Under Climate Pressure, CFOs and Audit Committees Have a Chance to Shine

Ross Pounds

With net zero goals, heightened investor scrutiny and a growing awareness of climate change as an existential threat, the pressure is on for corporations to provide more detailed reporting on climate impact and action. For audit committees on the board side and CFOs on the management side, it’s a golden opportunity to step in, help and utilize their existing oversight roles, comfort level with granular detail and familiarity with applying scrutiny, challenging assumptions and reporting outcomes.

Joyce Cacho explored this topic as part of the Climate Leadership Certification Program’s ‘Structuring Oversight’ session, lending her insights as an independent board director with Sunrise Banks, NA, the World Benchmarking Alliance and the Institute of Tropical Agriculture. Here we explore the topic further, with next steps for audit committees, CFOs and corporate boards.

A pressing gap in today’s climate reporting and oversight

“Climate change has emerged as a central and existential risk for organizations—and fertile and critical ground for innovation. Yet new Deloitte research shows that many audit committees, an essential bulwark in helping companies manage and respond to risks and opportunities, haven’t yet sufficiently placed climate change initiatives at the core of their agendas.”

-Deloitte

At the end of 2021, the Deloitte Boardroom Program surveyed more than 350 audit committee members in 40 countries about climate oversight:

  • 70% said they have not completed an assessment of how climate change will affect their company’s operations, supply chain and customers
  • Nearly 60% said they don’t regularly discuss climate change during meetings
  • Nearly half said they lack the basic climate literacy for informed decisions

In fact, a recent blog post by the National Association of Corporate Directors reported that only 10%of audit committees today have oversight responsibility for ESG reporting.

Amid these gaps lies great opportunity. While SEC compliance and Scope 3 emissions may seem worlds apart in spirit, climate’s connection to risk makes it well-suited for audit oversight, much as cyber risk has made technological security well-placed on the audit committee’s agenda in recent years.

As for the CFO on the management side, growing acknowledgement of climate’s direct and indirect financial impacts makes it an ideal oversight opportunity for this executive role. Picture this hypothetical scenario, for example. The CFO can use a framework like the Task Force for Climate-Related Financial Disclosures (TCFD) to not only review financial performance, but also conduct a materiality assessment and highlight opportunities for the senior management team and board: future cost savings, capital allocation that positions the company for future growth and beyond.

A natural extension of existing roles and responsibilities

“How should companies that aim to be good corporate citizens identify relevant components of EESG (Employee, Environmental, Social and Governance) ? How does EESG align with existing Caremark compliance efforts? How should we think about incorporating EESG oversight into the board’s organizational structure? Is this another job for the already burdened audit committee?” Cydney Posner inquires in the Cooley PubCo blog of international law firm Cooley LLC.

We believe the answer to Posner’s final question is yes — with a reassuring caveat to busy board members. Audit committees are critically important to effective climate governance. Yet climate oversight in many ways is an extension of their existing role and responsibilities, rather than an entirely new job.

For example, the audit committee’s detailed scrutiny and oversight of financial reporting, including the company’s financial statements, gives it a key role in how the company communicates strategies and financial results to investors, regulators, and other stakeholders. Both of these roles make the audit committee a powerful potential contributor to oversight of strategic planning, business planning and risk management.

Harnessing the audit committee’s climate potential

Bringing this potential to life requires structured processes and best practices. Specific to audit and risk assurance committees (ARACs), the UK National Audit Office has developed a Good Practices Guide. The guide covers steps from risk identification and assessment through monitoring, reporting and continuous improvement and offers recommendations for governance and leadership — for example:

“The accounting officer is responsible for setting the overall approach in relation to climate change,” the guide advises. “The ARAC supports and advises the board and the accounting officer in their responsibilities over climate-related risk management. Crucially, the organization’s governance and leadership must be dynamic in supporting the identification and emergence of significant risks such as climate change.”

The Canadian Climate Law Initiative (CCLI) offers more best practices in “Audit Committees and Effective Climate Governance: A Guide for Boards of Directors.”

