Audit committees are now increasingly finding themselves at the forefront of ensuring organisations integrate ESG and sustainability factors into their strategy, decision-making processes and risk management frameworks as well as playing a significant part in determining how companies communicate these topics through appropriate disclosures.
There is a continuing trend away from voluntary towards mandatory disclosures and this is expected for SMEs in the foreseeable future, meaning that the role of audit committees and boards alike will be fundamental in providing oversight and governance to the transparent reporting of reliable and robust information.
This article explores the role audit committees play in enhancing corporate responsibility, their expanded oversight to ensure ESG risks and opportunities are identified, prioritised and transparently reported, while promoting sustainable practices. Though this article focuses on companies with audit committees, the principles are relevant to all businesses and their directors.
ESG challenges and opportunities
The disclosure of ESG information represents a change from an audit committee’s traditional role in the oversight of risk management and internal controls, as well as the validity of financial information. This will require leadership and adaptability from the top of every organisation to ensure required processes and internal controls are established given the growth of ESG and relative immaturity of controls. There are three key areas for audit committees to consider:
- Understanding current ESG reporting obligations
- Implementing strong processes and controls for ESG reporting
- Gaining assurance over non-financial information
ESG reporting obligations for UK companies
As a reminder, the UK government now mandates climate-related financial disclosure (CRFD) for private companies with turnovers above £500 million and more than 500 employees, starting from accounting periods commencing on or after 6 April 2022. This requirement extends to specific UK-registered companies meeting the prescribed criteria. CRFD will be incorporated into a new Non-Financial and Sustainability Information Statement within the strategic report, typically alongside a “section 172 statement”.
Several significant initiatives have been introduced recently, including new reporting obligations for companies which audit committees should be aware of. Among these, the International Sustainability Standards Board (ISSB) stands out as a major development, originating from the International Financial Reporting Standard Foundation (IFRS).
The first two ISSB standards were released in the Summer of 2023 and became effective on 1 January 2024, but it will be for individual jurisdictions to decide whether or when to adopt them. A key requirement of these new standards is that companies must now provide sustainability-related disclosures in line with their year-end financial statement.
Noteworthy developments also impacting UK entities include the EU’s Green Deal, a set of policies aimed at climate neutrality (often referred to as net zero) by 2050. One aspect incorporates the Corporate Sustainability Reporting Directive (CSRD), affecting around 50,000 companies worldwide, including non-EU companies that have subsidiaries in the EU or are listed on EU regulated markets. Another aspect is the EU taxonomy regulation, which will notably affect SMEs that fall under the CSRD. Under this regulation, disclosures will be required on the proportion to which turnover and expenditure align with environmentally sustainable activities.
In addition, the most recent Corporate Governance Code from the Quoted Companies Alliance (QCA) emphasises the importance of acknowledging social and environmental responsibilities. While not mandatory, the QCA advocates that companies disclose material environmental and social concerns within annual report and accounts, along with any KPIs. The code encourages website disclosures, particularly highlighting key stakeholders and relationships. Securing the confidence of material stakeholders concerning ESG issues is paramount, particularly in the UK where directors are required to integrate a “section 172 statement” into the strategic report. This statement highlights their consideration of stakeholders’ interests, how they engage with them while advancing the company’s best interests.
Establishing a stakeholder engagement framework calls for conducting a materiality assessment to identify pertinent stakeholders and actively involving them to integrate their perspectives to understand what matters most. A key recent finding by the Financial Reporting Council (FRC) followed its review of sustainability reporting by major UK private companies, and identified that while disclosures are improving, companies had unclear actions, milestones, and metric comparability, emphasising the importance of clear and concise ESG storytelling.
It’s therefore crucial for boards and audit committees alike to stay up to date with ESG and sustainability standards and legislation. When reviewing disclosures, the audit committee should work with management to identify how ESG metrics and priority ESG impacts, risks and opportunities have been determined.
