Regulators look to beef up sustainability assurance

New measures about the assurance of ESG reporting aim at ensuring its credibility and will affect the provision of auditing services in the EU and UK.

Regulators and policymakers are moving ahead with measures to legislate the assurance of environmental, social and governance reporting, to ensure its credibility and reliability. And the subsequent demand for assurance has led to auditing companies undergoing both an expansion and a revamp.

The EU has introduced mandatory assurance requirements under its Corporate Sustainability Reporting Directive. Meanwhile, the UK has had plans for an overhaul of its audit regime since 2019 when it proposed the creation of a new audit regulator, the Audit, Reporting and Governance Authority, to replace the current Financial Reporting Council.

The UK move was spurred by several financial audit scandals, including the collapse of construction company Carillion and high street cafe chain Patisserie Valerie. 

While UK legislation is delayed, the FRC has recently opened a consultation on updates to its 2018 corporate governance code, which include the introduction of assurance for sustainability information.

Andromeda Wood, vice president of regulatory strategy at software reporting platform Workiva, notes: “With the [UK] code applying on a ‘comply or explain basis’ and language such as ‘appropriate assurance’ and ‘assurance where necessary’ used in the consultation, a lot will depend on the regulator and investors.” 

The UK government’s latest update from May 2022 confirmed proposals for companies to implement an audit and assurance policy every three years – disclosing if and how the entity assures non-financial reporting – as well as a statement on how the entity prevents and detects material fraud.

“It will be up to the audit and assurance policy to decide whether companies need to commission external assurance, as well as the level of assurance that is required,” says Marijn van Diessen, a former McKinsey partner and now the chief commercial officer of STX, a company that trades biofuels and carbon offsets.

Mandatory approach

By contrast with the UK, the EU’s approach is mandatory and has a broader reach, with an estimated 50,000 companies operating in Europe having to comply.

Wood says: “In the EU, the CSRD has a defined roadmap moving from limited assurance to reasonable assurance in time and the language reflects the more prescriptive nature of the regime: ‘shall’ being a frequently used word.”

With the UK approach currently voluntary compared to the EU’s mandatory law, Van Diessen notes the EU regime could be seen as having more teeth. However, given that the mandatory level of assurance under CSRD is limited (at least in the initial phase), he anticipates that UK companies complying with the code – and voluntarily choosing to have an external audit to a reasonable assurance level – will actually be subject to greater scrutiny. 

Furthermore, Van Diessen warns there have been some concerns from market participants that sustainability reporting audits might focus too much on backward-looking indicators. Still, since the CSRD places a considerable emphasis on climate-related targets as well as transition planning, he says it should even out the balance between forward and backward-looking indicators.

However, he stresses that assurance does not provide any guarantee on outcomes, but “only provides assurance that information is properly prepared in line with the correct reporting standards and is based on reasonable assumptions”. 

Wood at Workiva agrees there are limits to the power of assurance, and she adds that assurance standards for sustainability information are still being drafted and will take time to mature.

Ongoing issues

Under CSRD rules, member states can allow for assurance assessments to be carried out by companies other than the traditional auditing firms. Eric Baudrier, director general of France’s High Council of Statutory Auditors, previously told Sustainable Views that combining the supervision of traditional audit firms with that of independent assurance service providers would be a “very big challenge”.

Another frequently debated issue related to non-financial audits is the skillset required to assess sustainability information. Both Van Diessen and Wood say that increasingly investors are requesting assurance checks as part of their own due diligence assessments. However, the professional skillset required for these tasks is still being defined.

Van Diessen adds that finding an auditor with sufficient experience can be difficult: “As the majority of sustainability directors are recent appointments, many of them don’t have much experience built up on the complexity of sustainability matters.” 

Wood says business leaders should also look beyond compliance when dealing with sustainability reporting, as it can enhance their organisation’s reputation, strengthen relationships with stakeholders, and provide a competitive advantage. 

Though different disclosure regimes might further complicate the auditing of non-financial information, the investment community is seeking reassurance that companies are delivering on their ESG commitments, which ultimately must come from a credible audit sector.