Internal audit and climate change: Bigger than Covid?
Times of plague leave a mark on human history, as we see in the books, paintings and histories by those who survived earlier pestilences. However, as we know from previous pandemics, coronavirus will pass. By contrast, the destruction we are wreaking on our environment and ecosystems is becoming clearer and, continuing life as normal will unleash more of the four horsemen of the Apocalypse than COVID-19. We need to act now to keep them at bay.
Fires are raging from the Siberian tundra to the Amazon rainforest, ice caps are melting, coral reefs are bleached and dead, species are going extinct at an unprecedented rate and the global thermometer edges ever higher. We can already see the damage – and the escalating risks. However, the coronavirus pandemic gives us reasons for hope.
COVID-19 has been a catastrophe, however, it has also shone a light on the best that humans can be: collaborative, empathetic, imaginative, resourceful, creative and industrious. There is still much we can do to combat the risks of climate change. Businesses have a huge part to play – and internal auditors can make a major contribution within their businesses, from scanning the horizon for emerging risks and raising the alarm at board level to offering assurance on emissions claims and highlighting opportunities.
Talk about the R number
For a start, internal audit should make sure that senior executives recognise and understand the business risks. COVID-19 has offered useful lessons, not least what it means to experience exponential growth. As Robert Muir-Wood, vice-chair of the OECD High Level Advisory Board of the International Network on the Financial Management of Large Scale Catastrophes, told the Chartered IIA’s Internal Audit 2020 conference: “For many people, the COVID-19 pandemic has been their first encounter with exponential growth and what it means. Exponential growth in biological terms means that the cause of production increases constantly and the “R” number provided a clear demonstration of this in practice.”
For Muir-Wood, this was one of the extraordinary features of lockdown. “Who else has recent experience of exponential growth – only those exposed to hyper-inflation or unimpeded biological expansion, for example weed on some lakes,” he said. “Now we’ve all been exposed to it.”
He advised businesses to consider the implications for climate change – what “R” numbers are there in climate change issues and what could this mean? Where are the feedback loops that could lead to exponential growth? Melting permafrost in Siberia caused by forest fires releases methane into the atmosphere, accelerating warming. Melting ice from Greenland’s ice shelf and from the Arctic Ocean raises sea levels and warms the water causing more ice to melt. The cumulative impact of species extinction also has an exponential element.
The R numbers of climate change could, Muir-Wood suggested, be a starting point for internal auditors to broach a conversation about the potential risks for business. The urgency of mitigating actions will vary depending on whether you are looking at, say, insurance or investments, or at business planning.
“The uncertainty of the answers will increase as we look further into the future and we need to get used to operating within this uncertainty and factoring it into our cost benefit analyses,” he told delegates at the conference.
Tipping points are already being crossed. In the US, high tides are flooding Miami streets, while California is seeing more frequent and devastating wildfires. Around the world, businesses need to look at what climate change is already doing to their operations, customers, employees and products.
The COVID-19 effect
COVID-19 has provided stark reminders about the effects of sudden change as investments in cruise liners, the business districts of cities, shopping malls and jumbo jets have plummeted. What products and assets will be worthless if climate change projections materialise?
However the pandemic has also shown us how people can respond in a crisis, and businesses and governments should seize the opportunity to ensure that shifts that alleviate environmental risks are developed further. Examples include initiatives to reduce road traffic and increase cycling, provisions for more people to work frequently from home and fewer business flights.
In addition, while many sectors suffered, others saw a boom – according to Rapid Transition Alliance, a network run by a group of bodies including Sussex University to promote and share positive stories of action on climate change, Brompton, the UK’s largest bike manufacturer, enjoyed a five-fold increase in online sales between April and May and Halfords’ share price rose by 23 per cent.
We should be encouraged by the ways in which people have collaborated to overcome urgent problems caused by COVID-19. We must hold on to this energy and this commitment to radical ideas and rapid action.
Positive action
Pressure for change is already being applied by external sources such as insurance companies and governments. Internal auditors need to scan the horizon constantly for emerging and evolving risks and the course of direction is clear. Recent research by Deloitte found that over 90 per cent of audit committee chairs want to see internal audit focus more on new and emerging risks. Any organisation that is not watching for forthcoming environmental regulations in any jurisdiction in which it operates will be exposed to reputational, financial and operational risks.
“Assurance is vital here,” warns Mark Peters, managing director of global consultancy Protiviti. “Whether you are looking at annual reports, market reports or disclosures about your organisation’s carbon footprint, you need to be able to attest to the statements you are making. Internal audit can play a key role in providing assurance over the mechanisms that provide evidence of an organisation’s footprint.”
