Performing a successful ESG audit – UK companies

An ESG audit, short for Environmental, Social, and Governance audit, is a systematic evaluation of your company's performance in these key areas. It involves assessing your environmental impact, social responsibility initiatives, and governance practices to identify strengths, weaknesses, opportunities – and importantly, risks. The aim of an ESG audit is to provide stakeholders, including investors, regulators, employees, and the public, with a comprehensive view of your company's sustainability efforts and adherence to ESG principles.

ESG risks encompass environmental, social, and governance factors that can harm your company's financial performance, reputation, and long-term viability. These risks arise from climate change, labor practices, regulatory compliance, governance issues, supply chain risks and vulnerabilities, and emerging threats. Environmental risks, such as pollution and carbon emissions, may lead to fines and supply chain disruptions. Social risks, like labour violations and product safety scandals, can result in legal liabilities and loss of trust. Governance risks, such as ineffective board oversight, affect investor confidence. Identifying, assessing, and mitigating these risks is crucial for resilience, stakeholder trust, and long-term value creation.

ESG auditing offers a range of benefits, including enhancing transparency, improving risk management, strengthening stakeholder relationships, driving innovation, and fostering long-term sustainability.

Verifying ESG data integrity is crucial. ESG audits, similar to financial audits, validate the accuracy and reliability of reported information, building trust among stakeholders. Companies with strong ESG credentials, verified through audits, attract socially conscious consumers and investors, enhancing competitiveness and brand value.

Audits are also essential for compliance with global ESG regulations, mitigating regulatory risks, and meeting reporting requirements like the EU Corporate Sustainability Reporting Directive (CSRD).

Importantly, audits can be carried out internally, or by externally appointed bodies. 

In internal ESG audits, a dedicated audit team evaluates your company’s internal processes, controls, and adherence to ESG standards. These audits give you insight into how well you are aligning with your own ESG goals and policies, offering customization, continuous improvement, and cost efficiency.

Meanwhile, in external ESG audits, independent third parties assess your company's ESG performance. They provide stakeholders with an unbiased evaluation of your adherence to ESG standards, enhancing credibility, transparency, and compliance assurance. External audits often include benchmarking against industry peers.

Conducting a successful ESG assessment presents several common challenges that external auditors must navigate to ensure comprehensive and accurate assessment of a company's environmental, social, and governance practices. These challenges include:

• Data availability and reliability: Obtaining access to comprehensive and reliable data is often a significant hurdle. Companies may lack standardized reporting mechanisms or comprehensive data collection processes, requiring auditors to address issues related to the availability and accuracy of transactional data and track changes to data points effectively.

• Complexity of ESG issues: ESG issues are inherently complex and interconnected, making it challenging to identify and assess all relevant aspects comprehensively. Auditors must grapple with the multifaceted nature of ESG issues, requiring thorough understanding and analysis to ensure a holistic assessment.

• Stakeholder engagement: Engaging with diverse stakeholders, including senior management, employees, investors, and community members, is crucial for gaining comprehensive insights into the company's ESG performance. Effective interfaces for collaborating and robust stakeholder engagement strategies are essential to gather relevant information and perspectives efficiently.

• Integration into existing practices: Integrating ESG considerations into existing audit processes and frameworks requires careful planning and coordination. Auditors need to ensure alignment with organizational objectives and goals while implementing robust data management systems and internal controls to facilitate seamless integration.

Successfully addressing these challenges requires a proactive and systematic approach, including robust data management systems and internal controls, stakeholder engagement strategies, and ongoing monitoring of regulatory developments to ensure compliance and transparency in ESG reporting and auditing practices.

ESG reporting frameworks, such as SASB, TCFD, and GRI offer principles-based guidance to identify and address ESG topics pertinent to businesses.

• Sustainability Accounting Standards Board (SASB): SASB is a widely recognized ESG framework that offers comprehensive sector-specific guidance on various environmental, social, and governance (ESG) risks. Its approach tailors recommendations to specific industries, allowing companies to address pertinent ESG issues more effectively within their respective sectors.

• Task Force on Climate-Related Financial Disclosures (TCFD): TCFD is a specialized framework primarily focused on climate-related financial risks and opportunities. It provides guidance for companies to assess and disclose climate-related information, enabling investors and stakeholders to better understand the financial implications of climate change on businesses. 

While TCFD was disbanded in 2023 after fulfilling its initial role, its framework continues to hold significant value in guiding companies towards disclosing climate-related financial information and managing associated risks effectively.

