Climate change is not only sparking record-shattering heat waves across the U.S. this summer, but also prompting more accounting firms to get involved in environmental, social and governance services.
Investors are expecting companies to provide more disclosures about the risks of climate change, and the Securities and Exchange Commission has taken greater interest in climate-related disclosures, especially with the growing popularity of ESG-related investment funds. In March, the SEC asked for public input on climate change disclosures and is expected to issue new rules mandating such disclosures.
Accountants are increasingly being asked to vet such disclosures, while some firms, especially the Big Four, have already started offering ESG assurance services. According to a recent survey by Ernst & Young, the proportion of investors who are dissatisfied with environmental risk disclosures has increased by 14% since 2018.
EY has been bringing ESG into its international assurance and audit practice. “We have regrouped all the professionals having expertise in sustainability under one umbrella, under assurance,” said EY assurance global vice chair Marie-Laure Delarue. “The people are very connected across the world, and they are naturally linked to the audit. Where ESG becomes not only a strategic and risk measurement topic, but also a reporting topic, it’s going to be incredibly helpful to have them along with our auditors.”
She is seeing heightened focus on climate change issues at companies. “The whole ESG topic is quite important, but we see more and more focus, if not anxiety, about climate-related topics and disclosures,” said Delarue. “It’s because regulators, politicians and investors are putting more and more emphasis on this topic. Depending on where you are sitting around the globe, you have different agendas. Some of them are more regulated and more target oriented. Some of them are a bit more voluntary and use influence, but everywhere around the globe you see this focus on ESG and climate change. What we try to do with our clients is really to help them navigate through the agenda, trying to help them prioritize and also make sure they focus not only on the reporting, but also on the strategy, and if they commit to a target that they do a better job of explaining how they’re going to achieve those targets.”
For its global climate risk barometer survey, EY surveyed 1,100 corporations across about 45 countries, measuring how they complied with the TCFD framework quantitatively and qualitatively. “While 75% of issuers are really applying the framework from a quantitative standpoint, from a qualitative standpoint there is still a long way to go,” said Delarue. “We have assessed that only 42 of the issuers really have good quality of disclosure, which shows that while everybody is engaged and trying to do something, the depth, the relevance, the consistency, the way you describe outcomes is still not there.”
EY is planning to work with the International Financial Reporting Standards Foundation on setting up an International Sustainability Standards Board, and has been active in the European Union, the United Kingdom, Japan and Australia on sustainability reporting as well.
“We really try to bring as much support as we can to all these initiatives because we believe that’s the right thing to do,” said Delarue. “We believe that non-financial reporting will become as important for investors and stakeholders as financial reporting. Our view is that you should really create the same disciplines and rigorous framework as has been created around financial reporting. And in this respect, of course, the EU has led the charge because they have drafted a new directive. Not only do they have the intention to be quite prescriptive on what firms and corporate should disclose, but also they have been clear that they want some level of assurance from independent firms for disclosures, starting with limited assurance and then moving toward reasonable assurance, which is the level of assurance that you provide on financial reporting and disclosures.”
FASB standards
Deloitte has also been expanding its ESG services, trying to get accountants more involved in the process. “When companies are talking about targets in terms of their environmental goals and carbon footprint, and they’re thinking about their operational strategies, those discussions tend to happen at the board level or the senior management level, and typically the finance and accounting departments within companies are likely not involved in those discussions,” said Eric Knachel, a senior consultation partner in the Professional Practice Network at Deloitte & Touche. “It’s easy for there to be a lack of consideration and evaluation of the impact of a company’s initiatives around those environmental issues, or a company’s response to proposed regulatory action when they prepare the financial statements. Hence there’s a potential blind spot, because accounting and finance aren’t necessarily plugged into the discussions that are happening at the board level around their strategies and plans. It’s not like a company entering into a contract, having invoices going through the accounting function. Companies don’t necessarily have the same type of controls in place for sustainability issues and reporting. They don’t necessarily have the same process that they do around financial accounting controls. If a company is not deliberate about communicating between groups, it’s easy for some of the knowledge and the plans that are being discussed in one part of the organization not to make their way into the finance and accounting considerations.”