Demands for organisations to be more accountable and to take more responsibility for their environmental impact will increase, he adds. “The environment and climate change may struggle for management time and attention at the moment because of the demands of COVID-19 and economic recession, however the internal audit function must play an important role in identifying environmental risks that need management attention and potential gaps in assurance – and many organisations are not sufficiently focused on this at the moment.
This warning is supported by evidence in the Chartered IIA’s new report on climate change – “Organisations’ preparedness for climate change – an internal audit perspective” (published this month, see box on page 29). Over half of respondents reported doing very limited or no work related to climate change and more than half said they had not yet discussed climate change with their audit committee chair.
Helen Clarkson, CEO of the Climate Group, advises auditors to look ahead at what net zero will look like in the UK – and what this means to their business and their sector. “By 2050, the only industries we should have left that may still have a carbon footprint are cement and aviation,” she says. “Everything that currently uses oil and gas will have to be powered by renewables and the big issue is when will the large energy companies stop exploring for more fossil fuels. Heavy industry is adapting, but other areas of the economy must be more nimble and move much faster.”
It’s also worth remembering that this is a global phenomenon and the actions of others could accelerate change far faster than expected. “The market can take a while to move, but then will suddenly shift extremely fast if the right pressure builds,” Clarkson points out. “Once supply rises, prices fall and a tipping point is reached.” If your competitors are already doing something that you are not, or you are using obsolete technology, your business will suffer.
So COVID-19 is not a reason to avoid climate change issues or to postpone them to next year. The pandemic is a wake-up call and an example of what we can do if we see the need. Climate change is an urgent need and we must all understand what we can do together before we reach a crisis that is worse than coronavirus.
What to do now
Turn down the heat
A 2012 study commissioned by the Department for Energy and Climate Change found that lowering the thermostat from 20°C to 18°C across the British housing stock would save the equivalent of 33 TWh of electricity (about two-thirds of Portugal’s domestic electricity consumption in 2019).
Electrify your fleet
Ikea and Tesco, among others, have done this. Corporate fleets account for more than 50 per cent of new vehicles on the road each year, according to Helen Clarkson at the Climate Group. The lifetime cost of an electric vehicle engine is already cheaper than that of a combustion engine, although upfront costs are higher, she adds. Leasing company Lease Plan has also committed to electric vehicles.
Innovate with waste
Dairy cooperative Arla is the first British business to use waste from its farms (cow manure) to generate power for its fleet. During a three-month trial, farmers will send manure to an anaerobic digestion plant to be converted into fuel.The manure from 500 cows (around 190 tonnes) will create 27,000kg of biofuel each week.
Commit to renewables
Switch to renewable energy sources wherever possible and review the potential regularly as renewable sources increase and options change. Consider signing up to the Climate Group’s RE100 initiative to bring together businesses committed to 100 per cent renewable electricity.
Talk it up
Start – or escalate – discussions about the risks of climate change at board level.
Engage widely
Talk to staff and customers about what changes would improve your organisation’s footprint – US corporation Johnson Controls set a competition for staff to identify ways to cut carbon, while Hilton Hotels found that when they gave customers choices they chose the greener option.
Test your disclosures
Are you confident that what you are reporting on environmental issues is correct and verifiable – the Chartered IIA published guidance in March on how to measure and verify your
carbon usage.
Look to your chains
Speak to suppliers and find out how they are exposed to climate change risk and what their carbon footprint is – what are they doing about it and can you support them or apply pressure to improve your own disclosures and protect your reputation?
Assess your environmental audit capabilities
Stephen Licence, group chief internal auditor at Legal & General Group, told the Chartered IIA climate change survey: “Perhaps the first work that internal audit teams ought to do is discovery, which does not necessarily need to fit into an audit. This also includes assessing the skills and capabilities within the team to audit these risks”.
Do your research
Find out what others are doing – see the case studies in the Chartered IIA’s climate change report, and on websites including those of the Climate Group, Chapter Zero, the We Mean Business Coalition and Rapid Transition Alliance.
Why this matters: Key climate stats to share
Five of the top ten global risks in the World Economic Forum’s Global Risks Report are environmental.
The Global Commission on the Economy and Climate estimates that between now and 2100, the potential financial losses arising from climate change could rise as high as $43trn.
215 of the world’s largest companies have valued climate risks to their businesses at almost $1trn – but say that climate business opportunities are worth $2.1trn, nearly all of which are highly likely or virtually certain, according to analysis by CDP.
80% of global trade is embedded in supply chains and, according to the World Economic Forum, 76 per cent of suppliers have identified ways in which climate change could increase the risk of disruption to their business.
According to Project Zero, unless we act, the world’s average surface temperature is likely to rise by more than 3˚C this century.
This article was first published in November 2020.