Global Reporting Initiative (GRI)

: Unlike SASB and TCFD, GRI offers a broader scope covering a wide range of sustainability issues beyond climate-related matters. It emphasizes stakeholder engagement and inclusivity in reporting, encouraging companies to disclose their impacts on society and the environment in a transparent and standardized manner.

Before you embark on your audit, it's important to understand the key climate related disclosures and ESG frameworks in your area of jurisdiction.

Current reporting requirements – Companies Act

At present, ESG policy in the UK is shaped by a combination of domestic legislation and EU-derived regulations, with the Companies Act serving as a key regulatory framework for ESG disclosures. Under this act, larger companies meeting specific criteria are mandated to include sustainability details in their annual reports, such as reporting on energy usage and carbon emissions. Furthermore, certain sectors and organizations of a particular size are beginning to adopt specialized standards like the Sustainability Reporting Standard, paving the way for more standardized ESG reporting frameworks and practices.

Upcoming reporting requirements

Looking ahead, future ESG regulations in the UK are poised to introduce more stringent reporting requirements.

Sustainability Disclosure Requirements (SDRs)

The forthcoming Sustainability Disclosure Requirements (SDRs) aim to establish a comprehensive framework for handling sustainability opportunities, risks, and impacts, with mandatory disclosure anticipated by 2025. Additionally, the introduction of net zero transition plans and the influence of European corporate sustainability reporting directive (CSRD) are expected to shape the ESG reporting landscape in the coming years, potentially impacting non-EU companies with significant European operations.

The International Sustainability Standards Board (ISSB)

Amidst these regulatory developments, the International Sustainability Standards Board (ISSB) is proposing guidelines for climate and ESG reporting, likely to be integrated into UK legislation by 2024 or 2025. Although not all companies are directly subject to these regulations, the growing investor demand for transparent ESG reporting underscores the importance of embracing best practices in ESG reporting without delay. As regulations continue to expand, businesses can proactively prepare by aligning with established frameworks like the Task Force on Climate-Related Financial Disclosures (TCFD) and adopting robust ESG reporting strategies to meet evolving stakeholder expectations.

Below, we're compiled a handy checklist for external audits of your company’s ESG performance.

1. Understanding organizational context

Before diving into the audit, take the time to understand your organization's context. Assess the industry landscape, identify relevant stakeholders, and familiarize yourself with existing ESG policies and objectives within your company. This understanding provides valuable context for selecting the right framework (point 2).

2. Selecting the right ESG audit standards and framework

Regardless of whether you're conducting an internal audit or engaging a third-party auditor, selecting the right ESG frameworks is essential. These frameworks should align with industry specifics and company objectives. They provide principles-based guidance for identifying ESG topics and structuring information and outline specific requirements for disclosing metrics.

3. Collecting your data

Begin by collecting quantitative data, which forms the backbone of your audit. Based on the framework of your choice, this data may include metrics such as greenhouse gas emissions, energy consumption, water usage, waste generation, and diversity statistics. Quantitative data provides objective measurements of your organization's environmental and social performance. Additionally, review qualitative data such as ESG-related policies, procedures, and records within your organization. Conduct interviews with key personnel to gather insights into ESG practices and performance.

4. Creating an effective workflow for validation

Establishing an effective workflow for validation is crucial for ensuring the accuracy and reliability of ESG audit findings. This involves implementing robust processes to validate collected data, verify compliance with selected ESG frameworks, and ensure consistency across audit procedures. Creating clear guidelines and checkpoints for validation helps maintain quality standards throughout the audit process, ultimately enhancing the credibility of ESG reporting and audit outcomes. 

5. Preparing for ESG assurance engagements

Third-party assurance enhances ESG information reliability and stakeholder confidence. Auditors conduct attestation engagements to ensure ESG information aligns with specified criteria. Internal audit functions play a vital role in implementing standards consistently and establishing independent processes, given the current self-definition of ESG program requirements by most companies. ESG assurance engagements vary in scope, with a trend towards moving from limited to reasonable assurance. Companies often undergo assurance readiness assessments before engaging third-party auditors.

6. Integrating ESG into annual audit plans

ESG reporting is becoming increasingly important, necessitating its integration into annual audit plans. Regulations, such as SEC requirements for human capital resources reporting, are expected to evolve, particularly concerning climate-related disclosures in financial reporting. Integrating an annual ESG audit alongside traditional audit plans ensures reliable, transparent ESG information that meets the needs of stakeholders and regulatory entities consistently.

7. Follow-up and continuous improvement

The audit process doesn't end with the report. Follow up on recommended actions to ensure implementation. Conduct follow-up audits to monitor progress over time. By holding yourself accountable and tracking performance improvements, you can drive meaningful change and demonstrate your commitment to sustainability.

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