The adverse impacts of rising global temperatures and extreme weather conditions are becoming a front-line risk for businesses. A 2015 Economist Intelligence Unit study estimated that the value of global manageable assets at risk due to climate change could be as much as $4.2 trillion between now and 2100 in discounted, present-value terms. That is roughly on par with the total value of all the world’s listed oil and gas companies. Meanwhile, increased regulation to confront climate change is gaining momentum around the world.
These trends are leading boards and executives to realize that today’s climate-related decisions may dramatically impact their organizations in the future. Leaders are recognizing that the magnitude of climate change risks warrants a collective action as their impacts are widespread and not just a future threat. As a result, organizations may incur increased production costs, decreased demand, and delayed delivery of goods and services to their customers.
The growing stakeholder concern about climate change risks is creating demand for climate-competent auditors to help analyze the threats and recommend remedies. Such practitioners can help their organization address financial, process, and governance implications. Through a multipronged approach encompassing both strategic and tactical activities, internal audit can assist organizations in confronting climate change risks.
Today, audit stakeholders are seeking answers to the basic questions about what climate change risks might impact them and the arrangements in place to mitigate them. Internal audit must adapt to these expectations and demonstrate the “insightful, proactive, and future-focused” characteristics described in The IIA’s Core Principles for the Professional Practice of Internal Auditing.
Internal audit functions that conform to the International Professional Practices Framework should be qualified to audit climate change risks. To supplement their knowledge, The IIA has published the Practice Guide on Evaluating Corporate Social Responsibility/Sustainable Development.
Yet, a worrying trend in audit reports is that many auditors do not see climate change risks beyond financial risks to the business. Some internal audit functions may not include climate change risks in the audit plan because they are not considered a principal risk to the business. For example, according to the KPMG Survey of Corporate Social Responsibility Reporting 2017, 72% of large and midcap companies did not acknowledge the financial risks of climate change. This could be because boards, executives, and internal audit lack understanding of climate change risks and their implications.
In other cases, although internal auditors may consider climate change risks in the audit plan, they may not understand the assumptions and estimates used in preparing the financial statements. Likewise, auditors may not comprehend the implications of climate change risks when applying existing accounting treatments and audit standards. Additionally, standard audit programs may not be helpful in assessing climate change risks, control criteria, and their potential impact. Finally, the audit team may not have climate-change risk specialists to assist the teams in focusing on key areas of concern.
Strategy and Risk Management Insight
Those internal audit functions can’t ignore climate change for long. With these risks looming on the near-horizon, auditors can advise the board and management by promoting accountability in addressing climate change risks.
Internal audit can help ensure the organization is identifying, prioritizing, and remedying key climate change risks appropriately. For example, internal audit can advise on strategies for developing a process to define, monitor, and assess climate change risks. Auditors can ask management about the organization’s resilience and sustainability, as well as audit the organization’s sustainability report.
Another way internal audit can provide value is reviewing whether the business strategy aligns with the applicable regulatory environment. Auditors can facilitate root-cause analysis of potential regulatory noncompliance. Coordinating control self-assessment workshops can identify the areas where the organization’s climate-change response strategy does not align with its business processes.
Internal auditors also should evaluate the financial and strategic implications of climate change risks. While the changes to carbon-free or low-carbon technology could pose potential financial risks, they also could result in opportunities such as alternative technologies, business processes, services, and products.
Internal audit should ensure the organization’s enterprise risk management process includes an appropriate focus on climate change risks. Auditors can assist in developing a granular view of risks that can enable management to create appropriate risk management strategies. In addition, they should evaluate whether management has established benchmarks, metrics, success criteria, key performance indicators, and leading practices.
Where management is reluctant to consider climate change risks, internal audit can help change executives’ attitudes by enhancing their knowledge of the risks and demonstrating how to assess and predict their impacts. In addition, internal auditors who have assisted other organizations in addressing climate change risks can share information and analysis of their experiences and promote the use of tools and systems for these purposes.
The Way Forward
The audit function should understand the climate change risks affecting the organization and be able to add value proactively, timely, and effectively. It is important to assess whether the organization fully grasps the implications of climate change risks. To move forward, internal audit should:
- Develop a consensus with the board and senior management about internal audit’s role.
- Champion a focus on climate change-related risks by participating in the risk analysis process and educating management on the best practices in climate change-related governance, risks, and controls.
- Ensure the audit function has the appropriate skills to evaluate climate change risks and execute related audit engagements.
- Empower audit teams by developing appropriate tools and procedures for assessing climate change risks, capacity building through mentoring and effective onboarding, and including climate experts in the audit teams.
- Incorporate climate change risks into the organization’s risk register and ensure appropriate audit units are contained in the audit universe. The chief audit executive should ensure that the identified risks are embedded in each audit engagement.
Climate change risks impact all of humanity. Consequently, there is much work to be done. The responsibilities of internal audit and the required skills are changing quickly. As a partner in a good governance process, the modern internal audit function can be pivotal in addressing climate change by positioning itself as an agent of change.