Environmental, social and governance (ESG) risks are inevitable for every business. But how these issues are collected, managed and reported are what will make the difference between a company that is prepared or not.
Businesses will incur costs in some form or another related to ESG issues because the environment is not an infinite resource that can be used without consequences. Therefore, it’s crucial for businesses to take these risks into account when making decisions about their operations, products and services. An ESG audit is a process that evaluates the environmental and social risks of a company’s operations, products or services. The goal of this audit is to identify any potential risk so they can be addressed before they become problems down the road.
Each ESG audit provides insight into the company’s approach towards these issues. Conducting an ESG audit also helps businesses look at their supply-chain risks, risk management capabilities and transparency with shareholders.
Why is ESG auditing important?
ESG audits are important for the public, investors and the company alike. They are necessary because more consumers are looking for products and services from companies that have strong environmental, social and governance practices. According to a study conducted by Nielsen , “9 in 10 Millennials will switch brands or retailers if that brand or retailer supports the wrong cause.” For investors, ESG audits help provide insight into the company’s approach towards these issues and how they manage risk. This is because information about a company’s environmental risks can affect its share price, and in some cases it could even prevent companies from getting funding.
For the company, regularly conducting an ESG audit means that companies are more prepared for emerging risks or future issues that could arise. They could also provide insight into the company’s supply-chain risks and transparency with shareholders. In turn this attracts better employees and investors.
What is the purpose of a sustainability audit?
Good quality audits are designed to help companies identify opportunities, improve on weaknesses and track progress of ESG initiatives. ESG audits are a type of engagement that companies conduct with external stakeholders as well as internal departments to assess their performance in the management of environmental and social aspects. This process should be separate from an audit for financial purposes because it has different objectives. An ESG audit seeks to answer certain questions:
- What environmental issues are directly relevant to the company?
- What are the risks associated with these issues?
- How is the business organized in terms of ESG policies, systems and controls?
- How are these issues communicated between senior management, employees, customers and other stakeholders?
It’s important for companies to continuously review their performance in regards to ESG issues because there are always changes within the external environment that can affect their operations. The company should also evaluate its performance to make sure it’s not at risk of non-compliance with any laws or regulations.
What’s the difference between an ESG audit and a sustainability audit?
ESG audits are separate from financial audits because they have different objectives. An ESG audit focuses on the environmental and social risks that come with doing business while sustainability audits focus on how companies can become more environmentally friendly and socially responsible.
What are the components of an internal audit?
The external environment is a key component that affects all businesses. That’s why it’s crucial for companies to evaluate their current performance against major ESG risks. This involves looking at stakeholder perceptions, compliance with laws and regulations as well as the company’s policies on environmental and social matters.
To conduct an ESG audit, it’s important to use a structured and rigorous process that aligns with international standards. The auditors should be independent and qualified – ideally, they should have expertise in environmental risk, sustainability or both.
What is ESG assurance?
The assurance aspect of ESG Reporting is about how companies demonstrate that they’re serious about corporate social responsibility and sustainability. It provides assurance that current and future investors can place their trust in ESG data and analysis. Some of the ways they can do this include:
- certification by a third party of the information included in the ESG report
- publication of an explanatory letter from management
- independent assurance that data and analysis is accurate and reliable
What does ESG mean in finance?
Environmental, Social and Governance relations to finance are defined as “factors that are not financial in nature but may affect the risk, performance or value of a company’s securities.” In other words, they are important because they may affect a company’s financial performance.
ESG disclosures Positive vs negative effects
Negative effects might include:
- low company morale
- bad publicity (reputation)
- legal fees to protect the environment (and society) and
- fines and litigation
Positive effects might include:
- low turnover in employees
- good reputation that attracts future hires
- reduced litigation due to environmental measures taken by the company and
- positive media coverage
Who is responsible for ESG reporting?
Not every company is required to submit an ESG report, (16 Reasons Why You Should Make One) but those that are must comply with the requirements of their country’s regulator. In the USA, the regulator for ESG reports is the Securities and Exchange Commission (SEC). Any company which is listed on a US stock (exchange) must submit an annual report to the SEC, which will be available to the public.
The European Union has similar requirements for its countries under the Transparency Directive requirement. In the UK, companies which issue or have publicly traded securities are required to produce an ESG report, but this requirement is not yet as well known as the USA’s. In Canada, for example, companies listed on a stock exchange (TSX or TSXV) must follow securities laws and regulations as well as National Instrument 51-102 which outlines how to report ESG issues.
What is an ESG disclosure?
An ESG disclosure is a report that provides relevant information from the company about its ESG performance. This includes how it complies with laws and regulations related to environmental, social and governance issues. From a more general perspective, the disclosure is also about the company’s ESG risks and impacts on society.
What is the difference between CSR and ESG?
CSR stands for Corporate Social Responsibility. It’s a process by which companies work to include social and environmental priorities in their business strategies, policies and operations. By complying with the principles of CSR, businesses become more responsible citizens in society. The goal of ESG is to make sure that companies are adhering to these same principles by understanding their impact on the environment and society.
ESG is thus the way in which companies demonstrate commitment to CSR, by ensuring their activities are transparently reported and evaluated for environmental and social issues.
What is the process of corporate social responsibility?
This can be summarized into 5 steps:
1) Identifying the main issues that the company is responsible for (e.g. environment, society and governance)
2) Evaluating and prioritizing these issues
3) Creating CSR management systems
4) Implementing these systems throughout the company, including training employees
5) Evaluating this program’s success and creating new plans to improve it if necessary.
