Norman Marks on Governance, Risk Management, and Internal Audit

Three parts to this post:

1. What is ESG?
2. What are those conflicting reports?
3. What does this all mean for practitioners?

Part 1

OK, it’s time for me to ‘fess up.

I am confused by “ESG”.

It seems to be the same as corporate social responsibility, (CSR) which was quite the fad only a few years ago. (Read this for an explanation of the difference between CSR and sustainability. I’m not sure there is a practical difference.)

My take is that it’s about organizations, especially for-profit corporations, being told (and complying) that they have a responsibility to the community to contribute to the fight against global warming and other social issues, like slave labor. (I’m not going to get into the debate between those who believe global warming is primarily man-made, and those who dispute that notion. My personal perspective is that it’s here and we need to do something about it!)

People didn’t get on board with CSR, even though there were standards like ISO 26000, “defined as the international standard developed to help organizations effectively assess and address social responsibilities that are relevant and significant to their mission and vision; operations and processes; customers, employees, communities, and other stakeholders; and environmental impact”. This article details others.

Don’t get me wrong. I am pleased that corporations are becoming more aware of their impact on the community within which they operate – and the risk to their reputation and their profits if they are seen as irresponsible members of society.

Then came ESG. People say that it adds metrics to CSR (my wording)

Worldfavor has an interesting article ESG vs CSR, what is the difference?

It explains:

Corporate Social Responsibility (CSR) refers to sustainability strategies businesses employ to ensure that the company is carried out ethically. In contrast, Environmental, Social and Governance (ESG) are criteria used to measure a company’s overall sustainability.

Think of it this way, CSR is a sustainability framework employed by organizations, while ESG measures the organization’s level of sustainability – increasingly demanded by investors and other stakeholders.

They continue:

Corporate Social Responsibility (CSR) is a management concept in which companies integrate social and environmental concerns into their business strategy, to positively impact society while improving brand reputation. CSR objectives could, for instance, be to reduce carbon footprint, improve labor policies, build green office spaces, or initiatives such as creating new products from plastic waste.

The term started to gain attention in the 1970s, and by the early 2000s, it had become an essential strategy for many companies, large and small.

A lot has changed since then. While CSR is an excellent strategy for driving awareness of an organization’s initiatives – today’s stakeholders demand transparency and clear evidence showing that you walk the talk.

…

ESG is a sustainability assessment using Environmental, Social, and Governance metrics to evaluate how sustainable and resilient a company is to make it accountable for its sustainability claims.

In recent years, investors and other corporate stakeholders’ interest in ESG has skyrocketed, and it has even been described as the decade’s trend. On the one hand, it is seen as a way to better capture a company’s risks and opportunities. On the other, the growing number of ESG regulations being introduced, such as the EU Taxonomy and the SFDR, is currently reshaping the entire corporate world and investors have no other option but to adjust. In fact, responding to evolving regulations and legal requirements was the number one driver for considering ESG factors in investment decisions and implementation, according to a survey by Barnett Waddingham.

Those survey results are interesting. Observe that the desire to “do good” is not even mentioned.

Of course, we now have regulators starting to mandate ESG or sustainability reporting.

PwC has a useful article, ESG reporting and preparation of a Sustainability Report. (It’s curious that they don’t distinguish ESG and sustainability. Maybe they are as confused as I am!)

They tell us:

An ESG report or Sustainability report is a report published by a company or organization about environmental, social and governance (ESG) impacts. It enables the company to be more transparent about the risks and opportunities it faces. It is a communication tool that plays an important role in convincing sceptical [sic] observers that the company’s actions are sincere.

From what I can tell, the regulators have not told organizations what they need to report, only that when they report it has to be accurate.

My thinking is that organizations need to:

• Define what they want to achieve when it comes to CSR/Sustainability/ESG.
• Establish those as enterprise objectives with strategies to achieve them.
• Identify, assess, and address related sources of risk (and opportunity).
• Make sure there are effective internal controls over those risks and how they are reported, both internally and externally.
• Disclose in public findings how you are doing, and that may well include disclosing related risks!
• Consider obtaining assurance on the accuracy of the disclosures, preferably from internal audit.

Part 2

Bloomberg recently published ‘ESG’ Is Too Important to Ax, Investors Say. They tell us:

Using environmental, social and governance metrics is now mainstream, according to 89% of investors who responded to a survey published Wednesday by Bloomberg Intelligence. And 57% said the “ESG” label shouldn’t be replaced by something less incendiary, despite the backlash.

ESG is primarily being used to “improve profit, competitiveness and brand value,” according to Bloomberg Intelligence, whose full survey findings are based on responses from 250 C-suite executives and 250 senior investors distributed evenly across the US, Europe and the Asia-Pacific region.

Overall, the survey found that 85% of investors think ESG leads to “better returns, resilient portfolios and enhanced fundamental analysis.” Among executives surveyed, 84% said ESG helps them “shape a more robust corporate strategy,” according to Adeline Diab, BI’s director of ESG strategy and research.

But they warn that:

The findings come as ESG fund flows have showed signs of cooling, against a backdrop of continued political attacks and disappointing returns. This year, investors in wind and solar stocks have seen their investments sink as higher interest rates and supply-chain bottlenecks have pummeled the renewable-energy sector.

Meanwhile, laws seeking to ban ESG are spreading across GOP-led US states. The development has drawn warnings from some of the biggest names on Wall Street, as banks and asset managers get punished for policies deemed unfriendly to the gun and fossil fuel industries. This month, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon warned that Texas risks undermining its business-friendly reputation with its anti-ESG laws.

