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5 categories of risk: Internal audit: Financial - Ernst & Young - United States

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Five highly charged risk areas for Internal Audit

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3. Financial

Risk areas | Strategic | Compliance | Financial | Reputational | Operational 

Increasingly, the CFO has an important seat at the table in terms of creating and driving climate change and sustainability strategy.

These issues are directly and indirectly affecting share price value through issues such as new compliance costs, corporate rankings by analysts based on sustainability performance and new marketplace risks. Those include potential loss of customers and market share if a company does not adequately respond to climate change risks and opportunities.

The price of carbon

As a price for carbon is set in varying jurisdictions, emerging compliance obligations to reduce emissions will have cash management and liquidity implications.

In addition, carbon-intensive sectors may face an increase in the cost of capital as financial institutions begin to factor carbon into their lending procedures. New regulations, rapidly evolving technologies and changing customer preferences are all contributing to stresses on shareholder value.

Combined, these issues are affecting how companies are valued. They are becoming increasingly important in the due diligence of proposed merger and acquisition deals.

Transparent reporting is expected

Another critical CFO issue revolves around external reporting. Investor groups are putting more pressure on companies to report transparently on climate change and sustainability performance. Shareholder actions on this subject were up 40% in 2009.2  

These actions are expected to increase as a result of the October 2009 SEC guidance allowing shareholder actions on environmental and health topics.

As the external stakeholders increase this pressure, companies need to have the systems and processes in place to collect the data to respond. Decisions need to be made as to what information should be disclosed in the annual report and what information will be disclosed in reports outside of the registration statements.

All of this leads to audit committees increasingly needing to know that the information reported across multiple formats is robust, accurate and complete. Transparent reporting is also a critical element of controlling reputational risk.

 

What this means for Internal Audit
A substantial majority (70%) of the global executives surveyed in Action amid uncertainty plan to increase their climate change spend between 2010 and 2012.3 Nearly 50% say that they will spend 0.5% of their revenue, with some planning to spend more than 5% of their revenue on climate change initiatives.

With revenues of US$1b or more, at a minimum, this represents anticipated spends of US$5m to US$50m annually.

For Internal Audit, this means that there will be an increasing need for robust controls as organizations focus on reducing costs, generating new revenue streams and reducing risk.

The study further reveals that priorities reflect a mix of short- and medium-term business goals, including:

  • 82% of executives plan to spend on energy efficiency
  • 65% have plans to invest in the development of new products and services
  • 64% now report greenhouse gas emissions data in annual reports
 
Questions Internal Audit should ask
  • What management systems and internal controls are in place to identify, monitor and quantify the risks and opportunities of climate change and sustainability-related issues?
  • Does the organization have robust fiscal controls to manage this fast-growing spend?
  • What effect will emerging compliance obligations to reduce emissions have on cash management and liquidity?
  • Has the organization decided on what is material for non-financial reporting purposes?
  • Are key performance indicators (KPIs) and the assignment of risk responsibility clearly defined?
2 Ceres, 4 March 2010. http://www.ceres.org//Page.aspx?pid=428
3 Action amid uncertainty: the business response to climate change, Ernst & Young, 2010.
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