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Society comments on the UK’s sustainability assurance market

This IR Society response calls for increased standardisation, given the sizeable disparities in price and quality, rigour and methodology amongst providers.

The Investor Relations Society

Suite 717, 70 Gracechurch Street

London, EC3V 0HR

Financial Reporting Council

8th Floor, 125 London Wall

London, EC2Y 5AS

By email: competition@frc.org.uk 

 

28th June 2024

 

Dear FRC Competition Team,

Re: FRC Market Study on Assurance of Sustainability Reporting

Introduction

Thank you for your invitation to comment on the current market for the assurance of sustainability reporting by UK companies. This response is made on behalf of the UK’s Investor Relations Society (‘the IR Society’).

The IR Society represents Members working for publicly listed companies and investor relations focused service providers, to assist them in the development of effective two-way communication with the markets. It has approaching 800 Members, drawn mainly from the UK, including the majority of the UK FTSE 100 and many of the FTSE 250 constituents and some from companies listed overseas.

The IR Society’s mission is to promote best practice in investor relations; to support the professional development of its Members; to represent their views to regulatory bodies, the investment community and Government; and to act as a forum for issuers and the investment community. As such, our response has been primarily constructed through the lens of a corporate issuer.

We set out below our general comments and then our answers to the specific questions.  We have also provided some empirical data from our membership on whether they will be required to report under the CSRD, as this will require them to obtain assurance. 

Overview

In summary, we believe there is currently insufficient choice in the UK sustainability assurance market, there are significant burdens and costs associated with obtaining external assurance (especially for small/mid-cap companies), and the current lack of standardisation creates sizeable disparities in price and quality and also results in confusion for investors.

Headlines

  • Assurance providers are currently predominantly either audit firms (who have brought in ESG specialists) or ESG/sustainability specialists who have brought in some assurance expertise.
  • Currently there are sizeable disparities in price and quality/rigour/methodology amongst providers, illustrating a need for increased standardisation.
  • There appears to be insufficient current capacity in the market given we are aware that some companies have had to seek sustainability assurance from overseas providers.
  • These capacity issues have been exacerbated by alignment of reporting cycles, although we hope this could in future be mitigated by tech/platforms.
  • Use of the statutory auditor can bring benefits as financial materiality can feed into ESG materiality and vice versa, although obtaining ‘Big4’ assurance can be expensive and also involve a huge amount of additional internal resource, so it can be more cost effective to use a specialist firm such as an ‘environmental boutique’.
  • A methodology review (akin to a “pre-assessment” engagement) can also provide greater value than an assurance engagement.
  • Given sustainability assurance is still an immature market, the regulators need to be realistic and expect only limited assurance, with priority being given to improving standardisation.
  • There is also a current lack of market practice/experience with conducting (and providing assurance on) double materiality assessments that require corporates to consider all their potential impacts and take account of the (often competing) interests of all their different stakeholders.

Answers to specific questions

Q1. How well is the UK sustainability assurance market currently functioning? To what extent does it help support economic growth or create burdens and costs on business?
To what extent does sustainability assurance help support economic growth or create burdens and costs on business?

The potential benefits of obtaining sustainability assurance include:

  • the internal benefit of increased confidence in ESG data/reporting;
  • increasing credibility amongst investors and wider stakeholders;
  • increasing ESG ratings/indices performance (eg for CDP, a B score requires verification of ESG metrics);
  • reduction in reputational risk/greenwashing; and
  • it can pave the way for verification of sustainability targets (eg SBTi).

However, we note the following costs and burdens:

  • especially for resource-constrained small/mid-caps, there is a trade off between achieving the above potential benefits against the need to allocate resources towards value-adding (and/or impactful/reduction/mitigation) activities, although we note that the balance may become more tipped towards seeking assurance once there is more standardisation.
  • obtaining assurance introduces additional steps into the (already busy) reporting timeline/calendar; completing the internal calculations in time can be a challenge in itself, leaving very little time for obtaining assurance. This can be further exacerbated by last minute financial reporting changes, perhaps arising from points raised in the financial audit (eg carbon accounting and emissions data), which have a knock-on effect on the sustainability reporting/assurance, and there can also be increased challenges around supply chain data assurance.
  • the trend towards calendar reporting for ESG-related data also causes an industry-wide ‘capacity crunch’ for service providers, although challenges with a business and with the industry can be reduced once ESG data collection is streamlined/digitised, and might be further mitigated by technology/platform tools and solutions (eg automating ‘outlier checks’).
  • some companies feel the need to look for overseas assurance providers (eg to reduce costs and/or to obtain assurance within their very tight timescales), which can involve sensitive data and thus lead to GDPR issues meaning care needs to be taken to check where is it feasible to send data and what additional checks are needed.
  • Members have made anecdotal comments that using a large accountancy firm can currently bring a much larger price tag and associated internal workload with exhaustive challenges (100hrs of management time for each reporting cycle over a 5 year period, irrespective of any learnings from previous years), sometimes examining aspects that are not necessarily material to the business, and provided little or no additional value, with examples cited of £50k+ fees for a large audit firm vs £15k for an ‘environmental boutique’.

