New IIA report addresses risks and importance of assurance by internal audit

10-06-2021

As environmental groups, activists, and asset managers step up pressure on major companies to make public commitments to sustainability, leaders in business and government are realizing the urgency and importance of environmental, social and governance (ESG) as an enterprise imperative. Understanding the challenges related to this growing risk area is the focus of Internal Audit’s Role in ESG Reporting: Independent Assurance Is Critical to Effective Sustainability Reporting, a new report released by The Institute of Internal Auditors.

There is a growing momentum for organizations to strategically manage ESG risks, particularly as investors and regulators push for more comprehensive and uniform reporting on sustainability efforts and pressures increase on executive performance as more organizations tie incentive compensation metrics to ESG goals.

“Internal auditors continue to focus on risks that can significantly impact their organizations. With the heightened focus on ESG, where failures could affect an organization’s long-term outlook, companies are quickly waking up to the urgency of confronting and responding to these issues seriously and immediately,” said IIA President and CEO Anthony J. Pugliese. “Internal auditors must be ready to provide objective assurance to management and the board.”

This report explains the risks, the opportunities, and how internal audit can help identify and establish a functional ESG control environment. Its unique, enterprise-wide view also allows it to provide crucial assurance on the effectiveness of assessments, responses, and controls.

ESG reporting involves a wide array of metrics, requiring organizations to establish policies and implement effective processes and internal controls that will generate reliable information for decision-making, according to Internal Audit’s Role in ESG Reporting. “Similar to financial reporting,” according to the report, “data used to create sustainability reports are based on the day-to-day operations and decisions driving organizations toward achieving objectives. Proper control activities must be designed and operating effectively — from the operational steps to the collection and analysis of the data that will be used in reporting.”

In addition, ESG initiatives and reporting demand sound governance practices, with the governing body, management, and internal audit working “collectively to align with each other and the prioritized interests of stakeholders.” Internal audit is a key player in effective governance, as detailed in The IIA’s Three Lines Model released in 2020. “The challenges and complexity of ESG reporting are abundantly evident, and the risks associated with poorly managed reporting can be high in terms of regulatory compliance and reputational damage.”

To be sure, more companies – encouraged by investors and public interest – are responding to ESG challenges with increasingly sophisticated approaches to measuring potential impacts. The IIA report cites a KPMG survey showing 80% of companies around the globe, including 96% of the world’s largest, now report on sustainability. That has prompted regulators to increase their attention on the accuracy of sustainability reports and what they actually reflect.

“It is good news so many organizations are focusing on ESG,” Pugliese said, “but many more are struggling or are ill-equipped to determine exactly what should be reported. A key reason for this is a lack of a single set of standards and uniformity in reporting.”

In a recent letter to the U.S. Securities and Exchange Commission, The IIA called for uniform climate disclosure by corporations and recognition of the role internal audit plays in providing assurance around complete, accurate, and reliable information. As part of its commitment to addressing such issues on a global level and advocating for independent internal assurance, The IIA is a member of the International Integrated Reporting Council (IIRC). The IIRC and the Sustainability Accounting Standards Board recently announced a merger as the Value Reporting Foundation, with the goal of providing investors and corporations “with a comprehensive corporate reporting framework across the full range of enterprise value drivers and standards to drive global sustainability performance.”

“Business performance is no longer judged purely on short-term financial returns,” Pugliese wrote in the letter to the SEC. “ESG issues represent a broad range of risks, including to external supply chains, internal operations, third parties, general control weaknesses, data accuracy, human capital, and more. A single system of climate disclosures would provide an opportunity for comparability among corporations and investors and allow for more informed business decisions that consider ESG impacts. This also would enable long-term organizational resilience.”

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