Environment, Social, and Governance (ESG)
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Understanding Environment, Social, and Governance (ESG) for Socially Responsible Investing
Overview of ESG Categories:
Environment, Social, and Governance (ESG) represent three critical dimensions for Socially Responsible Investors. Rather than solely focusing on profitability and risk, these investors prioritise incorporating values and concerns, particularly related to the environment, into their investment decisions.
The Three Ps of Sustainability: Profit, People, and Planet
Companies aspiring to be sustainable and profitable should concentrate on the three Ps: Profit, People, and Planet, which have evolved into the framework of ESG.
Exploring Each Element of ESG:
Environment (E): Encompasses a company's energy consumption, waste generation, resource utilization, and its impact on humans and the environment. This includes considerations of carbon emissions, climate change, pollution, waste, greenhouse gases, and deforestation.
Social (S): Addresses a company's relationships with people, its reputation in the community, labor relations, and diversity. Focuses on human capital management, diversity, working conditions, and health and safety of employees.
Governance (G): Pertains to the internal systems, controls, and procedures a company adopts to govern itself, comply with rules and laws, make effective decisions, and meet the needs of external stakeholders. Examines management practices, executive remuneration, tax practices, corruption, board diversity, and structure.
MSCI ESG Rating:
MSCI ESG Rating measures a company's resilience to long-term industry-specific ESG risks. It identifies industry leaders and laggards based on exposure to ESG risks and their management.
Ten Steps for Developing an ESG Strategy:
Focus on the Best Strategy:
Acknowledge the uniqueness of each business and tailor the ESG strategy accordingly.
Establish Top-to-Bottom Goals:
Engage top executives to set broad goals, refining them after conducting a comprehensive audit.
Conduct Materiality Analysis:
Prioritize issues through materiality analysis, considering both external and internal stakeholder perspectives.
Use an Objective Third Party:
Seek an unbiased third party for materiality analysis to legitimize results.
Engage with All Stakeholders:
Collect data from employees, emphasizing feedback loops, and foster external stakeholder collaboration.
Assess Cost:
Consider budget and lifecycle approach, evaluating costs and risks of inaction.
Build an ESG Team:
Hire sustainability professionals to maintain the strategy and create a strong governance structure.
Ensure Third-Party Verification:
Demonstrate the robustness of the strategy through third-party verification.
Manage the Supply Chain:
Embed ESG in the procurement process, reflecting the company's values and committing to continuous improvement.
Align with Existing Frameworks:
Establish a sustainable policy aligning with existing frameworks, such as UN Sustainable Development Goals, when expanding the supply chain.
Enhancing ESG Practices: The Integral Role of Internal Audit
Internal Audit's Advisory and Assurance in ESG:
Internal Audit is a pivotal player in a company's ESG journey, offering valuable advisory services by identifying and establishing an effective ESG control environment. It provides critical assurance support through independent reviews of ESG risk assessments, responses, and controls.
Internal Control's Crucial Role:
Internal Control is a process driven by the company's governing body and management to provide reasonable assurance concerning operational, reporting, and compliance objectives. For ESG reporting, the company must establish policies, processes, and internal controls ensuring the generation of reliable and relevant information.
Importance of Governance in ESG Strategy:
A robust governance structure is crucial for executing an ESG strategy effectively. This structure ensures the accuracy of ESG data and overall strategy implementation. Governance should include:
Accountability by a governing body with integrity, leadership, and transparency to stakeholders.
Action by management to achieve company goals through resource application and risk-based decision-making.
Advice and assurance from an independent internal audit function for continuous improvement, clarity, and confidence.
Advisory Role of Internal Audit:
Internal Audit can recommend frameworks to manage or mitigate ESG risks and provide guidance on developing specific internal controls over ESG reporting. It plays a key role in identifying roles and responsibilities and offers training on internal controls.
Assurance Provided by Internal Audit:
As per the Institute of Internal Auditors, internal audit must provide assurance over ESG reporting, including:
Reviewing reporting metrics for relevancy, accuracy, timeliness, and consistency.
Ensuring consistency between ESG reporting and formal financial disclosure filings.
Conducting materiality assessments of ESG reporting risks.
Incorporating ESG into a regular audit plan.
Leveraging Sustainability Reporting Frameworks:
Sustainability Reporting Frameworks to leverage include:
Global Reporting Initiative (GRI):
Discloses a wide range of ESG issues relevant to stakeholders.
Sustainability Accounting Standards Board (SASB):
Focuses on selected disclosures relevant to a company's sector, targeting investors.
Task Force on Climate-related Financial Disclosures (TCFD):
Focuses on reporting framework for climate-related financial risk.
International Integrated Reporting Council (IIRC):
Supports the development of integrated reports on the company's strategy, governance, performance, and prospects.
Role of Internal Audit in ESG Implementation:
Internal Audit goes beyond identifying risks to include root causes, risk management strategies, and preventive controls. It ensures the company's governance, risk management, and internal controls are operating effectively, examining aspects like ESG policy, oversight, awareness, risk assessment, and due diligence.
Internal Auditing Methodologies for ESG:
ESG Risk:
Risk and opportunity assessment.
Regulatory requirements.
Review of new products.
Due diligence of third parties.
High-Level Oversight:
Definition of ESG.
Mission, vision, values, and strategy.
Top management's periodic review.
Context and stakeholder analysis.
Time, resources, and budget.
Policies and Procedures:
Entity-wide policies and procedures on human rights, health and safety, etc.
Consistency between policy frameworks.
Culture and Awareness.
Culture and Awareness:
Engagement and dialogue with stakeholders.
Regular training and communication.
Tools and Data:
Technology supporting ESG programs.
Predictive measures (key risk indicators and key performance indicators).
Root cause analysis and trending.
Auditing Monitoring:
Monitoring and tracking regulatory change.
Transactional, process, and control testing.
Third-party and employee compliance due diligence.
Periodic ESG risk program evaluation.
Issues Management and Investigation:
Issues or complaints management and remediation.
Responding to government investigations.
Continuous improvement.
Reporting:
Reporting periodically to management and remediation.
Mandatory regulatory reporting.
External reporting to stakeholders.
Record-keeping.
Let's Get Started
Required Document List
- Documents on Potential Risks to the Environment (ESG Front) and Mitigation Measures
- Document on ESG-Related Projects or Initiatives by the Company
- Documents on Company Governance and Oversight Mechanism for ESG Strategy
- Documents on Management Issues: Actions, Schemes, Targets, and Value Preservation
- Performance Documents Supporting Sustainability Outcomes from Business Activities
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