The global sustainability and environmental, social, and governance (ESG) regulatory landscape continues to grow in complexity, and practical navigation of ESG compliance and reporting requirements is key to successfully managing the many dimensions of ESG. Organizations are increasingly facing regulations in multiple jurisdictions on a variety of topics, including human rights, supply chain transparency, climate change, and corporate governance. All this must be accomplished while simultaneously addressing concerns voiced by a range of stakeholders, including investors, clients, and employees.
ESG reporting is foundational to sustainability programs and compliance, and internal audit leaders can help their companies stay the course. In a recent webcast, our team of presenters covered ESG reporting concerns and the role played by internal auditors. Here, we provide an overview of key takeaways.
Understanding the ESG Reporting Regulatory Landscape
Thinking holistically about ESG and sustainability can put a company’s ESG reporting on strong footing. The path requires consideration of local, federal, state, and international regulations due to the ESG regulatory landscape’s global nature. Factors that may determine a company’s compliance requirements include its geographic location, industry, annual revenue, and status as public or private.
Sifting through the acronyms associated to ESG reporting can seem overwhelming. The sheer breadth and number of regulations is a concern for many companies and their internal audit teams.
In the U.S., both national and state-level regulations exist and primarily focus on environmental disclosures. In contrast, the European Union’s Corporate Sustainability Reporting Directive (CSRD) and its associated European Sustainability Reporting Standards (ESRS) cover a wide array of sustainability disclosures and are considered the most stringent sustainability reporting requirements to date globally. Many U.S. companies (both public and private) with an EU presence will need to comply with the CSRD, highlighting the importance of approaching sustainability compliance from a global perspective.
Reporting Challenges and Strategies
Understanding ESG regulations is just part of the journey; the next step involves data collection and reporting, and it is not without obstacles. Here are some common challenges that companies may encounter:
- Local adoption of reporting standards: The emergence of various regulations and uncertainty on how regulators and countries will adopt new reporting standards (e.g., IFRS S1 and IFRS S2) can push companies to address ESG and sustainability from a compliance standpoint. However, focusing solely on compliance may result in missed opportunities to integrate sustainability in a more strategic manner.
- Depth and level of reporting: Some of the most recent regulations, such as the EU Deforestation Regulation (EUDR) and the EU’s Carbon Border Adjustment Mechanism (CBAM), require product-specific disclosures and/or disclosures about traded commodities. Some regulations also emphasize due diligence measures, focusing on the mitigation and remediation of adverse impacts in a company’s value chain.
- Phased requirements: Many regulations phase in requirements over time, making it necessary to develop compliance strategies that consider both immediate and longer-term demands. For example, many require third-party verification initially at the limited assurance level and then later at the reasonable assurance level. In the case of the CSRD, a U.S. company’s EU subsidiaries may be required to comply initially, but the U.S. company may be required to comply at the group level later on. This phase-in approach is forcing companies to adopt a two-fold compliance approach:
- Compliance at the EU level while ensuring alignment with the group-level sustainability strategy (if already developed); and
- Initial consolidation at the EU entity level, which may require local expertise on topics and processes typically developed and managed at the corporate level.
Given this evolving landscape, internal auditors can help at each phase of an organization’s ESG planning by identifying and addressing challenges as they arise.
The Role of Internal Auditors
ESG reporting must be approached differently from financial reporting in the following attributes:
- Control vs. influence: Sustainability reporting may be based on different concepts of control or influence than financial reporting.
- Quantitative vs. qualitative: While there are quantitative metrics, ESG reporting tends to be more qualitative in nature.
- Long term vs. short term approach: Sustainability programs typically take a long-term view of an organization’s operations, focusing on the wise use and preservation of resources, and integrating sustainability targets and goals with overall business objectives.
- “Single” materiality vs. double materiality: Some regulations require companies to perform an assessment to determine E, S, & G topics material from both a financial and impact dimension. While in the past companies only considered the financial implications of ESG for their businesses, a double materiality requires integrating external stakeholders’ considerations on what organizations should determine as ESG priorities.
Internal auditors can be uniquely positioned to support an organization’s ESG strategies and compliance. Their comprehensive view of the company and its ESG requirements can help inform ESG planning by identifying root cause issues and recommending potential solutions. ESG programs impact more than one department, and internal auditors can facilitate cross-departmental collaboration that can strengthen internal controls and processes throughout the organization.
Are Internal Auditors Included in Your Company’S ESG Reporting Efforts?
Leveraging an internal auditor’s skillset and experience can help leaders and key stakeholders understand and comply with diverse, evolving ESG requirements. Please contact our Internal Audit Services team to learn more about internal auditing.