  • Consider the full spectrum of climate-related risks, including technological, regulatory, social, litigation and market risk
  • Scrutinize and challenge materiality: “Climate risks may be significant even if the directors do not think they are, and it is important to remember that significance and materiality are assessed from a stakeholder’s perspective,” the CCLI guide cautions
  • Move reporting beyond rote exercises and generic disclosures: “Companies must ensure that public disclosure meaningfully reflects their estimate of climate-related regulatory, physical and operational trends and uncertainties.”

Next steps for getting started

How can the audit committee and CFO become more deeply involved in overseeing climate planning, accountability and use of the right metrics, KPIs and incentives?

PwC offers an audit committee climate reporting checklist, with many recommendations dovetailing with those of the UK National Audit Office’s Good Practices Guide. Some first steps:

  • Evaluate the board’s existing capacity for climate oversight
  • Assign clear roles and responsibilities, and make sure a strong knowledge base exists for assessing climate risks and their strategic and financial impacts
  • Leverage external expertise and education if needed
  • Establish a clear process for keeping the committee up to date about climate considerations — for example, how investors and other providers of capital are factoring climate risks into their investment decisions

With a foundation of knowledge and structure in place, the audit committee will be ready for detailed, rigorous discussions with the CFO and other top management, starting with questions to achieve a baseline level of understanding.

Assessing climate risk:

  • Is climate change integrated into core risk management systems?
  • What does the risk assessment process look like? How is it documented and kept up to date?
  • Do risk assessments span the full value chain, upstream and downstream, from the company’s direct climate impact to use of the company’s products and services?
  • Do assessments consider short-, medium- and long-term impact?
  • How does the organization define material risk?

Reporting and disclosures:

  • What are the company’s key climate change commitments and targets?
  • Does your company appropriately acknowledge and disclose these targets and its responses, with scenario analyses as needed?
  • Is the level of climate-related disclosure proportionate to the level of risks and opportunities?

Integration of climate throughout the enterprise:

  • Is climate factored in to your organization’s business model and strategic plans? What about accounting assumptions and estimates — e.g., impairment testing, depreciation rates, asset decommissioning and situations requiring cash flow forecasts?
  • Does climate play a role in compensation and incentives, with robust key performance indicators?

To keep evaluations, conversations and insights moving productively forward, audit committees and CFOs can draw priorities from a recent article by the Harvard Law Forum for Corporate Governance. The article recommends that companies focus on:

  • Climate change’s impact on risks, including physical risk, liability risks and the risk of transitioning business operations due to climate
  • Climate change’s impact on opportunities and innovation
  • Requirements for transitioning to a low-carbon economy
  • Financing and investment needs
  • Sector-specific trends and impact, plus the competitor and industry landscape related to climate

Finally, the audit committee and CFO must keep close tabs on the company’s climate reporting strategy, from voluntary and required disclosures to channels of reporting such as the proxy statement and company website. Is climate data accurate and supported by the right systems, processes and controls? Is there value of assurance? Finally, is the company owning the narrative, with clear measures of accountability and progress?

As climate continues to rise to the top of the corporate agenda, the urgency opens an opportunity for audit committees and CFOs to reveal their commitment and expertise, with a long eye toward innovation, resilience and growth.

Diligent’s Climate Leadership Certificate Program

Diligent’s newly launched Climate Leadership Certificate Program gives directors a competitive edge on climate risk and strategy – for themselves and for their companies.

Hear from leading experts in the field, participate in in-depth case studies and learn what your peers are doing around climate oversight and strategy. To learn more, watch our latest Inside America’s Boardrooms episode with Dottie Schindlinger, Diligent Institute’s Executive Director, and register at the link below.

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Ross Pounds
Ross Pounds is a Content Marketing Manager at Diligent. Based in the UK and a graduate of the University of Warwick, he has worked as a journalist and across a variety of industries in both corporate and early stage environments, and specializes in long-form content and broader content strategy. Ross has'a particular interest in ESG and pre-IPO companies.