The increasing importance of climate risk demands effective ESG auditing, integrating evolving standards, investor scrutiny, and tech advancements
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The big picture |
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Why this issue matters |
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Understanding ESG auditing |
The big picture
Climate change can be a tricky topic to discuss, but there’s no doubt that a great many businesses are having to discuss and account for climate risk. This past year, an unprecedented wave of thunderstorms has caused massive amounts of damage to businesses and driven up insurance costs. Climate risk has become such a huge issue that in 2022, Amazon (which operates one of the world’s biggest logistics operations) hired its first meteorologist.
In other words, climate risk has become a major environmental, social, and governance (ESG) risk priority for businesses—and investors. ESG is an important framework for evaluating risks and opportunities related to a company’s operational impact on the environment, social issues, and governance. More and more companies are being asked to assure investors and other stakeholders that they’re meeting ESG goals relating to their climate impact through ESG reporting. Those stakeholders are looking for metrics on a company’s carbon footprint and energy usage–and evidence that the business is working to reduce both.
To provide that kind of information, organizations need to perform ESG auditing. The challenge for those businesses that want to show that they’re meeting ESG climate risk expectations is developing a useful approach to auditing. Guidelines for reporting haven’t been clear or consistent. But that has been changing. And there are reporting best practices for ESG auditing that can be helpful to companies and the legal and tax agencies providing auditing support.
Why this issue matters
Climate risk isn’t just a government policy issue. It’s also a business issue and one that investors are increasingly monitoring among other ESG predictions. A survey conducted in 2023 by asset manager T. Rowe Price found that 49% of the global investors it surveyed had increased their focus on ESG investing. Only about 2% reported a decrease.
Consumers are taking notice, too. A survey of consumers in 12 countries published in 2023 by Italy-based research and communications firm SEC Newgate revealed a widespread interest in ESG issues, particularly those related to climate risk. Among survey respondents, 67% rated their interest in ESG at seven or more out of 10, up from 56% in 2022. And 77% agreed that companies should take move-the-needle actions on ESG issues.
Worldwide, numerous countries are establishing reporting standards for companies’ climate risk activity. That means that U.S.-based companies doing business overseas will have to pay close attention to climate risk. Recent research suggests that companies may be at risk of losing customers across the world if they don’t take demonstrable action on ESG issues such as climate risk. Businesses would need to demonstrate confidence, integrity, and assurance of their ESG information.
The U.S. has been slower to develop corporate climate risk reporting standards, but it may be starting to catch up. In May 2021, President Biden issued an executive order on climate-related financial risk, requesting the U.S. Treasury Department to develop plans to mitigate climate risks—including the development of risk-reporting standards for businesses. In October 2023, federal bank regulatory agencies issued a framework that large financial institutions can use for managing climate-related financial risks. The U.S. Securities and Exchange Commission is expected to issue a corporate climate disclosure rule that would standardize climate risk data for investors.
Making climate an ESG risk priority can also offer many organizations opportunities for growth and profitability. An example is carbon capture—taking carbon dioxide that would otherwise be released into the environment and “reusing” it for applications such as concrete manufacture and fuel. Some governments are investing in companies developing carbon-reutilizing technology; investor interest and corporate ESG efforts could develop the market further.
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Understanding ESG auditing
To demonstrate to investors, employees, and other stakeholders how well they’re addressing climate risk, companies can and should develop ESG auditing protocols.
What is an ESG audit?
ESG auditing is intended to assess a company’s ESG-related risks and gaps, in part by evaluating the effectiveness of its ESG-related controls and activities. It also seeks to verify the accuracy of the ESG-related data that a company discloses to stakeholders and regulators. In many cases, businesses are engaging third-party assurance auditors to in their ESG reporting. And they’re looking at ways to incorporate ESG and climate risk into their annual auditing plans.
Best practices for ESG
There are several best practices for ESG auditing companies can follow. Here are two particularly essential strategies:
Developing manageable targets
To provide investors with useful climate risk reporting, companies must disclose relevant information and data. This is a challenge because standards for ESG data and measurement, including those related to climate risk, are still evolving. The standards that are currently the most widely used worldwide are those developed by the Global Reporting Initiative. The GRI is an independent international organization whose mission is to develop and promulgate a comprehensive set of sustainability reporting guidelines for organizations of all sizes and sectors. As noted earlier, the U.S. government has been working on climate risk disclosure standards of its own.
This is crucial because the ability to report on ESG factors is enabled by data. A company needs to identify specific metrics regarding its ESG climate risk so that it can fit in with the auditing process. That specificity makes its reporting meaningful to stakeholders. It also establishes targets such as energy use and carbon capture that a company can pursue.
Making use of digital technology
Assembling the useful data needed for auditing climate risk can be extremely time-consuming and complex. However, advancements in technology can make an impact on your firm’s profitability. Software and online audit solutions designed to measure and evaluate risk can accurately automate and integrate the metrics that are top of mind for each stakeholder group. Tech tools can also assign specific duties to employees regarding climate risk. This, in turn, can boost an organization’s governance, data management, and auditing activities. These tools will increasingly incorporate AI and machine learning into their processes, which (among other advantages) could not only help companies keep compliant with changes in regulations and ESG guidelines worldwide but also stay on top of their ESG narrative.
Standards in the U.S. and worldwide for determining and auditing climate risk are likely to become more specific in the coming years. Investors, consumers, and other stakeholders will increasingly be using those standards to evaluate how companies are addressing climate as an ESG risk priority. That’s the way the wind is blowing for most large businesses seeking investors—and customers. To stay on top of current and future ESG issues, visit our ESG Resource Center which captures what you and your business need to know.
