Internal Audit’s Role in ESG Reporting

Date: April 19, 2023

A trusted partner to investors

First Published in Business Times on 23 Mar 2023

In many discussions and forums on environmental, social, and governance (ESG) issues, large institutional investors are escalating their requests for greater corporate transparency. Investors are keen to know how companies are addressing ESG risks and opportunities because they provide insights to the ability to adapt to the ever-changing business environment. This resulted in a surge of ESG-related data collection and eventual disclosures in the form of a Sustainability Report.

In his 2022 letter to all CEOs, the Chairman & CEO of BlackRock, Larry Fink said, “We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients… These targets, and the quality of plans to meet them, are critical to the long-term economic interests of your shareholders. It’s also why we ask you to issue reports…because we believe these are essential tools for understanding a company’s ability to adapt for the future.”

Harvard Business Review published an article The Investor Revolution – Shareholders are getting serious about sustainability that mentioned, “Environmental, social, and governance (ESG) issues have traditionally been of secondary concern to investors. But in recent years, institutional investors and pension funds have grown too large to diversify away from systemic risks, forcing them to consider the environmental and social impact of their portfolios…To respond to this shift in focus, companies must publish a statement of purpose, provide investors with integrated financial and ESG reports…”

As ESG continues to take centre stage in world news, investors and other stakeholders are appraising companies, not just on their financial reports, but also on their ESG reports issued.

As the pace of change is accelerating in the business environment, stakeholders are sharpening their focus on ESG risks that many organisations are facing. This amplified awareness is exerting pressure on organisations to gather, assess, and disclose their ESG positions along with their associated risks and opportunities.

Due to such enormous pressure, organisations realise that the reputation and cost of conducting business have an almost direct relationship to the ESG-related activities they engaged in. That leads to some organisations reporting inflated and/or obfuscated information relating to their ESG activities, commonly known as greenwashing.

On the other side of the table, investors understand that the risks and opportunities related to ESG would have, immediate or future, financial and/or strategic impacts on the organisation. Therefore, the escalated request from all readers of the Sustainability Report (not just the investors) is that the information disclosed in the Sustainability Report needs to be reliable and germane for any decision-making.

To achieve the additional transparency which encourages efficiency and innovation, Singapore Exchange (SGX) requires each listed company to publish an annual Sustainability Report, describing the primary components on a ‘comply or explain’ basis, and in relation to the primary component where the issuer is in any of the industries identified, on a mandatory basis, in accordance with the SGX’s Listing Rules.

In order to increase stakeholder confidence in the accuracy and reliability of the sustainability information disclosed, SGX (with effect from 1 January 2022), mandated that the Sustainability Report of all SGX-listed companies would require, minimally, an internal review to be conducted by the Internal Audit department of the organisation.

SGX, in its Practice Note 7.6 Sustainability Reporting Guide mentioned that the board has ultimate responsibility for the sustainability reporting of the organisation. The board’s role includes setting strategic objectives which should include an appropriate focus on sustainability. Internal Audit’s position, therefore, plays a critical role in governance and control in the organisation. Not only does internal audit provide the board with the independent assurance that the sustainability governance is structured and functioning through the various levels of management, but the risks and opportunities, related to ESG, are adequately considered, and disclosed in the Sustainability Report.

In order to assist the internal audit profession in Singapore to navigate through the new mandate, The Institute of Internal Auditors (IIA) Singapore swiftly developed a Guide to Internal Review of Sustainability Report, which is available for free to all its members.

As a trusted partner, internal auditors support the stakeholders in connecting the dots by assessing the organisation’s ESG risks from multiple perspectives. For example, in assessing governance and policy, internal auditors can consider whether a governing structure supports effective climate risk management and whether information on climate risk is being reported to the board.

The independence of the internal audit function is the most critical part of its role in governance and ESG assurance as demonstrated by the IIA’s Three Lines Model.

The internal review can highlight the adequacy of policies, controls, and responsibilities with respect to ESG strategies and tactics at a particular point in time. More focused ESG reviews can provide a deeper dive into specific ESG areas, such as control activities surrounding the ESG-related data collection process. The internal review can be extended to determine how various corporate functions, businesses, local and overseas entities form an integral part of the entire data collection workflow so that the disclosed information is complete and representative of the organisation’s business and global presence.

Internal audit can consider adopting a continuous auditing approach, incorporating assessment of ESG risk areas into the audit plans to provide a pulse check on the business during the year. This approach can help highlight the extent to which ESG-related activities are being identified, considered, and documented throughout the year. Any observations made can be addressed immediately, and manifest into a clearer, balanced, and objective Sustainability Report.

ESG disclosure is going to intensify in the coming years as more stakeholders are heightening their demands for reliable information. Information reported by a company needs to be credible and well-supported for investors and other stakeholders to rely on for their decisions. Internal audit is well-positioned to provide that assurance, not only to the board but also to all the readers of the Sustainability Report.

Stephen Ching is a Governor of the board at IIA Singapore and Senior Vice President, Group Head Internal Audit at ST Engineering Ltd.