The Increasing Focus On Integrated Reporting & ESG

Swift change is all around us, generating risks and opportunities which require rapid responses. While many businesses may be aware of the basic survival tactics required during economically pressing times, stakeholders are showing increasing awareness and acknowledgement of issues around climate, environment, social and governance (ESG).

Stakeholders are demanding quality information. Integrated Reporting aims to meet this demand, by allowing for better decision making and a better future for all generations. The announcement by the International Financial Reporting Standards (IFRS) Foundation on 3 November 2021, at COP26 – the United Nations global summit to address climate change is testament to this: The newly formed International Sustainability Standards Board (ISSB) will develop a comprehensive global baseline of high-quality sustainability disclosure standards focussed on meeting investors information needs.

So, what is ESG?

Environmental, Social and Governance encompasses the following:

  • E – Environmental criteria, including an organization’s energy consumption, waste discharges, carbon emissions, resources needed and the consequent impact on living beings.
  • S – Social criteria, such as the relationships and reputation an organization has, with people and institutions within the communities where it conducts business. S also includes labour relations, diversity and inclusion.
  • G – Governance, being the system of practices, internal controls and procedures by which an entity is managed and controlled, including how decisions are made, compliance with laws and regulations and meeting the needs of external stakeholders.

ESG Reporting is built on integrated information and thinking.

Integrated Reporting

The King IV Code describes an integrated report as a “concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value in the short, medium and long term.”

The process of integrated reporting involves integrated thinking that results in a periodic report by the organization about its value creation over time. Integrated thinking is the active consideration by the organization of the relationship between its various operating and functional units and the capitals (financial, manufactured, intellectual, human, social and relationship & natural) that the organization uses. Value creation occurs when the organization uses its capitals to create outputs that is worth more than its inputs. Through Integrated Reporting, businesses can reflect the value that they have created over time, in terms of environmental, social and governance (ESG) aspects.

Accelerating ESG investment

ESG has become an inseparable part of doing business. The individual elements of ESG are often overlapping, for example social criteria overlaps with environmental criteria and governance. Good leaders know that excelling in governance requires not only adhering to the letter of the law but also embracing the spirit thereof. This means not simply following a tick-box approach but actively focussing on outcomes.

The Global Sustainable Investment Review 2018, reflects that ESG-oriented investing has grown by 68% since 2014, reaching US $30 trillion. This acceleration is driven by intensified social, consumer, investor, C-suite, and governmental attention to the impact organizations have on the world. In a survey of Investopedia and Treehugger readers, 58% of respondents indicated that their interest in ESG grew during 2020. About 19% began incorporating ESG standards into their portfolios. More than half of the ESG investors surveyed started investing in ESG-related products within the last five years.

With accelerating ESG investment, there is an increased focus on the interconnectedness of sustainability and the financial system. ESG metrics are not (yet) commonly part of mandatory financial reporting, many companies are increasingly making ESG disclosures in the annual or standalone sustainability report. With no standardized approach to the calculation or presentation of different ESG metrics, investors can employ a variety of analytical approaches to assess whether an entity is worth their investment.

ESG investing focusses on financial returns while considering the ethical, environmental, social and governance aspects of a business. ESG investing should be distinguished from Impact investing, the latter which is focussed less on financial returns and mainly on the organization’s intent to have a positive social and environmental impact on the rest of the world.

Why is ESG reporting important?

  • Enhanced brand and reputation - Quality ESG reporting can enhance your entity’s brand and reputation. Consumers are increasingly exercising their preferences for sustainable responsible companies. The same is true for attraction and retention of talent. Employees are increasingly looking at the positive social impact and the notion of the company “giving back” when considering their careers.
  • Top-line growth and cost reductions - A strong ESG proposition can also help businesses expand into existing markets and reach into new ones. This could contribute to top-line growth. Together with cost reductions such as raw-materials costs and water consumption, this can lead to better returns on investments for stakeholders.
  • Better returns on investment - Thoughtful and transparent ESG reporting can enhance value and attract investors. Businesses that focus on the longer term, being sustainable and satisfying the needs of their customers, employees, communities (often the global community) are more likely to maximize value creation.
  • Getting a head start in ESG reporting can help save time and efforts in the long run when regulatory disclosures become mandatory.

The role of Internal Audit in ESG reporting

For many organizations, ESG reporting is a new risk area which encompasses a variety of risk factors – the accelerating effects of climate change, addressing historical social imbalances, ethical behaviour, corporate culture and sustainability across the entity. Other risk areas can include reliance on third-party data, potential reputational damage from defective reporting and the inability of the organization to meet specific sustainability goals.

ESG reporting should be treated with the same care as financial reporting. A strategically developed system of internal controls and accurate reflection of how the organization’s ESG efforts relate to each other, the entity’s finances and value creation is critical.

Internal Audit can advise an organization by helping to identify and establish an effective ESG control environment. Providing independent assurance on the entity’s ESG information, an independent and objective review of the effectiveness of ESG risk assessments, responses and controls and acting as a sounding board for the entity’s ESG endeavours are part of the role of Internal Audit.

Integrated and ESG reporting is not only for large entities – it is scalable to all organizations regardless of size and sector. The integrated report can be an effective way to help SMEs better understand and manage how they create value, and report on that value creation. This can also help attract investors.

In the same way, Internal Audit is not only for large entities. At GrowthSmiths, we aim to bring Internal Audit solutions within reach of all businesses, no matter their size. Providing you with bite-sized solutions, we make tailored Internal Audit solutions that add value to business available to everyone.

This article was written by Tania Knoetze, Service Line Leader for Internal Audit.

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