Confidence makes the economy go round.
There is a very good reason why financial statements should be audited by an external auditor: because it builds trust.
Sustainability and environmental, social and governance (ESG) reports are also subject to external assurance in order to foster trust. Ninety-one percent of the 1,400 companies in 22 jurisdictions report some level of sustainability reporting and 51% provide some level of security. That’s according to “The State of Play in Sustainability Assurance,” a recent report by the International Federation of Accountants (IFAC) and the Association of International Certified Professional Accountants.
The question is: How can ESG assurance build confidence in ESG disclosures when external auditing, the most advanced form of assurance, is struggling with a trust deficit? Or will the ESG guarantee replicate the same mistakes and become old wine in a new bottle?
Not long ago, amid a wave of corporate scandals, The Financial Times made it official: “Regulators, investors and the general public have lost confidence in the audit market.” It wasn’t the first time such audit-related statements were made, and it probably won’t be the last. But to ensure ESG, many are looking beyond traditional audit firms for the necessary verifications.
That said, while hiring non-traditional warranty providers is a good step, it may not be good enough. After all, external assurance has many of the same stakeholders as external auditing (reporting companies and investors, for example), and sustainability and ESG investing already face fierce criticism for alleged money laundering ecological Therefore, to avoid a repeat of the crisis of confidence in external audit, ESG assurance must chart a different path.
Unlike accounting and auditing matters, ESG issues are diverse. Disclosure and assurance are mostly voluntary and have a lot of flexibility built in. A company with varied sustainability issues and multiple locations can choose between the issues and geographic areas it reports on. In fact, some companies may choose not to report on certain criteria or locations. However, sustainability reporting is critical at the local level.
The 2020 Sustainability Governance Scoreboard includes sustainability leaders listed in one or more sustainability indices from 10 sectors and seven countries. Its integrated report on Coca-Cola İçecek (CCI) is a useful example of sustainability reporting in practice. CCI produces, distributes and sells carbonated and still beverages of Coca-Cola products for Azerbaijan, Iraq, Jordan, Kazakhstan, Kyrgyzstan, Pakistan, Syria, Tajikistan, Turkmenistan, Uzbekistan and Turkey, where it is headquartered. It is listed on Borsa Istanbul and reports its sustainability results separately for each of the countries in which it operates. Between 2011 and 2020, CCI sought external assurance on its water and energy use, among other issues.
The 2020 report and previous CCI sustainability reports refer to different frameworks and standards, including the Global Reporting Initiative, the United Nations Global Compact and the United Nations Women’s Empowerment Programme, AA1000, ISAE 3000, etc. The insurance providers’ reports tend to give “limited assurance” and state that nothing has emerged to suggest that the selected information does not present, in all material respects, “in accordance with the reporting criteria developed internally by CCI”.
External auditing is different from sustainability assurance. There is nothing to pick and choose – the notification criteria are final and binding. CCI’s 2020 auditor’s report clearly states that the consolidated financial statements were prepared in accordance with the accounting standards of the Capital Markets Board of Turkey. It certifies that the audit was conducted in accordance with applicable auditing standards and that the consolidated financial information is “presented fairly in all material respects.”
Strong global standards are required to make ESG and sustainability reporting comparable within and across jurisdictions. Unfortunately, the development of these standards has taken the better part of a generation with no end in sight. The first GRI guidelines were published in 2000 and established the framework for sustainability reporting. In 2004, the Association of Chartered Certified Accountants (ACCA) report “The Future of Sustainability Assurance” highlighted the need for “a complementary set of generally accepted accounting principles for sustainability (GAAPS) and d ‘generally accepted assurance standards for sustainability (GAASS).” Fast forward to 2021 and we’ve seen the creation of the International Sustainability Standards Board (ISSB) with a lot more work to do.
At SustainFinance we believe that the current moment is a once-in-a-lifetime opportunity to set ESG assurance on the right track. As it evolves and catches up with external audit, ESG assurance must fulfill the following four tasks, to avoid creating a trust deficit like the one now affecting external audit.
1. ASG insurance must maintain its independence.
The consensus is clear: independence is the cornerstone of external assurance. But the practice of auditing has created its own concept of independence that is not so intuitive. Can the auditor really be independent of the entity that appoints him, pays him, takes business from him and potentially fires him? The obvious answer: not really. Of course, the auditor’s answer has long been: Why not?
2. ESG assurance must go beyond offering generalized audit-like opinions.
It took the global financial crisis (GFC) and a lot of time for the audit practice to come up with a discussion of the key audit issues in the auditor’s report. ESG assurance providers would do well to provide feedback on key assurance issues immediately.
3. The ESG guarantee must require management to maintain its sustainability reports.
Such reports must be accompanied by a self-certification letter signed by the CEO and relevant board committee members stating that the report contains the material truth, the whole truth and nothing but the truth.
4. ESG assurance providers must be ready and willing to submit to regulatory oversight.
Unlike external auditing, ESG assurance does not have to go through the prolonged and failed experiment of self-regulation. When stakeholders ask who audits the auditor, the answer from those offering ESG assurance should be an independent regulator, which may be the same as the pre-existing audit regulator.
In short, to generate sustainable trust, an ambitious task in any context, ESG assurance must replicate the knowledge and experience of external auditing while avoiding its pitfalls.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Usman Hayat, CFA
Kübra Koldemir