Q2. What, if any, interplays exist between the UK sustainability assurance and UK audit markets?

We note that process synergies with the statutory audit, and the interplay between financial materiality and ESG materiality, can make use of the statutory auditor more cost effective. This is likely to become increasingly so with the move towards <Integrated Reporting> and the growing demand for connectivity (for example, an IASB ED is expected in July 2024 on climate-related and other financial uncertainties in the financial statements). Sector specifics can further amplify the cost efficiencies of using the statutory auditor (eg financial institutions may be even more likely to use their statutory auditor as there will be synergies with audited financed emissions).

However, the 70% cap on non-audit fees in the ethical standards can currently deter PIE statutory auditors from providing sustainability assurance, limiting the choice of provider for those PIEs and preventing them from benefitting from these potential synergies/efficiencies.  

Choice and competition 

Q3. To what extent do UK companies have sufficient choice of sustainability assurance provider? What factors, such as quality, influence their choice? How might this change?

Q4. How does competition work in the UK sustainability assurance market? How might this change?

Assurance providers consider the design of sustainability data collection, calculation and reporting methodology, its implementation, and the quality of the raw data, and are currently predominantly either audit firms (who have brought in ESG specialists) or ESG/sustainability specialists who bring in some audit/assurance expertise.

We are aware of some corporates that tender each year for sustainability assurance, whereas others have yet to seek assurance but are investigating the market, with some statutory auditors keen to provide these services, along with Environmental specialists eg ERM, or other providers eg GHK offering a full suite of non-financial metrics assurance.

As mentioned at Q1 above, currently there are sizeable disparities in price and quality/rigour/methodology amongst providers, due to the lack of standardisation for sustainability assurance engagements.

For example, ISAE 3000 can be used for assurance engagements with accountancy practitioners, and provides flexibility to agree what level of comfort is relevant to the purpose of a limited assurance engagement and permits a wide range of levels of comfort. There are also ISO environmental standards that can be used as the basis for voluntary independent verification/assurance. 

We do not have a view as to which are the most appropriate for the UK market, not least as the non-financial limited assurance engagement market is relatively new, and may cover sustainability data collection, methodology and reporting that is less well defined and for which the control environment is far less mature and robust than for more established and standardised assurance engagements.

This can cause potential providers to be hesitant due to concerns about their own risk profile, given lack of clarity on what constitutes an acceptable level of work, which may impact on availability/choice.

As mentioned at Q2 above, use of statutory auditor can bring benefits as financial materiality can feed into ESG materiality and vice versa, and sector specifics can also influence choice (eg financial institutions may be more likely to use their statutory auditor as there will be synergies with audited financed emissions). However, independence measures in auditor ethical standards restrict non-audit fees, which could currently restrict the use of the statutory auditor (unless/until sustainability assurance is mandated by DBT or the FCA, or the ethical standards are amended to prevent such services being restricted).

Anecdotally, we are also aware of at least one corporate that will soon be required to report under CSRD but found that their statutory auditor was unwilling to provide assurance on their materiality assessment (which will be required under CSRD) due in part to both a lack of perceived ‘rigour’ around the ESG materiality process and also the lack of market practice/experience with conducting double materiality assessments. There is a lack of clarity around how corporates should try to balance the (often competing) interests of all their different stakeholders when carrying out a double materiality assessment - how do you assign weight to different potential impacts with potentially wide-ranging timescales? The ESRS do not prescribe a specific process for the materiality assessment, nor do they prescribe any specific documentation. However, some documentation will be needed to enable an assurance provider to better understand the materiality assessment process and the related results, which might be expected to include a description of the likelihood of material impacts and their severity (including scale, scope, and irremediable character), alongside the likelihood and potential magnitude of material risks and opportunities. Market practice can hopefully develop once EFRAG issues its finalised IG 1: Materiality assessment implementation guidance.

