Time to talk: time to act A&R Magazine Nov Dec 21

 

The COP26 conference in Glasgow presented an opportunity for the Chartered IIA to look again at what it could do to help internal audit grapple with the challenges and opportunities presented by climate change. We know that this is arguably the most acute challenge facing our planet right now, and it is an issue that is moving fast up the agenda for businesses and governments. As a profession, internal audit cannot afford to be complacent.

What’s more, there are many compelling reasons why internal audit can lead and excel in this space. Not only do internal auditors have the skills, knowledge and experience to tackle climate-related risks and opportunities, they also have a “helicopter view” over, and a unique perspective on, the organisations they serve. Internal auditors should understand the organisation’s overarching strategy, as well as its composite parts.

This, coupled with their direct links to the board and open lines of communication with directors and the audit committee, puts internal auditors in a strong position to add real value to this ever-increasing risk area. When we talked to our advisory panel of experts to help inform and shape our new guide, “Harnessing internal audit against climate change risk: a guide for audit committees and directors”, one of their strongest messages was that, when it comes to grappling with climate-related risks and opportunities, communication between the audit committee and internal audit functions is key.

But when we talk to members across the UK and Ireland we see that organisations in different sectors are at very different stages on their individual journeys to tackle climate change. In some organisations, internal audit functions are carrying out innovative work and stepping up to lead. But in others, climate-related risks are rarely (if ever) discussed by the audit committee.

We want to be sure that audit committee chairs demand that their internal audit functions are fully engaged from all angles. Whether we talk about increased threats to supply chains caused by extreme weather events, or reputational damage caused
by “greenwashing” and ill-thought-out environmental proclamations, or opportunities related to green investments, internal audit should be a critical friend, trusted adviser and independent assurer in all of these areas.

The Chartered IIA, too, has a responsibility to do all we can to encourage and support our members to rise to the challenges. Part of our role, and the purpose of this guide, is to engage actively with our members and encourage them to address the demands of an increasingly globalised and interconnected world in which complex and multifaceted risks and uncertainties come with the territory. There is no greater example of this than climate change.

With this in mind, the Chartered IIA is urging internal auditors to show their worth. Our new guide isn’t intended just to increase demands on internal audit teams. Its primary audience is audit committees, board members and directors. They also have a role to play and important questions to ask – we want them to initiate the discussions around climate change and the accompanying risks.

Few now question that organisations will face dire consequences if they fail to prepare for the transition to a more sustainable future and the physical consequences of climate change. It is now a question of “when” rather than “if” these happen. There has never been a better time for boards, and in particular audit committees, to start a conversation with their internal audit teams about the work they are doing on climate change. We urge directors to work in partnership and collaborate with their internal audit functions to ensure they are rising to the challenges.

 Audit committees need to reflect on how they’re using their internal audit functions. Could internal audit be doing more in this space? For those organisations that haven’t yet started fully assessing what climate change means for them, we want to inspire audit committees to start these vital conversations.

 


 

View from: Dermot Byrne, head of audit (Internal & EU Audit Unit), Department of Public Expenditure and Reform, Ireland

Climate change is a risk that has emerged in a very short time span. My role includes leading internal audit for the two central Irish Finance Ministries – the Department of Public Expenditure and Reform and the Department of Finance. The first of these is responsible for expenditure allocations for the budgets of all Irish government ministries. As well as ensuring that state spending is effective and sustainable, climate change initiatives are monitored to ensure they meet the exacting and challenging demands set out in Ireland’s Climate Action and Low Carbon Development (Amendment) Act 2021 and other EU requirements.

Ireland has committed to cutting greenhouse gas emissions by at least 50 per cent by 2030, which is an ambitious target. Each time the government allocates money to a department, it asks a series of questions, one of which is now: “What are you doing to combat climate change?” Our department then has to monitor how they are meeting their obligations.

The key sectors for climate change policies are: electricity and power; transport; the building sector (both public and private); industry; agriculture; and land use and forestry. The department’s focus is on financial oversight of cost-effective policies to encourage more climate-sustainable practices among all our citizens and organisations. Although the government is only a small direct contributor in terms of greenhouse emissions, we also try to demonstrate a “do as we do, not as we say” approach to other organisations. Schemes to retrofit older buildings to make them more heat efficient must be able to demonstrate that this is having, or will have, the intended effect.