Processes and controls for ESG reporting
It will come as no surprise, given the relative immaturity of ESG reporting, that companies are experiencing gaps in their systems, controls and expertise for ESG disclosures compared to their financial reporting, leading to claims of ‘green hushing’ and a reluctance to voluntarily publish targets. The challenge organisations face is to align the two in terms of quality, to ensure ESG data is auditable. This emphasises the need for the audit committee’s involvement in understanding whether there are appropriate underlying controls, systems and processes in place, and they ought to inquire about existing systems and processes, as well as determine if any additional resources are necessary.
Data collection and analysis is key and by implementing robust processes and controls, a company can enhance the accuracy, consistency and reliability of its ESG data and ultimately build trust amongst its stakeholder groups. This will likely involve the standardisation of data collection procedures across different countries, business units and departments and the establishment of clearly defined data collection policies, methods, sources and frequency to ensure that ESG information is reliable and complete. Investment in technology, such as carbon accounting systems, to streamline and automate the collection of ESG data can be enormously beneficial, enabling companies to enhance efficiency and accuracy.
Audit committees should not forget that an assessment of sustainability processes and controls will be required for disclosure on the governance of sustainability matters. This is evidenced in European Sustainability Reporting Standard (ESRS2) and is likely to form part of future standards. At Saffery, our maturity assessments can assist organisations in gauging the current position of their sustainability journey, internal workflows, and reporting capabilities, as well as provide recommended improvements to systems, processes and controls.
Assurance over non-financial information
‘Greenwashing’ can be a significant reputational risk for organisations and is an important concern for audit committees, investors and other stakeholders. The reliability and accuracy of the information being disclosed to the public and regulators is paramount to any organisation wanting to build trust. Audit committees must focus on the validity and quality of any such ESG information.
This could be achieved via the internal audit function or through independent external assurance, with ultimate oversight of the process residing with the audit committee. The maturity of a company’s sustainability data and internal assurance processes, however, directly impacts the company’s readiness for external assurance.
Internal audit can support ESG data quality for both management decision-making and external reporting. This can be achieved through developing the internal sustainability control environment to ensure robust controls and the veracity of data. Whether an organisation has the necessary skills to deliver on ESG aspects internally or whether external support is required should be considered.
Companies are increasing their independent external assurance in relation to ESG information to enhance the reliability and confidence of reporting to external stakeholders, especially in relation to key metrics. This is predominantly relevant for material ESG metrics and an understanding of how these will benefit the external assurance report. In some countries, an independent assurance report is, or will soon be, mandatory. The European Commission has already announced a requirement for companies to have the ESG data they disclose subject to an independent limited assurance review.
The disclosure of an assurance review can take various forms, such as part of the audit report or part of a separate sustainability report. Either way, it must be comprehensive and assess the credibility of the information being disclosed, as well as include an opinion of the business’s material ESG targets and metrics. Like an audit report, those charged with governance should be signing off on an ESG report to demonstrate their understanding of its contents and overall accountability, thereby enhancing the credibility of their sustainability strategy.
Final thoughts
As businesses recognise the synergies between financial success and ESG, audit committees will play a greater and more pivotal role in ensuring transparency in the information disclosed and that sustainable practices are embraced.
By expanding oversight beyond traditional financial matters, audit committees can more effectively contribute to the long-term objectives and success of companies in an era where ESG issues are integral to corporate performance and societal impact. What is clear is that the collaboration between audit committees, management and wider stakeholders is essential for creating a successful sustainable future – one that balances economic growth alongside environmental and social responsibility.
How we can help
Here at Saffery, we can provide clarity in this rapidly changing space, helping you to navigate the standards and legislation you’re required to report under. We provide a range of sustainability and ESG services to help you get set up for ESG reporting or assist you in beginning your sustainability journey.
Please contact Richard Collis or Stuart Macdougall for further information or if you’re considering ESG reporting for the first time.
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