What are some examples of what can be evaluated in an ESG assessment?
- Facilities management, to ensure they are being built in an environmentally friendly way
- The company’s performance on social issues related to human rights, diversity and labour standards
- Environmental standards, environmental management systems and energy saving initiatives.
- The company should also have a plan for monitoring carbon emissions.
- Recycling, water management and chemical management
- Employee satisfaction rates, including diversity of the workforce from a social perspective.
- Companies should report on all their activities that impact the environment and society.
- Product development process, manufacturing processes and efforts to reduce waste during all stages of production.
- Hazardous materials used in their products or any toxic waste produced.
- Compensation for employees, including benefits and working conditions
- Compensation for factors like environmental damage or community impacts
- Corporate transparency (e.g. the company’s response to freedom of information requests)
How is a company assessed for its environmental impact?
This can be broken down into three main areas:
1) Transportation – the way the company’s supply chain moves goods to customers, including emissions from transportation vehicles and fuel use
2) Location of facilities- how these are built will have environmental implications, for example if water needs to be sourced from a long distance
3) Products- are they being designed with the environment in mind? This area also includes energy use.
What is the standardization of ESG reports?
The International Organization for Standardization (ISO) recognized that voluntarily prepared CSR and ESG reports will not be as consistent as required. In response, ISO released a publicly available standards framework which offers an international approach to reporting. Under the ISO 26000 guidelines, companies are encouraged to report on their ESG principles as well as on some of the risks and impacts that their CSR activities have had.
What are the benefits of an ESG audit?
ESG audits help companies:
1) Meet regulatory requirements for reporting environmental and social issues:
- in the United States under SEC Regulation S-K
- in the European Union under Directive 2013/34/EU
- in Australia under ASX Corporate Governance Council’s CG50 Guidelines
- in the UK under FRC’s Stewardship Code
- in Canada under IIRC’s Corporate Governance Guideline-2.1,
- in New Zealand under NZX’s Corporate Governance Disclosure Guideline
- and in China under PICC’s Sustainable Development Reporting Guidelines
- in India under SEBI’s Corporate Governance Guidelines, and
- in Brazil under CVM Instrução 569
- in Mexico under CNBV’s Recommendation on Sustainable Development
- in Chile under CNMC Resolution N° 105
- in Norway under SSM’s Guidance on environmental reporting
- in South Africa under PAS 55
2) Improve their social license to operate by identifying risks, taking effective corrective action, reporting on progress transparently, and communicating effectively with stakeholders about ESG issues.
3) Gain market advantage by differentiating themselves from their peers, building new business opportunities, and demonstrating a commitment to high environmental and social standards.
What is the value of ESG reports?
The value of ESG reporting lies in making sure that corporate activities are sustainable and do not affect the environment or society. These reports provide transparency and allow companies to be accountable for their actions.
What is ESG risk?
A common example of ESG risk would be a company’s operations violating environmental laws and regulations. Another would be the risk that the company’s business model will fail to meet changing social, economic or technological conditions.
How do we prepare for an ESG audit?
Before conducting an ESG audit, companies should:
1) Identify their stakeholders
2) Understand how these stakeholders perceive their company’s business activities
3) Identify the risks and opportunities related to ESG issues
4) Develop a plan for reporting on these issues, as well as procedures for evaluating them regularly.
3 main components of an ESG audit?
The three main components of an ESG audit:
1) The scope: which issues are being evaluated?
2) The timeline: when is the assessment being carried out, and which periods or time frames are being studied?
3) The methodology: this part describes how the audit will be conducted. Companies should keep in mind that a good methodology should have layers of checks and balances to ensure it’s as accurate as possible.
How many ESG reporting frameworks are there?
At the time of this publication, there were over 50 ESG reporting frameworks, with the Global Reporting Initiative (GRI) being a widely adopted standard that covers a broad range of sustainability issues.
What is an ESG KPI?
ESG refers to assessing environmental, social, and governance factors in the performance of an investment. Environmental factors include items such as greenhouse gas emissions or waste generation. Social factors refer to labor practices, human rights, diversity outreach and inclusion. Governance issues look at who manages a corporation (shareholders may be more important than stakeholders) and the relationship between a company and the community where it operates.
In summary on internal auditors
In conclusion, ESG audits allow companies to evaluate their business impact on the environment and society. This information can be used to develop effective, long-term strategies that help a company maintain an ethical and sustainable business model while improving their relationships with stakeholders. As we experience more massive weather events from the effects of climate change, companies will be under more pressure to exhibit their awareness and adherence to Environmental, Social and Governance standards. And, of course, there are always the Big Four.
Caveats, disclaimers and ESG auditing
We have covered many topics in this article and want to be clear that any reference to, or mention of reporting, internal auditors, disclosures, risks, financial, accounting, global metrics, independent assurance, internal, quality, role, risk management, function, assessments, strategies, independent, controls, professionals, standards board, processes, limited, regulatory information, committees, public company, regulatory filings, committee, external, effective reporting, climate, independent member firms affiliated, considerations, securities and exchange, other stakeholders, breaking news, groups, asset, operating effectively, human capital, private english company limited, public companies, professional advice, public commitments, report states, growing momentum, reporting, reliable information, vital role or more detail in the context of this article is purely for informational purposes and not to be misconstrued with investment advice or personal opinion. Thank you for reading, we hope that you found this article useful in your quest to understand ESG. Please also see our article outlining a related topic of CFA ESG investing certificate.