An article published earlier this year in The Wall Street Journal highlighted investor concern about the impacts of climate change, citing “a record of 75 or more climate-related shareholder proposals” expected at annual company meetings. Dupont investors, for example, proposed disclosure of the company’s risks from expansion of its operations in hurricane-prone areas, and nearly 30% of Starbucks shareholders voted for disclosing the coffee giant’s recycling plans. In addition, more and more institutional shareholders are backing the Sustainability Accounting Standards Board’s standards for corporate sustainability, aimed at helping publicly listed companies disclose environmentally relevant information to investors. Internal auditors, and the organizations they serve, should take note of these developments — particularly in businesses where such concerns may not currently be a priority.
Within the financial industry, climate risk is not always on the agenda. For example, financial companies, and their internal audit functions, may neglect to consider the credit evaluation risks associated with lending money to companies susceptible to climate-related events. In doing so, lenders overlook impacts that could severely disrupt the borrowing companies’ operations, and possibly hinder their repayment abilities. Even if it’s discussed, resulting impacts to the company’s credit risk rating may not be sufficiently accounted for when calculating the borrower’s credit rating.
By contrast, insurance companies are at the forefront of addressing climate-related risk. Policy calculations, for example, factor in threats to homes and businesses in wildfire-prone areas and flood risk to regions susceptible to hurricanes. Financial institutions, however, typically do not include such considerations when calculating the impact of risk to capital. And even if bank leaders do incorporate climate-related impact in their credit risk analyses, there is no real metric in place for that risk.
As independent assessors of risk, internal auditors could raise the issue of climate change risk with senior management, and even consider it as a point of concern when challenging the organization’s current risk management framework. Internal audit has the opportunity to create value, facilitate improvement, and execute its mission of providing independent assurance over the effectiveness of risk management. From envisioning the impact of climate-related risk on the bank’s daily operations to the impacts on clients’ operations and ability to perform against their credit risk, auditors can place themselves at the forefront of an important debate.
The financial industry, with the help of its internal audit practitioners, could get ahead of the curve by promoting a broad discussion about how to consider, monitor, and report climate change risk. If past crises taught us anything, reacting to stressed scenarios is arguably more expensive and takes longer to recover from than acting preventively. Let’s start the debate — the sooner the better.