In addition, we need to be prepared for possible slippage in the achievement of targets or, indeed, the potential for more stringent EU targets in the future. And we need to identify conflicting targets – for example, the government needs to secure our national energy supply, yet we still have electricity plants that are based on burning peat, which is not sustainable.

Importantly, in internal audit, we need to structure our work on climate change to ensure we are conducting meaningful reviews of the department’s key risks and the planned mitigations in place. Many of these involve other government departments, where their own internal audit teams will have a role – we don’t want our work on climate change requirements and capital expenditure to duplicate what they are doing internally.

Our department needs to ensure that all climate change projects are assessed centrally and to the same standards in all departments – so we are consistent and can offer clear guidance on integrating climate change into capital expenditure. This may require extensive collaboration and a joined-up approach between different internal audit teams and managers in various departments.

Right now, our audit committee is asking how internal audit will incorporate climate change into our own departmental audits. Our three key areas of concern would be expenditure pressures caused by increased climate ambition (ie, how much money will it cost to meet our climate change challenges and are our actions cost-effective?); whether the geo-physical impact of climate change will lead to economic damage (such as reviewing our actions to mitigate flooding); and the risk that failure to meet our climate change commitments could lead to compliance costs (eg, EU-regulated carbon taxes).

Over the past ten years, our internal audit team has sought to offer a more proactive and consultative approach. We hope this increased traction will help our review of climate risks mitigations. We recently conducted a review of culture in partnership with the HR function that was extremely successful and opened up areas where we previously had little involvement. I hope this has helped us to develop our role as a business partner.

Perhaps we can try to flag any gaps between the department’s climate change ambitions and the policies and actions being put in place. To some extent, we are starting with a blank sheet of paper. If we can’t look to commercial businesses for comparisons, we may look further afield to other governments, including the UK and our other European neighbours for successful and cost-effective initiatives. In the end, we are all in this together. 


 

View from: Jeremy Lawson, group internal audit manager, Persimmon Homes

As a house builder, we are very alive to the risks of climate change and there are two main ways it affects our business. We have to consider how climate change will manifest itself physically – for example, how extreme weather events may affect build programmes and our land holdings. We also have to think about the requirements of the transition to a low-carbon economy – for example, potential changes to building regulations and energy standards, and the ways we will heat houses in the future (and who will bear the cost of this).

We are actively trying to get on the front foot on both of these. We’ve built our own concrete brick factory, because this helps to mitigate our supply chain risks and because concrete bricks are more sustainable than clay ones (typically, manufacturing concrete bricks produces 28 per cent less carbon than manufacturing clay bricks). We also have fully accredited, science-based carbon reduction targets, and we have built a zero-carbon home as a demonstration project, so we can monitor its ongoing efficiency when people are living in it. This will help us to understand how we can build low-carbon solutions cost effectively at scale.

Internal audit has been involved in some of these initiatives. Three years ago, we worked with second-line functions to establish a climate change risk register. We didn’t own this process, but we facilitated it and we were well placed to help the business carry out the exercise. This project also looked at transition risks – for example, the effect of new building requirements and how land availability may become constrained in higher flood risk areas. However, we also looked at the opportunities for new markets – for example, offering customers low-carbon solutions such as vehicle charging points in houses – as well as ways to increase the efficiency of our own buildings and operations across our 31 operating companies and three off-site manufacturing plants.

Global prices and competition also affect us, because some of our materials, such as timber, come from overseas, so climate-change-related natural disasters (for instance, forest fires in Canada) can influence global prices and affect us in the UK.

Internal audit has to understand these challenges, because we assist and advise the audit committee in discussions about the principal risks that the organisation declares in its annual report and accounts. The company recognises climate change as one of our principal risks and we need to show stakeholders that we are committed to actions to meet obligations and mitigate the key risks.

We have also started doing more assurance work on environmental issues. We’ve completed audits on waste management and sustainability disclosures and this is likely to be a huge growth area for us. I know there will be more demand for this kind of work in future, and doing the audit work now means that we highlight the issues to the board and help to prompt the discussions that management needs to have.

