We are experiencing a watershed moment for environmental, social, and governance (ESG) issues. Investors increasingly put money into funds comprising public companies with strong environmental policies, social impact, and governance practices. Asset flows into sustainable funds in the United States continued at a record pace through the first half of 2020 to nearly $21 billion, almost the same amount that flowed into such funds in all of 2019, according to Morningstar. This is an extraordinary indication of the value investors place on companies committed to ESG as well as the direction in which companies and their boards are moving.
With the increasing investor attention, public companies are also ramping up communication around their sustainable business practices. The need for this ESG information has been exacerbated by COVID-19, as investors have sought information and metrics around employee health and well-being.
Despite this trend, one of the biggest challenges to assessing a company’s ESG practices that the Center for Audit Quality hears from investors, companies, and board members is the lack of broadly adopted ESG reporting standards. This contrasts significantly with the well-established standards that exist for reporting and evaluating a company’s financial performance and internal controls effectiveness. The health and stability of our capital markets depend upon the reliability, comparability, and relevancy of such company-reported information.
What is the solution? A globally accepted system built from existing standards and frameworks, and adapted to market needs, could help to ensure that companies put forth readily comparable ESG information for their investors and other stakeholders.
The focus on ESG reporting as a way for companies to communicate business risks and opportunities has rapidly translated into growing interest from standard setters, regulators, and corporations in this type of enhanced corporate reporting.
Earlier this month, five leading framework and standard-setting bodies announced plans to collaborate on comprehensive corporate reporting—a move the Center for Audit Quality applauds. At the same time, the International Federation of Accountants called for the creation of a new sustainability accounting standards board that would exist alongside the International Accounting Standards Board.
The Role of Auditors in ESG Assurance
So where do auditors fit in? According to a 2019 study by McKinsey & Co., nearly all participating investors (97%) want assured sustainability information. Nearly seven out of 10 investor respondents (67%) say assurance of sustainability information should be as rigorous as a financial audit.
In our public interest role, public-company auditors play a significant part in the flow of reliable information for decision-making. Auditors are experienced at bringing accountability, standards-based analysis, and objectivity to the review of company-reported information, and these skills are transferable to areas of company-reported information beyond financials. Put another way, third-party assurance from a public-company audit firm enhances the reliability of information presented by companies to investors and other stakeholders, as it does with audits of financial statements and internal control over financial reporting.
We’re already seeing prominent public companies move in this direction. Johnson & Johnson, Guess?, and Etsy, to name a few, are early adopters of obtaining assurance on their ESG reporting and we anticipate that going forward more companies will take this approach.
What Boards Can Do
With investors and other stakeholders placing increased emphasis on ESG information, it is important for boards to understand key ESG risks and opportunities specific to their companies’ business purpose and core operations. Board members must consider where their organizations are today with respect to their ESG information. They should also consider some key questions outlined in the Center for Audit Quality’s recently released report on the role of auditors in company-prepared ESG information, which include the following:
Has the company identified all relevant or material risks associated with ESG reporting?
Does management have the necessary information needed to assess ESG-related risks, and on what cadence should ESG information be provided to the board?
Does the company have the appropriate internal controls, policies, and personnel in place to accurately track and disclose ESG information?
Who in management is preparing and providing the ESG information, and what is the finance function’s role in the preparation of this information?
Do one or more board committees have explicit oversight responsibility for ESG, and what role do other committees and the full board play in ESG oversight (e.g., governance committee involvement in overseeing related factors, audit committee involvement in assessing the appropriateness of management’s risk assessment of this information)?
Where and how is the information currently being reported? Is this in line with where investors expect to see it?
Is the company currently following a framework or a standard for disclosing this information? If so, is it the appropriate framework or standard for the company?
Boards that prioritize these considerations now will have a leg up as stakeholders rally around a market-based system for reporting reliable, comparable, and relevant ESG information. It no longer seems a question of whether this will happen but when.
Julie Bell Lindsay is the executive director of the Center for Audit Quality.
For a deeper dive into the climate-related aspects of ESG oversight, register today for Virtual NACD Summit 2020’s Expert Insights: Environmental Risk Oversight session, which will air on October 15 at 3:00 PM EDT.
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