Mastering ESG proficiency The cornerstone of value-driven NBFCs Internal Audits

Over a period of last few years, we have seen companies are increasingly recognising the importance of Environmental, Social, and Governance (ESG) factors in shaping long term success and resilience. Among the various sectors that are embracing ESG principle, the Non-Banking Financial Companies stands out as a critical player. ESG disclosures are increasingly becoming a requirement for NBFCs both from regulatory and investor perspectives. Companies that are proactive in getting ESG policies and frameworks in place are better positioned to meet these requirements attracting investors and gaining a competitive edge.

As we all know, ESG reporting began in India after the “Ministry of Corporate Affairs” (MCA) released the “Voluntary Guidelines” on “Corporate Social Responsibility” (CSR), which in 2011, became the “National Voluntary Guidelines” (NVG) on “Social, Environmental & Economic Responsibilities of Business” After that, the reporting process has been continuously evolving with the introduction of:

• Corporate Social Responsibility (CSR)
• Business Responsibility Reporting (BRR)
• National Guidelines on Responsible Business Conduct (NGRBC), and
• Business Responsibility and Sustainability Report (BRSR)

W.e.f 1st June 2023, RBI introduced framework for All Deposit taking Non-Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs) to accept “green deposits”. This is to ensure funds get utilized for environmentally friendly and sustainable products and services.

Driven by growing awareness of ESG risks and opportunities among investors, we see ESG regulations strengthen and gaining traction in recent times. We note NBFCs have begun reimagining their governance structures over ESG by developing ESG policies, creating steering committees at the leadership levels and making strategic decisions about their commitments, actions and disclosures.

Since there is so much happening in this space at the Management level there is an obvious need to get independent views or validation checks on the work done and hence a growing expectation from the assurance functions, particularly internal audit. Expectations manifold into either providing views on ESG policy considerations or testing for policy adherences or helping them build an ESG program – before it can be audited by any external auditor etc.

Although addressing these expectations may be an opportunity for internal auditors to go beyond their core remit, it is important to understand that ESG is not taken as a tick-box exercise. ESG assurance activities have to be seen as a transformative tool that would help to unveil the pillars of responsible business. Hence it is essential for auditors to diligently seek out opportunities for skill and competency development and build expertise in the multifaceted landscape of ESG standards before taking up any ESG assignment.

Recently, Our Honourable Finance Minister Smt. Nirmala Sitharaman emphasized and called for the need to develop ESG auditing skills at par with other nations in one of the ICAI events.

By developing subject matter expertise and understanding ESG intricacies, auditors can find themselves best placed to assess risks, create an ESG audit plan, determine a variety of audit approaches and make recommendations. They can therefore be in a position to have meaningful conversations with the Mgmt. across all levels of the organization including the Board and Audit Committee.

At the initial stages we may find companies taking third-party support in getting their ESG audits done, however the trend will sooner or later move towards obtaining reasonable assurances from the Internal audit function. As similar to cyber security or IT audits, ESG will also need to be integrated with the internal audit plans. This will drive discipline and controls around ESG risks and controls.

Finally, yet importantly, ESG is a place for the auditors to contribute and add value to stay relevant. This contribution can be extended in various capacities during different stages of the ESG journey. However as emphasized, this can only be accomplished when auditors possess the requisite skills and expertise and do not consider this as a perfunctory checkbox activity.

Crucial Trends and developments to keep an eye on for future preparedness

Recent developments were seen where the Business 20 (B20) engagement group of the G20 recommended “adoption of universally adaptable ESG standards and disclosures that will be comprehensive, transparent, inclusive and equitable; creation of ESG implementation pathways for fast adoption of responsible and sustainable process; augmentation of ESG governance; etc. These recommendations require policy actions where regulators agree on and mandate the implementation of a common policy and regulatory framework for standards and disclosures that adopt a phased approach to encourage businesses to apply standard global best practices.”

Although a road map has been drawn in terms of timelines for consideration and adoption of a common ESG framework & regulatory mandate for the adoption of the appropriate framework. This is an interesting area to closely watch for in terms of upcoming developments for the NBFC sector and regulators’ expectations emerging for the assurance functions.

Views expressed by: Deepti Rathor, Group Head – Internal Audit, JM Financial