Sustainability-Key questions for Internal Auditors.
Sustainability: The Environment & Social Ethics (Risk in focus – 2019)
Companies are increasingly expected to behave in an environmentally and socially responsible manner, both by regulators and the public. This is creating sustainability reporting challenges and is influencing the strategic decisions companies must take to achieve future growth.
Some 27% of our interviewee cohort cited environmental and social ethics as an area of focus, and this is the first time that this topic has made it into Risk in Focus; there was a notable bias towards the Netherlands, with half of CAEs in the country highlighting this as an area in need of attention. Further, in our quantitative survey nearly one in ten (8%) respondents cited environment and climate change as a top five risk faced by their organizations.
The EU’s Non-Financial Reporting Directive, applicable since 2017, requires that listed companies and banks with more than 500 employees publish reports on various policy implementation, relevant risks and performance results. These policies concern:
- Environmental protection
- Social responsibility and treatment of employees
- Respect for human rights
- Anti-corruption and bribery
- Diversity on company boards
Sustainability reporting requirements are clearly a welcome development — they help to improve corporate transparency and highlight the efforts companies are making to meet environmental and social targets. However, a major challenge is in providing accurate information. The maturity of sustainability reporting is far behind financial reporting and not all organizations are well equipped to measure and report on KPIs. This increases reputational risk as there is potential for a company’s behavior to be found to contradict or fall short of its claims. Even if sustainability reporting is deemed to be sufficiently accurate, any KPIs that show the organization has low standards relative to its peers will be looked upon unfavorably by investors, who increasingly benchmark companies’ environmental and social governance (ESG) performance
Social Impact: The increased impetus on organizations to be socially responsible and protect human rights represents another challenge. Compulsory non-financial reports must be published annually, and should include what steps are taken to identify risks to human rights in the company’s operations and how these are managed.
An internal audit perspective
Organizations must now report on what they are doing to identify and mitigate sustainability risks and should look to the Global Reporting Initiative’s Sustainability Reporting Standards (GRI Standards) for guidelines on how to achieve this.
Internal audit can assist by simply ensuring that this reporting requirement is being fulfilled, although it can go deeper by seeking evidence that what the company claims in its non-financial reports is accurate, complete, up to date and being put into practice. There is also value in seeking evidence of how processes are being developed to improve the maturity of such reporting, such as the number of KPIs measured and the accuracy of data collection. The deepest audits may assess sustainability reports within the relevant industry to benchmark both the organization’s reporting and its performance relative to its peers.
Key questions the Internal Auditor needs to look at:
- Is the organization publishing non-financial reports as required by the EU?
- Is there scope for internal audit to assess the maturity of sustainability reporting and review the extent to which the company’s environmental and social ethics statements reflect reality?
- Does the organization benchmark sustainability performance against sector-specific KPIs? Is there a gap between both the organization’s sustainability reporting and performance compared with that of its industry peers?
- Is the organization complying with all relevant environmental laws in all territories?
- To what extent is tightening environmental regulation likely to impact the company’s strategy, e.g. targets to reduce carbon emissions? Is senior management aware of this likely impact?
- Does senior management understand the importance of continuously improving operations in order to minimize environmental and social harm?
Is there value in internal audit assessing progress and providing evidence of relevant sustainability improvements?
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