Deloitte recently issued a
“From an accounting standpoint, if an accounting department in a company is trying to account for revenue, leases or goodwill, there are specific accounting standards for those topics, but there’s not a specific accounting standard as it relates to ESG,” said Knachel. “That leads a lot of people to say maybe this doesn’t really impact accounting, or we need something in the future because there’s not a specific standard for ESG. It’s important to recognize there can be a lot of activity that’s driven by environmental issues that is covered under today’s GAAP accounting standards. Let’s say a company closes down a plant and they plan to replace the plant and machinery. There are existing rules around how to account for an exit activity or abandoning a plant, as well as how to depreciate assets, modify useful lives and adjust residual values. There are all sorts of places in GAAP that would give accounting guidance for that type of activity, all triggered by environmental issues. Another example that comes to mind as it relates to environmental issues would be around estimates of future cash flow, basically fair value. If you think about goodwill impairment, or long-lived assets, or realization of deferred tax assets, there are existing accounting rules. Those rules require that a company use various assumptions and make estimates. Climate or environmental considerations are part of those assumptions. You have a number of standards today around accounting for goodwill, intangibles, property, plant and equipment, inventory, asset retirement obligations and income taxes that can be impacted by environmental issues, but because they’re not called environmental standards, people overlook them. They tend to think that maybe the SEC is going to provide some guidance around disclosures and wait for this to happen. In reality there are things that companies should be considering right now as it relates to climate events as well as plans around the environment, issues of sustainability, carbon footprint and those types of things.”
KPMG has also been focusing more on ESG reporting and assurance on the audit side. “While ESG and digital transformation are very different, I can’t help but find similarities between ESG and another transformational change, which was the adoption and implementation of Sarbanes-Oxley and how it was rolled out,” said Scott Flynn, vice chair of audit during a KPMG webcast last week. “I don’t want to be an alarmist around that, but this really is a transformational event that’s going to have an impact on a company’s internal process and how that company and similar companies document and attest to critical internal data. As it relates to the marketplace, we’re hearing that investors and other stakeholders want to know where companies are in their ESG journeys. It’s not enough to say that you have an ESG strategy to demonstrate credibility to all stakeholders. It’s imperative that you deliver through your reporting with KPIs that are consistent with your strategic objectives and tell your stakeholders where your ESG journey is heading.”
The firm set up its KPMG Impact group to help clients meet the United Nations’ Sustainable Development Goals. “When you hear about KPMG Impact, it’s important to highlight that this isn’t a standalone effort that we silo in one corner of our business,” said KPMG Impact and ESG national leader Rob Fisher. “We really view it as a watermark under everything we do, and that’s requiring us to upskill every partner and every professional in order to serve our clients. I know many of the companies we work with are thinking about it in the same way.”
S&P ESG disclosures
Other auditing firms are also getting involved in ESG assurance services, but it may be a hard sell, as most public companies are not using their audit firms for ESG assurance. The Center for Audit Quality has been looking at the disclosures of S&P 100 and S&P 500 companies and recently
“With the regulators focusing on this information, there’s a real opportunity here for enhanced reliability of the information,” said Dennis McGowan, vice president of the CAQ professional practice team. “ Like the audits of the financial statements, with the reliability that an auditor brings to that information, there’s an opportunity here for auditors to bring that same level of reliability to ESG information.”
Most of the ESG information is sitting in standalone ESG reports, or on an investor relations web page. “There were probably a couple of instances where we saw an SEC submission, but by and large they were standalone ESG reports, or on a web page,” said McGowan.
Just over half (264) of S&P 500 companies subjected their ESG information to some sort of assurance. “Of that 264, there were 31 S&P 500 companies that subjected select ESG metrics to assurance from a public company auditor,” said McGowan.
The CAQ also looked to see what standards were being used by public company auditors. For the most part, they were using attestation standards from the American Institute of CPAs, or a combination of AICPA standards with the International Auditing and Assurance Board’s attestation standard, which is International Standard on Assurance Engagements 3000.
“For the most part we saw more often than not there were some instances where there was ‘reasonable’ assurance,” said McGowan. “That’s a level of assurance that people are probably most familiar with, and most similar to the assurance provided in a financial statement audit.”
Typically only part of the ESG report is subjected to some sort of assurance or verification, and often only selected metrics. “Greenhouse gas emissions is probably the most common metric that we saw being assured,” said McGowan. “Some would get greenhouse gases and a couple of other metrics assured. When a company did have more than greenhouse gas emissions assured, that assurance was from public company auditors.”