In future, sustainability is likely to be a key part of the work we will need to do to meet the new Audit and Assurance Policy that is likely to be introduced as part of current BEIS audit reforms. We must be in a position to explain how we provide assurance over all aspects of corporate reporting, including climate and sustainability issues, which for us could include tree planting or bio-diversity commitments. This will have to be robust, transparent and verified as rigorously as our financial figures. I feel strongly that internal audit is the ideal function to do this and to partner with the business to help it to establish new controls and procedures. We need to help it to ensure that reporting structures for our sustainability figures are reliable and operating effectively.

Emerging risks and opportunities are another important area for internal audit in the future. We’ve just completed an exercise on our principal and emerging risks for the audit committee and the board, and climate change and sustainability were high on everyone’s radar. 

More broadly, the organisation is exploring climate-related opportunities, but internal audit has not, so far, been involved in this. However, it’s clear that our engagement with sustainability and the requirements around this subject are developing fast and will only gain traction in the next few years. Things are changing rapidly and internal audit will need to stay ahead of these changes. 


‘Watershed moments’ at Cornwall Council

Cornwall Council has been on a sustainability journey for a number of years, but since it declared a climate emergency in January 2019 this has accelerated. “It led to an organisational shift that is so fundamental we’ve almost had to redefine the role of our local authority,” explains Steven Ford, the council’s head of environmental growth, climate change and heritage. 

It was a “watershed moment” when the council realised the task ahead was far bigger than just getting its own house in order, he explains. After the political declaration, they formed an action plan and undertook a series of resourcing and strategy-building exercises to inform and plan the way they would act to meet the stated aspiration of becoming carbon neutral. “This changed the nature of our decision-making and planning, the way we travel to work and the way we travel within work and it led to a real change in the behaviour and consumption habits of staff. It’s changed the way we work forever,” he says.

Changing the way council staff work and act was only one strand of the ambitious plan. It also looked to influence the way local businesses and residents act and the decisions they make by forming strategic coalitions with The Cornwall and Isles of Scilly Local Enterprise Partnership and The Cornwall & Isles of Scilly Local Nature Partnership. 

Last, but not least, it identified where the council would need to collaborate regionally and nationally to reduce carbon emissions and improve sustainability.

“The whole programme was underpinned by incredibly complex data – we needed to know where we already were before we could establish where we wanted to go,” Ford adds. “And we needed to find people with the right skills, which was challenging in itself.”

One solution was to work with local universities to develop necessary skills. However, they also wanted everyone who worked for the council to understand how they could contribute by changing the way they worked and lived. They developed a climate literacy course for all staff and asked them to identify ways to make their jobs more sustainable and to pass on what they learnt to friends and family.

Another campaign targeted tourists with a “Love where you are” message via QR codes at beauty spots asking visitors to pledge money to community environmental initiatives.

“The council’s operations make up about 1 per cent of Cornwall’s emissions, but we believe we can influence up to 40 per cent of the Duchy’s emissions via our collaborations with businesses and organisations such as the NHS, and by educating residents,” explains Mark Holmes, Carbon Neutral Cornwall manager at the council. 

There are specific challenges. The largest cause of emissions in the county is transport, but electric buses and waste collection vehicles currently won’t cover the distances needed in rural communities. Half of Cornish houses have no gas and are powered by oil and electricity.

Enabling council employees to work from home one or two days a week was first introduced to reduce vehicle emissions, but Covid lockdowns accelerated this scheme, when everyone switched to remote working. While people use energy working from home and the aim is for Cornwall, not just the council, to go carbon neutral, Ford and Holmes are confident that it has had a net positive effect on emissions over the past 18 months based on the average energy use at home versus the previous average commuter journey. One of their tasks is to work out how to keep these gains in a post-Covid era.

Finding and verifying the data on which to base strategy has been challenging. Established international standards could be used in some areas, but in others the council had to identify the data it already had and what it needed to collect in future, as well as whether this could be cross-referenced and then refined and put into a usable format.

The internal audit team has provided independent assurance on this data, its sources and the way it is used to inform decisions. Beyond this, however, the internal audit team has also undertaken a higher level appraisal of risk, including examining the scale and size of the challenge and assessing whether the council is fully prepared for physical climate change risks, as well as those created by the transition to a lower carbon future.

“We have a three-pronged approach to strategy. The first part deals with the climate change emergency and how we decarbonise. The second focuses on the ecological emergency, including bio-diversity and nature recovery. The third concerns environmental resilience and climate adaptation, for example, natural flood management. These all interlink,” says Ford. 