In the US, investors pulled $2.7 billion from sustainable funds in the third quarter, and fewer new sustainable funds started than at any point in the past three years, according to data provided by Morningstar Inc. In Europe, meanwhile, ESG fund flows proved resilient.

The BBC sees a slightly different picture in How ‘ESG’ came to mean everything and nothing.

In 2015, Paris was buzzing with anticipation as world leaders gathered for the UN’s annual Climate Change Conference (COP21). After weeks of intense debate, on 12 December, they emerged with a promise: 196 nations pledged to take on climate change with the goal of net zero emissions by 2050.

For businesses, this signalled the beginning of the “ESG” movement: a focus on environmental, social and governance issues in business decisions. Across the globe, companies rolled out individual, ambitious campaigns towards net zero objectives; ESG-focused investment strategies ranged, but often included transitions to green energy and divestment from fossil fuels.

US telecoms company Verizon, for instance, committed to generate renewable energy equivalent to 50% of its annual electricity consumption by 2025. French insurance company Axa vowed to cut ties with the coal industry by 2030. And after George Floyd’s murder, global companies including Apple, AbbVie, Facebook, Pfizer, Johnson & Johnson and Procter & Gamble pledged a combined $340bn (£279bn) to furthering racial justice causes.

However, in the years since firms announced these splashy ESG commitments, often boosting share prices and bolstering corporate reputations, the term has created more confusion – even trouble – than positive change. In fact, some of those ESG commitments have created myriad problems for executives, says Alison Taylor, a clinical associate professor at NYU Stern School of Business, US. Increasingly, the ESG movement has been labelled as “woke” capitalism, and accused of enabling greenwashing.

As a result, Taylor says that even as businesses continue to issue net zero pledges, they’ve stopped labelling their business decisions as “ESG”. This could spell relief for firms that have faced increasing backlash for leaning into the term while failing to make any substantial changes, particularly in a time of growing public expectations around corporate responsibility.

I like this:

The fragility of the entire ESG movement – and in some aspects, a major catalyst for its downfall – may well lie in its name, which has morphed into an umbrella catchphrase with little concrete meaning.

First, argues Alex Edmans, a finance professor at London Business School, the words don’t belong together. “Environmental and social is about how we serve wider society. Governance is about how we generate returns,” he says. For instance, an environmental pledge could be a net zero plan. A social commitment could make sure to ensuring hiring is equitable. Governance refers to the framework of corporate policy, like CEO-to-employee pay ratio. And often, these ambitions are functionally incompatible.

…

Without a solid definition – and, often, a realistic way to action the pledge – “ESG” has come to represent different things to different people. For instance, many people assume the term refers only to investments in green financial instruments or support for companies who pledge to reduce carbon emissions. Others believe in a broader interpretation, like faith-based investing.

…

For some companies, these moves raised their profiles, snagging headlines and garnering investors’ praise. But at the same time, this rush to become an ESG-focused company has led to overuse of the term and devalued its meaning, says Edmans. “Anything which is good about a company, people say, is ESG. So, there have been some reports say, ‘oh, this company is well run, let’s call that good ESG’.”

Part 3

So what does this all mean for practitioners.

Earlier, I suggested that organizations need to:

• Define what they want to achieve when it comes to CSR/Sustainability/ESG.
• Establish those as enterprise objectives with strategies to achieve them.
• Identify, assess, and address related sources of risk (and opportunity).
• Make sure there are effective internal controls over those risks and how they are reported, both internally and externally.
• Disclose in public findings how you are doing, and that may well include disclosing related risks!
• Consider obtaining assurance on the accuracy of the disclosures, preferably from internal audit.

Practitioners can help with all of these activities. We can:

• Work with management and the board to make sure the right objectives are set, considering related risks and what is achievable.
• Help management identify, assess, evaluate, and address the risks.
• Provide assurance, advice, and insight over related internal controls.

AuditBoard shared their 2023 ESG Maturity Benchmarking Report. It tells us that:

…two-thirds of survey respondents have not implemented ESG controls to ensure accuracy of data, which opens organizations up to reputational damage from reporting incomplete or incorrect ESG data and leaves them unprepared to maintain compliance with the upcoming SEC ESG rules and other future reporting requirements.

The GRC report, says:

PricewaterhouseCoopers (PwC) has unveiled the findings of its 2023 Global Investor Survey, shedding light on the growing skepticism among investors regarding the reliability of sustainability reporting. The survey, now in its third consecutive year, engaged 345 investors and analysts across diverse geographies, asset classes, and investment approaches, providing insights into the factors influencing their investment decisions.

The survey underscores the significance of sustainability in investment decisions, with three-quarters of investors expressing its importance. However, a staggering 94% of respondents harbor doubts about the credibility of corporate reporting on sustainability performance. This marks a notable increase from 87% in 2022, reflecting a pervasive concern among investors.

…

Investors express skepticism about sustainability reporting, often attributing it to “greenwashing.” The survey indicates that 94% believe corporate reporting on sustainability performance contains unsupported claims.

Should practitioners make ESG/Sustainability/CSR a priority?

IMHO, it should be a priority if and only if the leaders of the organization make it a priority. There is never enough time, and we have to be prudent.

We need to weigh the value of spending our limited resources in this area vs. others. (Risk-based internal auditing for that team.)

The least we should do, IMHO, is to talk to leaders in top management and the board to understand where they see the topic, and whether they have defined objectives for it. If not, perhaps they should!

I welcome your thoughts.