What is an ESG audit? What ESG frameworks should be used to guide the ESG audit? How can a company effectively implement an ESG audit? Read our checklist to find out.
ESG / CSR
2024-03-05T00:00:00.000Z
2024-03-05T00:00:00.000Z
en-gb
ESG has become a hot topic, and even if your company isn’t legally required to disclose information falling under the ESG category, it’s definitely in your business’s best interest to do so. This is where an ESG audit comes into play, helping companies to effectively analyse their ESG performance. In this article, we’ll explore what an ESG audit is, what it measures, and how to conduct one.
👉 What is an ESG audit? What ESG frameworks should be used to guide the ESG audit? How can a company effectively implement an ESG audit? Read our checklist to find out.
First up, what is an ESG audit? An ESG Audit is a comprehensive evaluation of a company's practices in relation to environmental, social, and governance (ESG) criteria. It evaluates how a business manages and reports on sustainability and impact across three key areas. These three areas are:
Environmental - This aspect of the ESG audit is all about how a company treats the planet. Does it make an effort to minimise its environmental footprint, or are its operations responsible for lots of greenhouse gas (GHG) emissions and other negative ecological effects? It's an in-depth look at the company’s approach to environmental stewardship, covering everything from resource consumption and waste management to its efforts in combating climate change.
Social - Here, the audit examines the company's relationship with its employees and the wider community. This involves assessing labour practices, employee welfare, customer relations, and the impact on the local and wider society. It's a measure of how the company supports, interacts with, and affects people's lives.
Governance - This component scrutinises the company's internal governance - ie. its decision-making processes, ethical standards, transparency, and accountability. It’s about evaluating how the company conducts itself in the corporate world, its integrity in operations, and its commitment to ethical practices.
The ESG audit is guided by various global frameworks like those from the SASB, TCFD, and GRI, which provide the criteria and benchmarks for assessing a company's ESG performance. The choice of ESG framework can be tailored to fit the industry-specific challenges and the company’s own sustainability goals. Auditors use these standards to ensure that the company's ESG practices are not just for show but are impactful and verifiable.
👉 Learn more about ESG criteria in our article.
Who conducts an ESG audit?
An ESG audit is usually carried out by external auditors or specialised consulting firms with expertise in sustainability and corporate governance, allowing them to objectively assess a company’s ESG practices. In some cases, larger companies may have internal teams dedicated to conducting preliminary ESG assessments, but an external review is often required for impartiality and credibility.
How long does an ESG audit take?
The duration of an ESG audit can vary significantly based on several factors: the size of the company, the complexity of its operations, and the depth of the audit required. For a small to medium-sized enterprise, an ESG audit might take a few weeks to a couple of months. For larger multinational corporations, the process could extend over several months, given the complexity and global reach of their operations.
The legal requirement of ESG audits
The legal requirement for an ESG audit varies by country and region. In some parts of the world - particularly in the European Union - there is an increasing trend towards mandatory ESG reporting and auditing, especially for larger companies. These regulations aim to enhance transparency and accountability in corporate practices. In other regions, ESG audits may still be voluntary but are strongly encouraged due to growing investor and consumer interest in sustainable and ethical business practices.
United States
- Current status - The SEC's proposed landmark rule from March 2022 is pending a final ruling, expected in April 2024.
- Who is impacted - All U.S. listed companies.
- Requirements - The rule, influenced by TCFD recommendations, mandates the disclosure of GHG emissions (Scope 1, 2, and, if material or if there are publicly stated goals, Scope 3), climate-related risks, impacts, and risk management processes in registration statements and annual 10-K filings.
- Implementation timeline - The final ruling, requiring FY25 data, is expected to be implemented in FY26 filings. However, the proposed rule and timeline may undergo changes or revisions.
- Key aspects - Companies must provide a qualitative write-up of climate-related risks, governance, risk management, and climate goals. Additionally, a note to the financial statements will be required to quantify the impact of climate-related events and transition activities.
European Union
- Current status - The EU’s Corporate Sustainability Reporting Directive (CSRD) took effect on January 1, 2024.
- Who is impacted - The CSRD covers large companies (exceeding certain thresholds such as a balance sheet total of €20M, net turnover of €40M, or an average of 250 employees during the financial year) and companies listed on regulated markets.
- Requirements - Compliance with European Sustainability Reporting Standards (ESRS) for annual reporting.
- Implementation timeline - First reporting in 2025 for FY2024 for companies already subject to the Non-Financial Reporting Directive (NFRD); phased implementation for others.
- Key aspects - A “double materiality” requirement covering company impacts and broader community/environmental impacts.
United Kingdom
- Current status - The Companies (Climate-related Financial Disclosure) Regulations 2022 are currently in effect.
- Who is impacted - The regulations apply to over 1,300 large UK-registered companies and financial institutions. Specifically, this includes publicly quoted companies, large private companies, and LLPs meeting certain size criteria such as having more than 500 employees and a turnover of more than £500 million.
- Requirements - Production of a sustainability statement on climate-related disclosures in annual reports.
- Implementation timeline - Applicable for companies with accounting periods starting on or after April 6, 2022.
- Key aspects - Focus on environmental risks, governance, risk management, and integration into broader enterprise risk management strategy.
👉 Learn more about ESG reporting and whether you should be doing it in our article.
Regulations aside, there are a multitude of reasons that companies should undertake an ESG audit. Conducting an ESG audit shouldn’t be viewed as an annoyance but an opportunity, offering companies a number of surprising advantages, including:
- Stakeholder scrutiny - Investors, customers, employees - they're all watching closely. Today’s stakeholders demand transparency and accountability in a company's ESG practices. It's not enough to claim you're sustainable, you've got to show it.