As mentioned at Q1 above, some companies currently go to overseas providers in order to obtain assurance within their required timeframe, indicating there is insufficient current market capacity/choice. The current capacity ‘crunch’ (see Q1 above) due to alignment of reporting cycles could potentially be mitigated by digitisation, digitalisation and technology/platforms.

We are also aware that, rather than seeking assurance, some corporates instead choose to seek a methodology review (akin to a “pre-assessment” engagement, checking the underlying data from base estimation through to primary data) ie a deep dive into the methodology to give advice on how to improve internal calculations (often for scope 1&2), which can uncover a multitude of errors (eg errors of magnitude, missing facilities etc) and can provide greater value than an assurance engagement.

Market capacity, opportunities and barriers to entry / expansion

Q5. What, if any, capacity issues exist in the UK sustainability assurance market? How might these change?
Q6. What are the opportunities for firms in the UK sustainability assurance market? To what extent are there any barriers to entry/expansion?

See our comments at Q1- Q4 above.

Regulatory framework and future developments
Q7. How might international regulatory developments affect the UK sustainability assurance market?
Q8. What, if anything, would you like to see change in the UK market? (For example, any regulatory /policy changes and/or any specific actions taken by FRC, Government, firms, companies or others).

We acknowledge that sustainability assurance has inherent challenges due to the levels of estimation and qualitative elements within sustainability reporting, but also due to the lack of standardisation for reporting. The market needs more standardisation both in reporting and in what constitutes quality assurance, which would then drive consistency in quality and price (given the sizeable disparities in price and quality/rigour/methodology amongst providers that we mention above).

International standard ISSA 5000 is not yet finalised (final standard to be issued before end 2024), which may help in this regard. However, we note there is also international standard ISAE 3000 (Revised) for assurance engagements, which provides flexibility to agree what level of comfort is relevant to the purpose of the limited assurance and permits a wide range of levels of comfort, and thus can cause confusion for users.

The Corporate Sustainability Reporting Directive (CSRD) will require limited assurance on sustainability reporting/materiality assessment and tagging, although this is expected to increase to reasonable assurance in the future (the CSRD requires the EC to adopt limited assurance standards before 1 October 2026. By 1 October 2028, following a feasibility assessment, the Commission shall adopt reasonable assurance standards and specify when reasonable assurance is required). Larger corporates with sufficient operations in the EU will therefore be required to obtain assurance under the CSRD, and we note that in a recent survey over half (57%) of our member IRO respondents thought they would in future be caught by CSRD requirements (see Appendix for an extract of the relevant findings from that Member survey).

The level of assurance sought by any particular corporate will currently depend on basic principles around materiality, transparency etc, and in our view UK regulators need to be realistic and focus on standardisation for reporting and assurance, before considering and mandatory assurance. Any future requirements should initially be for ‘limited’ assurance (ie negative statement, nothing came to our attention..), and also within the ‘comply or explain’ environment.

Whilst ‘Limited’ assurance is more appropriate in the shorter term, we acknowledge that ‘reasonable’ assurance remains an option for those where it is feasible! This might be sector-dependent (eg ‘reasonable’ assurance may be feasible for an airline where 90% emissions are inhouse, but is not really feasible for large financial services organisation where bulk of emissions arise in the value chain).

 

We hope you find these comments useful. Please do not hesitate to make contact if you have any questions.

Your sincerely,

 

 

Liz Cole

Head of Policy and Communications

Investor Relations Society

(Email: enquiries@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

 

Ross Hawley

Chair of the Investor Relations Society’s Policy Committee

(Email: enquiries@irsociety.org.uk, Tel: + 44 (0) 20 3978 1980)

 

 

 

APPENDIX

Extract from IR Society Member Survey on Scope 3 and SECR Reporting

The Corporate Sustainability Reporting Directive (CSRD) will apply to:

  • companies that are already subject to the Non-Financial Reporting Directive (ie public interest companies and groups with more than 500 employees) for FY 2024 (reporting in 2025)
  • other large EU companies/groups for FY 2025 (reporting in 2026)
  • most small/medium sized EU public interest companies (except EU micro-companies) for FY 2026 (reporting in 2027)
  • non-EU companies with a net EU turnover above €150M and with either
    • a) large subsidiaries in the EU or EU listed small and medium-sized subsidiaries, or
    • b) branches in the EU with a net turnover above €40M) for FY2028 (reporting in 2029).]

 

Do you expect to have to determine your Scope 3 GHG emissions in future anyway due to: [select all that apply]

 

As illustrated in the chart below, 57% of respondents expect to do so anyway because their company/group would be caught by the EU’s CSRD (see above*) due to being registered, listed or doing sufficient business in the EU