Environmental, social, and governance (ESG) counts a company’s sustainability and social impact using metrics of interest to investors and stakeholders. ESG disclosure and reporting are now key factors in assessing business sustainability and auditing. The COVID-19 pandemic has sparked global interest in various forms of ESG reporting as stakeholders demand more ESG information and transparency from companies.

Businesses are now generally aware that they are socially and environmentally sustainable. If these two key elements are not considered in the overall governance of the business, future operations may not be able to continue. In addition, many companies and investors worldwide are increasingly considering financial returns after auditing and the sustainability of those returns within ESG (non-financial factors) to assess company performance. Therefore, companies must integrate ESG into their operations and regularly communicate ESG initiatives and their impact to various stakeholders. Many governments worldwide are also integrating ESG into public policy. As part of the long-term strategies of public corporations – this sets the “tone” for the country, followed closely by the private sector.

ESG – Background and Development

ESG disclosure and Audit Firms In Dubai reporting stems from environmental, health, safety, and corporate social responsibility (CSR) regulations. Before ESG, organizations were primarily concerned with CSR. ESG builds on the accountability of corporate social responsibility to stakeholders by providing quantifiable indicators that can be measured, monitored, and disclosed to stakeholders regularly.

Investors use ESG to evaluate and review a company’s performance regarding key environmental, social, and governance factors affecting financial performance. The non-disclosure of these factors mainly comes from the analysis of financial information.

Environmental Aspects – Describes the impact of the company’s operations on the environment and how the company demonstrates concern for the environment. This may be reflected in the company’s environmental management system and its mitigation plans for risks that may harm the environment, such as energy consumption, water use, waste generation and discharge management, biodiversity, and environmental pollution.

Social Factors – Refers to how a company manages its relationships with internal (employees) and external (suppliers and communities) stakeholders and how it creates value for these stakeholders. Investors will likely focus on companies’ attitudes towards their employees – diversity, well-being, human rights, customer protection, supply chain, anti-bribery and corruption, supply chain management, health and safety, and data privacy.

Governance factors—refer to the company’s leadership and management philosophy, practices, tone at the top, policies and shareholder rights, internal controls, and compensation. This is reflected in an appropriate corporate governance framework that supports transparency and long-term success, including board oversight of ESG and related reporting standards.

Auditing Environmental, Social, and Governance (ESG) Practices In Audit Firm

Financial institutions are key in financing the fight against climate change, challenging and promoting ESG best practices, and supporting organizations in achieving the United Nations Sustainable Development Goals (UN SDGs). The banking industry is facing increasing pressure from stakeholders and increasing regulations to consider and integrate ESG into the way financial institutions operate. In a 2021 global survey, 75% of chief financial services (FS) CEOs want to maintain the sustainability and climate change gains made during the crisis, and 34% plan to use Proceeds are used to invest in sustainability efforts—their own.

As ESG becomes a key success factor for financial institutions, extensive consideration, and adjustment may be required:

Know your current baseline.

This involves more than simply identifying financial risks and possibilities. Financial institutions should understand the common ESG expectations of key stakeholders, including regulators, and build awareness of leading ESG practices, current expectations, and emerging areas, especially among senior management and board members. This includes taking the time to understand their current practices and risks, including whether they have the right data and technology, the right capabilities, and the right processes to monitor and manage ESG going forward properly.

Develop/improve ESG strategies, frameworks, and products.

Once ESG sentiment and expectations are understood, they should be used to improve strategy, operating frameworks, and products for compliance and to create a competitive advantage. An ESG strategy should define the organization’s goals, focus areas, auditing, and goals, and the operating framework should facilitate decisions about who to lend to and invest in. Financial institutions are increasingly adopting the Principles of Responsible Banking and the Principles for Responsible Investment (PRI), as outlined in the UNEP Finance Initiative.

Improved governance framework

Governance frameworks must be adjusted to ensure ESG (especially climate) is a board-level consideration, ESG committees established with the necessary climate expertise to auditing and evaluate projects and support ESG decision-making, and ESG teams established to oversee and manage ESG within an organization. Furthermore, to ensure accountability, best practice includes incorporating ESG into role descriptions and performance evaluations where appropriate and including ESG at the board level as one of the key performance indicators related to director compensation.

Define risks and framework.

Many financial institutions worry they must prepare for the various prudential, auditing and conduct risks that may arise from climate risks and the transition to a low-carbon economy. ESG factors remain a reputational risk for many, but they must be more than that. Financial institutions must ensure that ESG risk is the basis for all decisions, especially regarding credit and valuation risk in their portfolios. Risk frameworks must be adapted to achieve this.

Report

Through audits of financial institutions (a regulatory requirement in some jurisdictions), many financial institutions produce reports to communicate ESG performance to the market. In most cases, this has only involved reporting internal ESG performance. Still, there is increasing market pressure for financial institutions to see the impact of investment reporting, thereby improving the ESG performance of the assets they invest in and fund.

Emphasize

With more than $40.5 trillion in assets worldwide using ESG data to guide decision-making, the need for assurance that considers the credibility of the information produced is more important than ever. While few regulations globally require guarantees, many organizations recognize the need and opt for voluntary guarantees. Fully integrating ESG not only increases the resilience of financial institutions but also increases stakeholder value by providing stakeholders with broader capital pools and tangible debt pricing benefits if they can demonstrate positive ESG impacts.

Developed regulatory environment

72% of 18 global banks say climate change is a financial risk that will affect their business in the medium to long term. As a result, international regulators auditing and plan to stress test banks and climate risk management. These can include stress testing to identify operational and credit risks to forecast balance sheet development and related losses over the years. Organizations must also take advantage of weather stress testing capabilities as requirements become more stringent.

Also, seeking consistency remains a priority. Key to achieving this goal and developing reliable market data is a globally consistent definition of E, S, and G. Recognizing the challenges companies face in disclosing ESG, standard-setting bodies seek to improve and harmonize their approaches to corporate reporting, both financial and non-financial. The emergence of mechanisms that drive alignment, such as the WEF (World Economic Forum) Stakeholder Capital Indicator and the recently established International Sustainability Standards Board (ISSB), are expected to bring some degree of alignment in the coming years.

Final Thoughts 

Within the UAE, however, the lack of formal oversight by the central bank and regulators means that many UAE-specific financial institutions only consider ESG (including weather) sufficiently if individual banks are linked to international regulators that enforce these areas. However, with the UAE setting a net-zero emissions target and the region hosting COP28 (Abu Dhabi 2023), the competitive and regulatory landscape is expected to change dramatically over the next few years, more or less on par with international markets. This allows UAE financial institutions to be the first movers in the region, securing a competitive edge.