Some of the other ESG metrics that received assurance included water usage and waste removal, along with employee health and safety metrics.
The CAQ did its analysis of the S&P 100 back in March and found a few things had changed in the more recent report on the S&P 500. “When we compared that analysis as of March to the S&P 500 as of June, we had seen 11 companies subject certain of their ESG information to assurance as of March,” said McGowan. “When we looked at the S&P 100 again as of June, that number went up to 13. We did see an increase in the assurance coming from public company auditors, at least within the S&P 100.”
Accounting firms have some catching up to do with the consulting firms and sustainability specialists that have been helping companies with vetting their ESG compliance. “We are seeing that companies are using not just public company auditors to obtain assurance over this information,” said McGowan. “Within the S&P 500, that was about 31 companies of the 264. There were a couple that had assurance and verification from both a public company auditor and another service provider, but the majority of it was being done by non-accounting firms. We are of the view that public company auditors are well positioned to do this work, but we did see that they’re not the only provider of assurance over the information. I think the non-accounting firms are probably issuing more verification statements versus assurance statements, but some of them do use their own assurance methodology that seems to be based upon ISAE 3000, though it’s not always clear how it’s based on ISAE 3000 in the report.”
The most popular ESG framework referenced among both the S&P 500 and S&P 100 was from the Carbon Disclosure Project. The Sustainability Accounting Standards Board (now known as the Value Reporting Foundation) framework came in second place among S&P 500 companies, while the Global Reporting Initiative Standards came in second among the S&P 100.
“We did look at what kinds of standards were being used,” said McGowan. “In particular, we did look for references to five of the more well known framework- or standard-setters. I think CDP was probably the most common, followed by SASB and then GRI. The other thing we looked at too was how many companies referred to more than one of those framework- or standard-setters. Quite a few companies are using multiple, and what that shows you is that these standards and frameworks have been built for different reasons. Companies are utilizing more than one of them to meet the information needs of their users. We were also interested to see how many companies were using more than one, with some of the work by the leading framework- and standard-setters earlier this year to show how their frameworks and standards are interoperable and work together. Seeing more than one reference shows that’s probably happening in practice. Companies are using more than one because they are interoperable to some extent.”
Companies are also using their own internal auditors to check on ESG information and the risks of climate change to companies. “Certainly when it comes to providing assurance around the effectiveness of risk control and governance, there is no substitute for an internal audit function that resides within an organization,” said Richard Chambers, senior internal audit advisor at AuditBoard and former president and CEO of the Institute of Internal Auditors. “You need to have access to co-sourcing partners out there if you’re in internal audit, but if I were the CEO of a company, and I were looking at obtaining assurance around the efficiency, effectiveness, quality of controls and risk management at my company, I’d be looking at having a resident internal audit function staffed with men and women who are going to have the most insight and the most knowledge about my company. Going out and hiring a firm to do that on a contract basis generally isn’t as efficient and sometimes not as effective.”
Accounting firms are nevertheless building up their ESG assurance and auditing capabilities. “There are 600 different provisions currently in the world around ESG,” said Delarue of EY. “Half of them are mandatory, and half are voluntary. You can imagine our clients are really seeking advice on which ones they should pick up, and also they are really supportive of the global initiatives that are underway to create a much more globally consistent framework of standards.”
While California lawmakers are proposing to require ESG disclosure by companies, most states are not asking for those right now, although the SEC may start requiring climate risk disclosures on a national level after its recent public consultation. But there is growing demand abroad for mandatory disclosures.
“In Europe, France has been the first country where it became mandatory to disclose and to provide some level of assurance,” said Delarue. “The second thing our clients ask for at the moment is really to get prepared for this wave of upcoming mandatory reporting. They are really very keen for us to help them assess the reliability and strength of their processes, data and controls. It’s very nascent because very often the people who are in charge of sustainability matters at large companies are outside of the finance area. Very often they have very specific ESG and climate sustainability groups who are not in the remit of the CFO, in the executive committee and the finance function. What is at stake is really to get their grip around how we are going to get prepared so that we don’t only disclose what is needed, but we are able to position this in a much broader frame where we can explain why we want to do this. The average company produces output, but what we tell our clients is that you have to create outcomes. You really have to be clear on what your journey is and how you are going to achieve your announced targets.”
