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Charting a Course in the ESG Journey

Nicodemus Tan Jul 1, 2024

Companies are facing the double whammy of growing disclosure requirements from regulators and increased pressure from stakeholders and investors for more transparency and accountability in their sustainability reporting. How can businesses tackle the maze of standards and regulations in their sustainability journey? Read on to find out more.

Companies in Singapore are at different stages of implementing a holistic environmental, social and governance (ESG) framework. Often, their journey starts in response to regulatory requirements, an initial public offering, or requests from customers. 

Typically, a company’s ESG journey will include the following steps, beginning (instead of ending) with the sustainability report.

  1. Sustainability reporting – the company uses a standard report and fills in the best available information.
  2. Sustainability governance – the board determines ESG roles and responsibilities, and sets ESG objectives with management.
  3. Implementation – management identifies material ESG factors, sets up monitoring and reporting processes, and encodes them into formalised policies and procedures.
  4. Draft roadmap – the company drafts a roadmap to improve its ESG metrics.

At each stage of this journey, the board and the company face different considerations and challenges. Let us examine them each in turn.

 

Sustainability reporting

Since 2016, it has been mandatory for issuers listed on the Singapore Exchange (SGX) to issue an annual sustainability report. From FY2023, issuers are further required to include the Task Force on ClimateRelated Financial Disclosures’ (TCFD’s) 11 recommendations on climate disclosures. At the same time, SGX has published a set of 27 Core ESG Metrics to assist issuers in providing, and investors in accessing, an aligned set of ESG data. 

On 28 February 2024, the government announced that it had accepted the Sustainability Reporting Advisory Committee’s recommendations and would introduce mandatory climate disclosures (International Sustainability Standards Board’s International Financial Reporting Standards IFRS S1 and IFRS S2) in a phased approach, starting with listed companies, then larger non-listed companies. Audits for Scope 1 (direct emissions from owned or controlled sources) and Scope 2 (indirect emissions from the generation of purchased energy) greenhouse gas (GHG) emissions will be mandated progressively. 

Companies new to ESG may be unsure of what to report and how to report. At the onset, boards may need to rely heavily on management to suggest the reporting framework and metrics to be disclosed. They may then be updated at a very late stage, with some even only at the point of endorsement of the sustainability report. This leaves little time and opportunity for the board to fully evaluate the report vis-a-vis the company’s operations. This can put the board at great risk. 

Management may suggest metrics that “look good” or for which data is easy to collate or enhance, even if these metrics are not representative of the company’s core ESG impact. Correspondingly, a company marketing its low electricity consumption today may appear in the news tomorrow for poor waste management, causing significant reputational and financial risks. 

To avoid such greenwashing, the board should insist on having adequate discussions with management on material ESG factors, metrics and roadmaps as early as possible. If the company spans different industries and countries, an employee survey could be conducted beforehand to provide inputs for the board’s discussion. This survey may require employees to vote on material ESG factors and suitable reporting metrics, report on bad ESG practices within the company, and offer suggestions on ESG initiatives. 

Standing board agenda items should also include a discussion on ESG strategies, especially when there are material changes in business operations.

 

Sustainability governance

The author witnessed a board meeting discussion on the governance of sustainability, where an independent director suggested forming an ESG committee. The chairman, also a major shareholder, immediately responded he was not keen to form another committee and pay additional directors’ fees. The responsibility was very quickly assigned to the audit committee with no discussion over whether the audit committee members had the required skillsets, nor was any amendment made to the audit committee’s terms of reference.

Such an attitude is risky for both the company and the individual directors. Without a proper evaluation of skillsets, the board may rely on an inept audit committee to make recommendations on ESG matters, leading to unacceptable ESG risks and a poorly drafted sustainability report for which the entire board is responsible.

While it is uncommon for a single individual to be deemed sufficiently knowledgeable about the application of ESG in the company, existing directors collectively may have adequate familiarity with the subject matter. Boards should actively discuss their relevant skill sets and, if needed, bring on board new directors to bridge any gaps.

Once the key roles and responsibilities are established, the board should amend the relevant terms of reference and have the management formalise their responsibilities and tasks.

 

Implementation – systems and processes

Many ESG metrics, such as gender equality and electricity consumption, are easily available from existing human resource records and utility bills. These do not require new technology or systems to capture the data. However, some metrics, such as relevant certifications or communication of anticorruption policies, may not have existing monitoring mechanisms and will require the development of new data collation tools and processes.

Companies with more complex structures and operations may have to use various digital tools to monitor ESG metrics. Management should consider future reporting requirements, expansions or changes to the company when choosing and implementing these new systems or processes. Once established, these systems and their use should be embedded in policies and procedures and become part of regular employee onboarding.

 

Draft roadmap

Many boards have big debates on setting targets for ESG metrics. Some common doubts in a director’s mind involve what are the right numbers or targets to aim for. Or what should be the right balance between operational costs and constraints versus achieving targets. Can the company hit the GHG targets in other ways besides changing its operations? How can the board know what is reported is correct when it is not on the ground?

Many of these questions are multifaceted, involving legal, engineering and social expectations for which there are no clear answers. However, there are some common considerations when setting ESG targets.

Instead of thinking of ESG as saving flora and fauna in countries far away, think of ESG as something closer to home. Good ESG practices may mean more hiring options (e.g., diversity through hiring across gender, age group and physically-challenged employees), reducing production costs (e.g., improving raw materials’ conversion rate to the final product) or increasing logistics efficiency through adequate planning (hence reducing carbon emissions).

There may be limited historical precedence or current comparatives for most companies to set their benchmark on a good ESG target, but countries such as Singapore have committed to being carbon neutral by 2050. This suggests that most companies in these countries should also be carbon neutral before 2050.

To achieve this, companies must devise climate-related roadmaps that are more meaningful and impactful in the long run instead of simply advocating the use of LED light bulbs in their annual sustainability report, for instance. A workshop could be conducted for the board and management to deliberate on key ESG factors from an impact-likelihood perspective and discuss both short-term and long-term plans to overhaul operations holistically. 

 

Assurance and internal audit

When all is said and done, some boards may be unsure of steering their companies the right way forward in their ESG journey. Boards are often keen to do the right thing but may not be sure what that entails and whether they or the management is on track. This is especially true for independent directors who are usually not on the ground and have to rely on management representations to discharge their fiduciary duties.

A way for directors to gain comfort over the ESG framework, obtain assurance over the information in the sustainability report, and build confidence in the ESG roadmap is to have the internal auditors review the ESG framework. Internal auditors who perform their internal audits in accordance with Global Internal Audit Standards will be able to review the ESG governance structure, evaluate the relevant ESG risks, and perform tests of actual controls. Such internal reviews are already codified for SGX-listed companies under SGX Listing Rule 711B(3), and their benefits are equally compelling for non-listed organisations.

Ultimately, the internal auditors will be able to play a critical role in overcoming key ESG challenges by providing an independent opinion and giving recommendations to safeguard both the company’s and the board’s risks.

Companies at different maturity levels of ESG development have to manage various challenges with limited precedence for guidance. While there may not be clear answers on the “right” ESG journey, companies should utilise their internal audit function to provide an independent opinion and recommendations.

 

DISCLAIMER: The views and opinions expressed in this article are those of the author who is from the internal audit function. They do not represent the views and opinions of people or organisations that the author may or may not be associated with in professional or personal capacity unless explicitly stated.

This article was first published in the Q3 2024 issue of The Institute of Internal Auditors Singapore's newsletter.

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Nicodemus Tan
Partner | CA (Singapore), Fellow (IIA Singapore), CIA, CFSA, CRMA, CCSA

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