As environmental, social and governmental (ESG) issues and sustainability become increasingly important to account for when building portfolios, the ways in which companies are evaluated in terms of sustainability also have to evolve. It’s not just the environmental effects of industries that are to be included in reports however. In the wake of Covid-19, investors are looking at how companies have dealt with the pandemic and in turn, are turning their gaze on how employees are treated and the environments in which they work. Corporate governance and social factors are to be held under a magnifying glass before funding is delivered, but the information is not always available.
According to a McKinsey study, around 67% of investors agree that sustainability audits should be as rigorous and regulated as financial audits, but how would such a framework be implemented? The issues surrounding ESG are often complex and multifaceted, it isn’t always simple to reduce them to facts and figures. How important then would in-depth, detailed sustainability reports be to a company’s revenues, public image and long-term future? What are the challenges that an inclusive auditing system faces as the market grows?
Why Is ESG Auditing Important?
There are a few factors at play when it comes to considering the importance of effective ESG audits and reports;
- On an investor level, clear evidence of ESG standards being maintained within a company is reportedly “essential to managing risk and executing strategy, and leads to long-term increases in shareholder value”.
- The sentiment that ESG accountability is intrinsically linked to long-term success only grows stronger. With a strong ESG audit framework that is recognised on a global scale, the way in which companies handle ESG issues would be more available to the public.
- Transparency in how companies are dealing with sustainability issues would not only ensure that organisations are truly adhering to ESG criteria, but also allow them and investors to evaluate risk and liability.
Who Is Involved in the ESG Auditing Process?
Organisations such as the FSB’s Task Force on Climate-related Financial Disclosures (TCFD), which announced it had gained the support of over 1000 organisations earlier this year, aim to increase the transparency of businesses when reporting their environmental impacts. 1000 participants may not sound like a lot, but when you consider that the 473 financial firms that are part of the collective are alone responsible for over $138.8 trillion in assets, the impact of the TDFD becomes self-evident.
At a company level, accountants are currently an important part of the ESG reporting effort but as the responsibility to report grows, so does the amount of manpower needed to effectively collate data and execute change. In terms of the future, having dedicated teams that are used to report ESG factors alone could become the norm.
Does ESG Auditing Work?
Studies have already been able to show that companies and indexes with higher ESG metrics have outperformed lower-ranked ESG companies/non-ESG indexed firms. There have also been cases in recent years of corporations being penalised for not following ESG measures where adequate reporting would have negated the issue. A prime example of this is when in 2018 Tesco was hit with a $4 billion fine due to gender salary disparity.
Arguments for improved ESG reporting are certainly ironclad. In an age where reputational factors are seen as increasingly important to investors, being able to see clearly how an organisation works to improve ESG issues is paramount. This is doubly true when it comes to environmental concerns, which are seen as being hand in hand with long term goals. In short if a company doesn’t factor in climate change, it is seen as not having an effective long-term strategy.
What Challenges Does ESG Auditing Face?
Just like all radical shifts in framework paradigms, this change in how companies report their ESG efforts faces many challenges and a good deal of scrutiny. A leading example of this is the fact that even though most banks have adopted change, the majority still refuse to integrate ESG reporting into their risk management. This may be in part due to the fact that to implement an effective ESG auditing strategy, companies would have to implement strict data management systems and controls.
As mentioned previously, ESG encompasses a spectrum of issues and it would be nigh impossible for a company to address all ESG of these. Because of the widespread scope of ESG reporting, one of the main challenges it would face would be how the data is standardised and compared between institutions. However, as ratings agencies engage in a new wave of M&A and work to improve disclosure methodologies, these companies could begin to create meaningful change in the ESG landscape if backed by the right players.