Published on December 14th, 2020 |
by Carolyn Fortuna
December 14th, 2020 by Carolyn Fortuna
Given the growing direct and indirect financial impacts of climate change, boards of directors have a duty to adopt a climate action strategy to tackle what Canadian courts have called “an existential threat to human civilization and the global ecosystem.” At no other time have audit committees been so essential to guide climate governance. Canadian securities regulators have been clear: the climate crisis is now a mainstream business issue, and companies must disclose their material climate risks and how they are addressing them.
External auditors are increasingly integrating climate issues into external audits, and it is only a matter of time before they will raise climate issues as a key audit matter for some entities. Audit committees must become prepared for fluctuations based on climate, including stranded assets — quickly.
One of the most underreported parts of effective climate governance is the important role that audit committees play. To help out, the Canada Climate Law Initiative (CCLI) has released “Audit Committees and Effective Climate Governance, A Guide for Boards of Directors,” a practical guide for corporate boards to respond to growing investor requests for effective management and disclosure of climate-related financial risks and opportunities.
“The Guide for Audit Committees on Climate Governance provides a comprehensive blueprint to assist corporate boards and their audit committees in effectively reporting on their oversight of management of climate-related risks.” said Catherine McCall, executive director at the Canadian Coalition for Good Governance (CCGG) and CCLI’s Climate Governance Expert.
In November, 2020, the CEOs of Canada’s largest pension plans, representing $1.6 trillion in assets under management, announced their commitment to sustainable growth by integrating climate-related and other environmental, social, and governance (ESG) factors into their investment decisions.
They reminded investee companies that they have an obligation to disclose their material business risks and opportunities through financially relevant, comparable, and decision-useful information. CPA Canada has set out 6 characteristics that may help audit committees review the appropriateness of management-selected key performance indicators (KPI) and how they have been disclosed.
- Relevance: Is the KPI a key metric in measuring the issuer’s strategic and operational performance goals?
- Transparency: Does the level of disclosure meet regulatory requirements and industry best practices (eg, have GAAP measures been given equal or greater prominence than those of non-GAAP financial measures)?
- Consistency: Is the KPI calculated in the same way as in prior reporting periods?
- Comparability: Is the KPI prepared in accordance with industry standards and practices (if any)? Comparability allows stakeholders to evaluate the KPIs against those of peers.
- Reliability: Has the KPI been accurately calculated, verified, and subjected to internal controls?
- Completeness: Do the KPIs present a balanced view of the entity’s performance?
Background: Directors, Auditors, & Climate Governance
No longer is it enough for companies to disclose climate risks in their annual reports. The first step is for the board and its audit committee to develop an understanding of the types of climate risks and how they might impact the company’s business, identifying significant financial risks and assessing climate impacts on the company’s supply and value chains
What does a board of directors usually do? They oversee the company’s strategic planning, business plan, risk management and integrity of its public disclosures. It is the board of directors that is ultimately responsible for oversight and management of climate change in the best interests of the company.
How does an audit committee differ from the board of directors? Audit committees are often delegated responsibility to undertake detailed scrutiny and oversight of financial reporting processes, including the company’s financial statements. Their role is key in determining how a company’s strategies and financial results are communicated to investors, regulators, and other stakeholders. The audit committee will always have a role, given its responsibility for financial reporting, whether the company is privately held or publicly-listed.
What is the objective of disclosure requirements? The objective of the continuous disclosure requirements is to improve the quality, reliability, and transparency of annual filings, interim filings, and other materials that issuers file under securities legislation.
What is the audit committee’s role? Accurate and complete climate-related data are key to ensuring that disclosure standards are met. The audit committee’s role, at various times in an organization’s maturation, may include:
- Setting the stage for integrating accountabilities around climate change and the overall maturation of climate risk management
- Initiating the identification of financial risks that arise as a result of physical and transition risks, which will facilitate comprehensive valuation of financial risk
- Incorporating a climate change lens across the three lines of defense: business ownership, risk management, and oversight of internal audits
- Validating and incorporating climate-related financial disclosures within the suite of corporate disclosure
What does the CCLI guide do? This guide draws together current legal standards and best practice guidance for Canadian audit committees, to assist them in taking a leadership role in effective climate governance. It offers practical tips for audit committees navigating a rapidly changing climate governance landscape.
Who are the experts behind the guide? The guide was authored by Dr. Janis Sarra, Professor of Law at the University of British Columbia, with contributing authors Meghan Harris-Ngae, Ernst & Young, Roopa Davé, KPMG, and Ravipal Bains, McMillan LLP.
Core Elements of Recommended Climate-Related Financial Disclosures
To encourage companies to include climate-related information within their financial disclosures, the Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD) set up to develop a set of recommendations for voluntary and consistent climate-related financial risk disclosures in mainstream filings. It identified a range of climate risks and how they may impact an organization’s income statement and statement of financial position (balance sheet), outlining the roles of the audit committee and the board as a whole.
- Governance: The organization’s governance around climate-related risks and opportunities
- Strategy: The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning
- Risk Management: The processes used by the organization to identify, assess, and manage climate-related risks
- Metrics and Targets: The metrics and targets used to assess and manage relevant climate-related risks and opportunities
A series of interactive, rather than linear, practices feed into each other, mirroring the existing core functions of financial reporting regarding the risks that are reflected in the financial statements and MD&A. The potential financial implications arising from climate-related and other emerging risks may include, but are not limited to:
- Asset impairment, including goodwill
- Changes in the useful life of assets
- Changes in the fair valuation of assets
- Effects on impairment calculations because of increased costs or reduced demand
- Changes in provisions for onerous contracts because of increased costs or reduced demand
- Changes in provisions and contingent liabilities arising from fines and penalties
- Changes in expected credit losses for loans and other financial assets
The CCLI guide helps audit committees to create protocols to identify significant/ material risks and opportunities; measure climate-related risks and opportunities; disclose strategies, financial metrics, targets, and progress in meeting goals; and, support the board in development and implementation of a climate strategy, including a risk mitigation strategy. Written in clear language with easy-to-follow sequential organization, the CCLI guide is an important new tool as Canada and all countries around the world push for zero emissions governance within 1-3 decades.
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