According to audit firm Deloitte, "[i]nformative climate reporting requires a complex transformation of reporting processes, of data collection, education of the finance function, and in many cases, of the audit committee itself. Yet, despite the urgency and magnitude of the task, many boards are hesitating in the face of inconsistent standards, fragmented global standard-setting, and myriad expectations from investors." Just how prepared are companies, their boards and especially their audit committees to deal with climate risk and climate reporting? That's the big question that Deloitte asked 353 audit committee members globally (56% of whom were chairs) in September 2021. The answer? Not so much. According to Deloitte's new report, 42% of respondents indicated that their company's "climate response is not as swift and robust as they would like" and almost half "do not believe that they are well-equipped to fulfil their climate regulatory responsibilities." Deloitte called the responses "sobering."
Deloitte advises that companies should begin to approach climate issues by first "assessing their own environmental risk profiles, establishing mitigation plans to reduce their carbon footprints, and accurately reporting on their progress. With this in mind, audit committees are beginning to address how assumptions about the future should be reflected in financial statements and risk assessments. However, for many, incorporating assumptions about our changing climate into both financial reporting and the data and narrative of non-financial reporting is a daunting task." And it's especially daunting when more than half of audit committee members "do not consider themselves 'climate literate.'"
Audit committees members, Deloitte observed, who are "viewed by shareholders and others as the 'reporting arbiters' at companies, may not be experts in this area-but they rapidly need to become climate literate." What does it mean to be "climate literate"? According to Deloitte, it "implies not only a good understanding of their company's operations and their impact on our planet (including third parties in the value chain) but also a solid understanding of both reporting requirements and emerging standards." Deloitte concluded from responses to its survey that, while not entirely surprising, "much work remains to be done in many of today's boardrooms in order to come to grips with the climate challenge. Climate literacy in the boardroom is patchy and there appears to be a significant reliance on management or outside parties."
While many attribute broad responsibility for climate oversight to the board as a whole, Deloitte observes that audit committees "find themselves in the climate spotlight. They are viewed as responsible for clarity in how companies report climate commitments and measure progress." One audit committee chair cited in the report observed that "[c]orporate reporting on climate and sustainability is increasingly integrated with financial reporting, not only the reports themselves but the reporting process is becoming integrated. The audit committee is taking more and more responsibility for non-financial information."
Audit committee preparedness. In the survey, almost 70% of audit committee members in the Americas reported that their committees do not discuss climate change on a regular basis; only 34% include the topic on their agendas at least once a year. When asked in the survey whether the audit committee was "climate literate," about 50% in the Americas said no (but that does include 7% that had at least one member who carried the load for the committee); only 14% said they all have training or experience. One audit chair commented in the report that he did "not believe that it is simply a matter of placing specialists in the audit committee. Instead, we need to have committee members who have an open eye for what is happening around us and in society." In a commentary in the report, BlackRock's Global Head of Investment Stewardship urged that "[a]ll directors, regardless of committee membership, .have sufficient fluency in climate risk and the energy transition to enable the whole board to provide appropriate oversight of the company's adaptation plan. We look to board directors on committees responsible for climate risk, which may be a dedicated ESG committee-or the risk or audit committee-to ensure appropriate board oversight and careful deliberation of issues." She noted that, last year, BlackRock voted against the re-election of the former Audit Committee Chair and the Governance Committee Chair at a large holding company "over shortfalls in the company's governance practices, climate action planning, and disclosure."
SideBar
In a keynote address in June before the Society for Corporate Governance 2021 National Conference, SEC Commissioner Allison Herren Lee said that addressing climate and other ESG issues requires that boards have "adequate expertise on these subjects." But some research suggests that boards may not have the appropriate level of competence in these areas. To enhance the climate and other ESG competence of boards, boards should consider "integrating ESG considerations into their nominating processes in order to recruit directors that will bring ESG expertise to the board; training and education efforts to enhance board members' expertise on ESG matters; and considering engagement with outside experts to provide advice and guidance to boards." (See this PubCo post.)
It was also about 50-50 in response to the question of whether committee members believed that their companies were "addressing the climate challenge as swiftly and robustly as you would like." And only 46% in the Americas said that they believed their committee had "the information, capabilities, and mandate to fulfill its regulatory responsibilities in relation to climate risks and carbon reduction targets" at their companies.
Climate assessment and reporting. A climate assessment requires the company to analyze how climate change may affect the company's "operations, supply chain, customers and the wider ecosystem" on which it depends to "create enterprise value." When asked about the status of their companies' climate assessments, only 20% in the Americas had even completed an assessment, and only 15% responded that the results of the assessment had been fully reflected in the judgments and estimates in the financial statements; 62% had not yet finalized their climate assessments but believed there would be no material impact.
