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ESG Disclosure: How Can External Assurance Help Build Trust?

Trust makes the economy go ’round.

There is a very good reason why financial statements must be audited by an external auditor: Because it builds trust.

Sustainability and environmental, social, and governance (ESG) reporting is moreover undergoing external warranty in order to nurture trust. Ninety-one percent of 1,400 companies wideness 22 jurisdictions report some level of sustainability information and 51% offer some level of assurance. That’s equal to “The State of Play in Sustainability Assurance,” a recent report from the International Federation of Accountants (IFAC) and the Association of International Certified Professional Accountants.

The question is, How can ESG warranty build trust in ESG disclosures when the external audit, the most wide form of assurance, is struggling with a trust deficit? Or will ESG warranty replicate the same mistakes and wilt old wine in a new bottle?

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It wasn’t long ago that tween a spate of corporate scandals, The Financial Times made it official: “Regulators, investors and the wider public have lost conviction in the inspect market.” It was whimsically the first time such audit-related declarations had been made and it likely won’t be the last. But for ESG assurance, many are looking vastitude traditional inspect firms for the necessary verifications.

That said, while engaging nontraditional warranty providers is a good step, it may not be good enough. After all, external warranty features many of the same stakeholders as external auditing — the reporting companies and investors, for example — and sustainability and ESG investing once squatter fierce criticism for so-called greenwashing. Therefore, to stave a replay of the conviction slipperiness in external audit, ESG warranty must orchestration a variegated path.

Unlike written and auditing matters, ESG issues are diverse. Disclosure and warranty are mostly voluntary and have lots of seated flexibility. A visitor with versicolor sustainability issues and multiple locations may pick and segregate among the issues and geographies it reports on. Indeed, some firms may segregate not to report on unrepealable criteria or locations. Yet sustainability reporting is hair-trigger at a local level.

The 2020 Sustainability Governance Scorecard covers the sustainability leaders featured in one or increasingly sustainability indexes wideness 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 sparkling and still beverages of Coca-Cola products for Azerbaijan, Iraq, Jordan, Kazakhstan, Kyrgyzstan, Pakistan, Syria, Tajikistan, Turkmenistan, Uzbekistan, and Turkey, where it is based. 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 warranty on its water and energy usage, among other issues.

The 2020 report and older CCI sustainability reports refer to variegated frameworks and standards, such as the Global Reporting Initiative, the United Nations Global Compact, and United Nations Women Empowerment Program, AA1000, ISAE 3000, and so on. Warranty provider reports tend to requite “limited assurance” and state that nothing has arisen to suggest that the selected information is not presented, in all material aspects, “in vibrations with CCI’s internally ripened reporting criteria.”

Ad for Sustainable, Responsible, and Impact Investing and Islamic Finance: Similarities and Differences

External inspect is variegated from sustainability assurance. There is nothing to pick and segregate among: Reporting criteria is definitive and mandatory. CCI’s 2020 auditor’s report unmistakably states that the consolidated financial statements were prepared in trueness to the Turkish Capital Markets Board’s written standards. It attests that the inspect was conducted in vibrations with the workable auditing standards and that the consolidated financial information is “fairly presented in all material respects.”

Robust global standards are required to make ESG and sustainability reports comparable within and wideness jurisdictions. Sadly, the minutiae of such standards has lasted the largest 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 Future of Sustainability Assurance” report from the Association of Chartered Certified Accountants (ACCA) highlighted the need for “a complementary set of Generally Accepted Written Principles for Sustainability (GAAPS) and Generally Accepted Warranty Standards for Sustainability (GAASS).” Fast-forward to 2021 and we’ve seen the megacosm of the International Sustainability Standards Workbench (ISSB) with much increasingly work still to be done.

We at SustainFinance believe the current moment is a once-in-a-lifetime opportunity to set ESG warranty on the right course. As it evolves and catches up with external audit, ESG warranty needs to succeed the pursuit four tasks, to stave creating a trust deficit like the one that now plagues external audit.

1. ESG warranty must maintain its independence.

The consensus is clear: Independence is the cornerstone of external assurance. But the inspect practice has created its own concept of independence that is not so intuitive. Can the auditor truly be self-sustaining of the entity that appoints it, pays it, refers merchantry to it, and, potentially, fires it? The obvious answer: Not really. Of course, the auditor’s wordplay has long been, Why not?

2. ESG warranty must go vastitude offering audit-like vanilla opinions.

It took the inspect practice the global financial slipperiness (GFC) and a very long time to come up with a discussion of key inspect matters in the auditor’s report. ESG warranty providers would do well to offer commentary on key warranty matters right away.

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3. ESG warranty must demand that management stand by its sustainability reports.

These reports need to be accompanied by a self-confirmation letter signed by the CEO as well as the relevant workbench committee members declaring that the report contains material truth, the whole truth, and nothing but the truth.

4. ESG warranty providers should be ready and willing to submit to regulatory oversight.

Unlike external audit, ESG warranty need not go through the prolonged and failed experiment of self-regulation. When stakeholders ask who audits the auditor, the wordplay from those who offer ESG warranty should be an self-sustaining regulator, which may be the same as the pre-existing inspect regulator.

In short, to build sustainable trust — an would-be task in any context — ESG warranty must replicate the knowledge and wits of external inspect while lamister its pitfalls.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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Professional Learning for CFA Institute Members

CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits hands using their online PL tracker.

Usman Hayat, CFA

Usman Hayat, CFA, writes well-nigh sustainable, responsible, and impact investing and Islamic finance. He is the lead tragedian of “Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals;” the literature review, “Islamic Finance: Ethics, Concepts, Practice;” and the research report “Sustainable, Responsible, and Impact Investing and Islamic Finance: Similarities and Differences.” He is interested in online learning and has directed three e-courses for CFA Institute: “ESG-100,” “Islamic Finance Quiz,” and “Residual Income Equity Valuation.” The other topics he writes well-nigh are macroeconomics and behavioral finance. He has wits working in securities regulation and as an self-sustaining consultant. His qualifications include the CFA charter, the FRM designation, an MBA, and an MA in minutiae economics. He has served as a content director at CFA Institute. He is a former executive director at the Securities and Exchange Commission of Pakistan (SECP) and former CEO of the Inspect Oversight Workbench (Pakistan). His personal interests include reading and hiking.

Kübra Koldemir

Kübra Koldemir is a sustainability merchantry writer at SustainFinance as well as a sustainability researcher at Argüden Governance Academy. She has written numerous sustainability wares that have been published at various global publications. Koldemir started her financial career in 2006 working as an investment reviewer in New York City, first at a long-only fund and later at a hedge fund with $1 billion in resources under management (AUM) that specialized in financial service companies. With a focus on international investments, she assessed strategy and results of numerous multinational corporations wideness several sectors. Koldemir holds a BA in international relations from Mount Holyoke College and an executive MBA stratum from the University of Texas at Austin.

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