“Internal audit is working out how these come together in its strategic assessment of risk. We’re working with the internal auditors to get a granular look at what climate change risk means – because, to a certain extent, the genie is already out of the bottle.”

Ford adds that he views the council’s internal audit team as a valuable partner. “What internal audit tells us about future risks is extremely helpful to us,” he explains. “Their assessment has more impact as it is viewed as being independent, rather than us  marking our own homework. They give management an independent view of what we’re doing and what needs to happen." 


New opportunities for collaboration at Northern Ireland Water

Water is not only a vital utility, but it is also a front-line resource when it comes to climate change. Northern Ireland Water has had to operate under drought contingency conditions for the past three out of four summers, so is well aware of the potential risks to its operations. However, the business is also working hard to prepare itself to take advantage of opportunities for innovation and collaboration.

“A risk analysis and scenario planning exercise is under way looking at the impacts of climate change on our operations – from physical risks to the financial and supply impacts, and also considering organisational transitional risks,” explains Nicola Brennan, head of internal audit at Northern Ireland Water. “For example, our assets on low-lying land are at risk from rising sea levels and flooding, while recent exceptionally dry and warm summers have shown that we need to plan for building in additional resilience.  The business is looking into various initiatives, such as recommissioning some smaller water treatment works and using borehole supply. Some pilots are already in action.”

The problem, she points out, is that demand for water rises sharply when it’s hot – at the very time when the reservoirs are at their lowest and water treatment processing is running at capacity limits. During these recent warm summers, operational teams have worked relentlessly to transport tankers of water to areas where the reservoirs are lower to avoid supply disruptions, which also comes with a cost. “We can already see that climate change is real and is happening here,” she says. 

This is one reason why the company has been conducting advertising campaigns to educate customers about water consumption. Last-resort measures, such as hose-pipe bans, damage customer relations and are a reputational risk, so the organisation is working hard to raise awareness of the issues and help customers to reduce their consumption.

Meanwhile, the internal audit team is examining the company’s preparations to meet future reporting requirements established by the Task Force on Climate-Related Financial Disclosures (TCFD). Northern Ireland Water is not yet required to report against these, but last year Brennan’s team commissioned their co-source partners to help them conduct a gap analysis so they can ensure it will be fully prepared when it is.

“This provided a framework so we can pull together all the good work the company has already done and produce a coherent and comprehensive action plan for those activities that still need to happen,” Brennan explains. “The company is currently developing its climate change strategy, including its net zero carbon routemap, and internal audit will be involved in ongoing advisory work supporting this. Then in the future it will provide assurance over the implementation of this and associated reporting.”

But it’s not all about risk. While the business has been examining its energy consumption – it is the largest user of electricity in Northern Ireland – it has also identified significant opportunities to assist an integrated low carbon energy system for Northern Ireland involving novel collaborations with other utilities, businesses and across government, and Brennan is considering the skills the internal audit team will need to provide the necessary assurance as these progress. “As the largest landowner in Northern Ireland, and with a lot of that land on high ground, there’s significant potential for wind turbines. Also, with over 3,000 sites connected to the grid across the province, we could potentially provide an enterprise battery solution for Northern Ireland, capable of storing electricity from renewable sources and feeding it into the grid and local networks as required. We are currently running a pilot scheme to use the electrolysis process to create green hydrogen as a by-product of the wastewater treatment process, which could be used to fuel vehicles or heat homes,” Brennan says.

“There are lots of potential new partnerships and revenue opportunities, which will also contribute to decarbonisation for Northern Ireland Water and the wider province – but also lots of new issues for internal audit to consider in the future. The critical thing for me is that we identify when and where it is most appropriate for internal audit to be involved,” Brennan says. “At the moment, the organisation is still setting out the possibilities.” 

 


Further information

This isn’t the first time the Chartered IIA has looked at climate change risk. In 2020 we published “Organisations’ preparedness for climate change: an internal audit perspective”, looking at how internal audit teams were tackling this area. We know from our annual Risk in Focus that climate change and environmental sustainability is becoming an increasing priority for CAEs across Europe and that this will only increase. 

Sophie Malleson is policy and external affairs executive at the Chartered IIA.


This article was published in November 2021.