ESG naturally raises a question about the need for specialist skills. Panellists agreed that audit committee members would need to up their game and bolster their knowledge base. But they may not need specialists.

“Many companies will find they don’t need specialist expertise in ESG,” said Shonaid Jemmett-Page, a non-executive director with Aviva and audit committee chair at QinetiQ, “but all members will need to go up the learning curve on training.”

Activity levels on ESG have increased in recent times she added, with pressure from investors to understand policies on emissions and climate. This is not just about managing threats: some companies see opportunities too. “I see real momentum behind this,” she said. “Doing this properly is going to be part of your licence to operate, going forward.”

New reporting standards

Perhaps the biggest challenge for audit committee members is coming to terms with the raft of reporting systems about to hit companies with demands for new ESG disclosures. Europe is working on a new sustainability reporting directive and COP26 in Glasgow saw the launch of the International Sustainability Standards Board to develop its own reporting scheme.

These two processes could appear to be in competition. But Maud Gaudry, global head of sustainability at Mazars, says not. The European project is broad and deep, while the ISSB project is narrow; but they are complementary.

“We tend to present the two as being competing initiatives. That’s not the right way to describe them because they have a lot of things in common,” she said. Europe’s priority, she added, would be to produce standards compatible with the ISSB approach “so that any given international company won’t have to produce two sets of different sustainability information”.

While Europe and the ISSB projects move forward, companies in the UK are already managing mandatory reporting using a framework from the Task Force on Climate-related Financial Disclosures (TCFD). It adds to a complicated landscape of reporting systems at a time when finance departments would perhaps prefer a single set of standards to work with.

According to Leïla Kamdem, head of climate risk at HSBC, systems will come together, but in the meantime, companies will find it hard work. “We are definitely going to get convergence at some point,” said Kamdem. “But we have to be honest about the fact that today, it’s a difficult journey to navigate for companies.”

But it won’t just be reporting for external readers that will be difficult. Internal reporting presents its own challenges. Companies are at different stages, usually starting with carbon emissions as a baseline on which they can build targets.

That raises questions about the extent to which audit committees can hold their own companies to account on ESG. For Jemmett-Page, the current era is witness to an evolving role for audit committees.

“Ten years ago they generally dealt with financial risks and systems of control. Now, more and more, they should be focusing on the total framework of risk managements and controls, financial and non-financial, and obviously, ESG sits in that.”

Net-zero transition plans

And that will include examination of net-zero transition plans, set to become a disclosure requirement in the UK from 2023. “It’s an urgent issue,” said Kamdem, “that the audit committee should be targeting on top of making sure they have robust strategies in place to manage the transition to reduce emissions in line with the net-zero pathway.”

Not every element of ESG is progressing at the same pace. For obvious reasons, the “E”, (environment), has received much of the focus. The “S” (social) element, especially, is still developing, even though the pandemic may have added weight to the argument companies must increase their activities in relation to employees and communities.

That places some constraints on what audit committees can achieve on the topic. Cultural differences mean social practices and expectations can differ from one country to another, making it difficult to define acceptable universal standards. Gaudry observed audit committees are “anxious” about the quality of data, its robustness and relevance.

But that is not to say the “S” is not writ large for corporates. Kamdem noted that climate goals integrate with the social and governance agenda. “I don’t think it would be responsible for companies to [transition to net zero] without considering the impact on communities and the countries and markets in which we operate,” she said.

Tools and standards for ESG assurance

Another element of ESG still evolving is assurance. Gaudry said at the moment the “appropriate tool” is yet to be defined for widespread assurance of ESG. And because of the lack of universal standards, many companies are currently taking a pass.

However, draft European legislation would eventually demand assurance. And that will require a new set of skills, especially from assurance providers. “We’re going to have to train a lot of people very fast,” Gaudry added.

But things will change. Jemmett-Page said the growing importance of climate data would force the development of standard-setting, audit and the audit profession “to progress very fast.”

“It has to,” she said. “The investment markets will demand it.”

One corporate process that will have a big role over ESG is internal audit. Jemmett-Page said internal audit may not possess the expertise, but it should ensure there is a “framework of risk management control” in place to deal with ESG.

Gaudry agreed. “You can’t have the level of comfort you need without having your internal audit team being involved.”

Audit committees under scrutiny

ESG concerns are here to stay and now deeply embedded in both public and investor consciousness. Inevitably regulators and policymakers will drive through new requirements that will enter into the risk deliberations of companies and their audit committees.

That will create new demands of audit committee members and they will be under scrutiny. Hans-Christoph Hirt placed the role of audit committees into perspective.

“It is really important to get to know the audit committee to some degree, really understand how they are comfortable signing off financial accounts, how they have assessed the risk and the risk management framework.

“Do they really understand what they’re doing? Can they challenge management and specialists enough? That’s key.

“Investors just need to know that financial accounts reflect all material topics, and climate is the number one concern.”

Watch the full discussion

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