The changing climate of audit committees by Rachael Johnson

Climate risk has been moving higher up the boardroom agenda throughout the pandemic thanks to an expanding coalition of investors calling for more transparent disclosures aligned with the Paris Climate Agreement and a cohort of central bankers, the Network for Greening the Financial System, stepping up efforts to introduce consistent global norms for integrating climate factors into prudential frameworks.

This collaborative responsibility to meet the target of a net-zero economy by 2050 is centered around companies, public and private, and their integral role in limiting climate catastrophe – not just through supply lines but also by impacting value chains and ultimately the way the world consumes. This presents Boards with yet more fresh challenges. It is their fiduciary duty to drive the company’s climate change responses, and given the Paris Climate Agreement’s short-term goal to reduce carbon emissions by 50% within a decade there is a lot of work to be done by Board directors in establishing a fit for purpose framework for that.

Whilst the Board oversees and assesses risk governance, it delegates climate risk reporting to subcommittees. New regulations and investor expectations are increasingly focused on that being the responsibility of the Audit Committee. This still can vary across businesses and sectors. If you consider comparing Energy and Financial Services, for example, each has a different stage of evolution given the varied organisational models and existential threats to business. It also depends on whether the company is in the business of selling carbon, selling to customers who use carbon, or financing economic development, which can either exacerbate or help climate change challenges.

The Task Force for Climate-related Financial Disclosures (TCFD) has been a helpful impetus in this respect. Likewise, the Financial Reporting Council and Bank of England have played their part in calling for companies to improve their accounting for climate risks. By putting together well-recognised frameworks, they along with TCFD and other accounting standard-setters, for example the Financial Accounting Standards Board, IASB, IFAC, and IFRS, are pushing the climate agenda into Audit Committee metrics.

As Audit Committees are finding, measuring carbon emissions directly and indirectly related to the company’s operations is not easy. Carbon accounting is laden with estimates, judgements, and understanding the numbers and their implications is very challenging. Although standards continue to develop and change for the better, they need to become clearer and more consistent, particularly within sectors.

Investors are joining forces more and engaging with sub-sectors, for instance in Oil & Gas. In June, British Petroleum announced that it would be aligning its accounting assumptions with the Paris Agreement goals, after much engagement with its investors on improved transparency of climate change risks.

Enhanced disclosures by certain companies in this sector have demonstrated just how material climate risks are.

“Whilst some sectors will be impacted by climate change more than others, all businesses in some form or other will be affected. The energy transition that the world is trying to implement is rewiring our economic DNA. So, it is very hard to see how any sector or company will be untouched by that,” Natasha LandellMills, Head of Stewardship at Sarasin & Partners, commented in a recent Deloitte-sponsored webinar on the topic.

More sector-focused initiatives are in the making. In August, the Partnership for Carbon Accounting Financials’ (PCAF’s) released its draft for public consultation on a standard, specifically for the Financial Services industry. The Global Carbon Accounting Standard for the Financial Industry offers asset class methods to measure and disclose greenhouse gas emission financed by loans and investments.

In Financial Services, the focuses are on risks to portfolio and lending, including opportunities in real estate and transport, particularly automobiles, while the Energy sector is naturally more focused on its core business and transitioning that into one which is not dependent on carbon production. Conversations might have different angles and be at different levels of maturity, but we have seen them become a top priority for Audit Committees in both sectors.

Audit Committees are also more involved with strategy as the risk landscape changes. They are playing a bigger role in what goes into annual reports and statements, particularly around climate but also in nonfinancial and traditional financial numbers. With new regulations around operational resilience on the horizon, the Audit Committee also needs to assess internal control framework and drive new ways of thinking about risk from the top down. Its assurance responsibilities will be increasingly crucial going forward.

The assurance industry is going to take on a new meaning in terms of how companies understand the risks that they face; how they measure them; how they measure progress; and, indeed, how this becomes consistent across sectors. Audit Committees will be at the centre of this transformation, as regulations change and digital transformation continues to accelerate.

author

Rachael Johnson

Rachael Johnson is Head of Risk Management and Corporate Governance for the Professional Insights division at the Association of Chartered Certified Accountants (ACCA). She has over two decades’ experience writing and researching about risk governance. She started her career as a journalist at RISK magazine and lived and worked in the US and Hong Kong before moving to London where she is based. Rachael also heads up ACCA’s Governance, Risk and Performance Forum, which advocates and produces thought leadership and comments for consultations.