Scope 3 GHG emissions. In the Americas, only 26% of respondents said they were reporting or planning to report Scope 3 emissions as part of their TCFD disclosures. Companies that were planning to report Scope 3 identified as the biggest challenges the ambiguity of measurement standards (92%), lack of robust information from the value chain (85%), lack of clear parameters to define Scope 3 emissions (77%), lack of understanding of the perceived value of this information (62%) and lack of co-operation from the parties in the value chain (46%). Deloitte observes that, while the entire task of addressing climate is enormous, "Scope 3 GHG emissions are significantly more difficult to quantify than those in Scope 1 or 2." However, Deloitte asserts, given that "Scope 3 emissions are likely to be the most material part of a company's carbon footprint, companies need to get more comfortable with preparing and exchanging information to facilitate greenhouse gas reporting in the value chain."
Audit committee responsibilities. While the audit committee has substantial responsibility for corporate reporting in general, respondents views varied as to the responsibility of the audit committee for climate-related matters. In the survey for the Americas, 63% said that the audit committee has risk management oversight responsibility for the effectiveness of the processes for identification and assessment of climate-related risks, but only just over half identified corporate reporting oversight responsibility for the front half of the annual report, the integrity of narrative reporting on climate risks and opportunities (such as TCFD disclosures and risks and uncertainties), and the impact of climate risks and opportunities in the financial statements (including judgments and estimates in valuations and impairments). Another responsibility identified by 53% was oversight of the approach taken by the external auditor to identifying and responding to climate-change related financial statement risks. Only 42% named oversight of the effectiveness, independence and objectivity of assurance obtained over climate-related information and disclosure as among audit committee responsibilities.
Management and the board. In terms of who has overall responsibility for sustainability and climate, 68% of respondents in the Americas pointed to the CEO, which, Deloitte concluded, "provides the board with the opportunity for the alignment of corporate strategy with carbon reduction targets, as well as the alignment of incentives to deliver these." At the board level, 54% said that the board as whole has overall responsibility; 13% pointed to the risk committee and only 9% to the audit committee. Deloitte suggests that "[m]any directors are now considering climate impacts when reviewing operational performance, budgets, forecasts, capital expenditure, and mergers and acquisitions - and many companies are also now prioritizing climate impacts when reshaping stressed supply chains. Traditional procurement functions, still focused on price and quality, will now include carbon as a decision criterion."
SideBar
In her keynote address referenced above, Commissioner Lee discussed the challenges boards face in oversight of climate change and other ESG matters. Powerful signals from stakeholders during the last proxy season, she said, underline the "ever greater responsibility on companies, and therefore boards, to integrate climate and ESG into their decision-making, risk management, compensation, and corporate transparency initiatives."
Boards clearly have a role to play on climate, she said. For example, she suggested, there is "broad consensus regarding the physical and transition risks associated with climate." Because the largest asset managers and other institutional investors view climate and other ESG to be "material to their decision-making,. boards increasingly have oversight obligations related to climate and ESG risks-identification, assessment, decision-making, and disclosure of such risks." Board's oversight obligations "flow from both the federal securities laws and fiduciary duties rooted in state law." The board plays a "critical and mandatory role" under the federal securities laws in connection with oversight of the financial statements, which is evident from SOX requirements, as well as Exchange rules and PCAOB requirements. Climate change, Lee asserted, "may bear on the valuation of assets, inventory, supply chain, and future cash flows," making engagement on those issues increasingly a part of board oversight of audits. (See this PubCo post.)
Identified challenges. In their oversight of climate change, audit committee members pointed to a number of significant challenges. Most often, respondents named having "a clear [and] agreed carbon reduction strategy, an action plan with milestones, and a way to hold management accountable for it (65%); 46% identified poor data and lack of accurate and complete management information. In overseeing climate change in relation to the external environment, 60% said that the lack of common global reporting standards was the biggest challenge, followed by the constantly moving reporting and regulatory landscape, the need for broad coalitions to achieve progress and the lack of clarity and consensus as to how best to approach the issue, all three at 46%. One commentator observed that the voluntary nature of current reporting has led to a "proliferation of multiple reporting frameworks, resulting in companies producing inconsistent and incomparable information and, in some cases, applying reporting frameworks selectively." Audit committees, he said, play a key role ensuring information quality and comparability, as well as whether information satisfies "the standards of financial information. Audit Committee Chairs should promote reporting quality and therefore assess the relevance and reliability of sustainability information for the benefit of shareholders, as well as compliance against applicable regulations and requirements. Furthermore, they should be ready to challenge the ESG metrics and methodologies used, scrutinize gaps in data and ensure the assurance process is of high quality."
Recommendations. The surveyed audit committee members have a number of recommendations for other audit committees, including, in the Americas, more education on climate (89%), internal alignment around the company's climate strategy (77%), ensuring good management information (75%), publishing a plan on the company's position on climate for investors (68%) and having a dedicated internal resource (64%). Interestingly, only 45% recommended appointing new board members with climate expertise.
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