- Spotting the risks - ESG audits help companies identify risks in environmental compliance, social responsibility, and governance areas. Ignoring these could spell trouble for your company.
- Smart business - It's about the long game. ESG audits push companies towards sustainable practices, aligning them with not just ethical but also more profitable futures.
- Regulation alignment - Corporate regulations are increasing across the world, especially when it comes to ESG factors. Audits are key to staying on the right side of these quickly-evolving rules.
- Investors' trust - With ESG investing on the rise ESG audits are a solid investment. They build confidence among investors by showcasing a company's dedication to ethical practices and long-term sustainability.
- Market differentiation - Standing out in today's market isn't just about your product. Strong ESG practices, verified by audits, set companies apart.
- Value creation for the future: We’re talking about long-term value creation. ESG audits aren't just good for the planet and people, they're good for the bottom line.
- Innovation drives progress - ESG audits can spark new strategies and innovative approaches, steering companies towards more sustainable and socially responsible ways of doing business.
Carrying out an ESG audit should be methodical and comprehensive - when conducted properly it has the potential to reveal transformative insights that can bring a range of benefits and opportunities for companies. Let’s walk through the critical steps in the ESG audit process.
Define the scope of the audit
- Identify key areas - The first step is to establish what will fall under the scope of the audit. This means deciding which aspects of ESG - Environmental, Social, and Governance - the audit will focus on. The scope can be fully comprehensive or focused on particular areas depending on the company's size, industry, and specific challenges.
- Set audit objectives - It’s crucial to establish clear objectives. What does the company hope to achieve with this audit? Is it compliance, risk management, improving sustainability practices, or all of the above?
Use an ESG audit checklist
- A structured approach - A checklist is an effective tool to ensure a thorough and systematic audit. This checklist can act as a guide through each stage of the audit process, making sure no critical area is overlooked.
- Customisation - It’s important to remember that this checklist should be adaptable. It should be tailored to suit the specific needs and context of the organisation being audited.
Data collection
- Gather information - This stage is all about collecting relevant data. Auditors need to collect documents, policies, and reports that reflect the company's ESG practices. This could range from environmental impact assessments to records of social responsibility initiatives.
- Engage stakeholders - Interviews and discussions with key personnel, including management and employees, are important. They provide insights beyond documents and data collection.
Data assessment
- Benchmark against standards - The gathered data should be evaluated against selected ESG standards and frameworks. This could include SASB, TCFD, or GRI guidelines, among others.
- Align with company objectives - The audit also evaluates how well the company’s ESG efforts align with its own stated ESG goals and objectives. Are there gaps or areas where the company is dining particularly well?
Reporting and recommendations
- Compile findings - After the assessment, it's time to consolidate the findings into a comprehensive report. This report should detail the audit’s discoveries, highlighting strengths and pinpointing weaknesses.
- Formulate recommendations - The audit should result in actionable recommendations. These suggestions should help the company improve its ESG performance, address identified gaps, and meet both industry standards and internal objectives.
Certification (if applicable)
- Seek endorsement - Whether an audit is conducted internally or by a third party, the company may choose to seek certification from a recognised body as a separate step. This certification is not automatically granted following an audit. Seeking certification from recognised bodies adds an extra layer of credibility to a company’s ESG efforts.
- Understanding the requirements - Certification often has its own set of standards and requirements, which the audit process should have been geared to meet.
When it comes to ESG audits the selection of appropriate criteria and standards plays an important role. There are a variety of global frameworks that offer guidelines and benchmarks essential for an effective audit.
Key ESG auditing standards
- SASB (Sustainability Accounting Standards Board) - Focuses on financially material sustainability information. SASB standards help businesses to identify and report on sustainability issues that most impact financial performance.
- TCFD (Task Force on Climate-Related Financial Disclosures) - Provides a framework for companies to develop more effective climate-related financial disclosures through their existing reporting processes.
- GRI (Global Reporting Initiative) - Offers a comprehensive set of standards for sustainability reporting, covering a wide range of ESG factors. GRI is known for its focus on the impact on the economy, environment, and people.
Importance of selecting the right framework
- Industry-specific relevance - Each industry comes with its unique set of environmental and social challenges. For example, a manufacturing company might be best suited to a framework like the Carbon Disclosure Project (CDP) which focuses on emissions and waste management, whereas a financial services firm may adopt the Global Reporting Initiative (GRI) standards to emphasise employee engagement and diversity. This industry-specific approach ensures the ESG audits are tailored to the particular nuances of each sector.
- Alignment with sustainability objectives - The selection of an ESG framework should closely align with a company's sustainability goals and objectives. This alignment ensures the audit zeroes in on the aspects most crucial and relevant to the company's strategy. For example, a firm focusing on reducing its carbon footprint would benefit more from a framework that emphasises greenhouse gas emissions and energy efficiency.
👉 Find out more about ESG reporting requirements in our blog.
ESG auditing isn’t without its own challenges, but understanding and overcoming these hurdles is key to achieving an effective audit.
Common challenges and solutions
- Complexity of data collection - Gathering comprehensive and accurate ESG data can be challenging. Establishing robust data collection processes and using specialised software can help streamline this step.
- Staying current with standards - ESG standards are continually evolving. Regular training and staying informed about changes in frameworks and regulations are important for staying up to date.
- Evolving standards and expectations - The dynamic nature of ESG factors means that audits must be adaptable to new information and changing stakeholder expectations. ESG standards are continually evolving. Regular training and staying informed about changes in frameworks and regulations will also help you stay up to date.
- Continuous learning and improvement - Auditors and companies alike should view ESG auditing as a journey of continuous learning and improvement, rather than a one-time compliance exercise.
👉 Find out what ESG scores represent in our article on the topic.
At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required.
If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.
