S1EP3 - Internal Audit and the Risk of Environmental Climate Change

The following podcast was recorded prior to the outbreak of Coronavirus COVID-19. Welcome to Ideagen Insights, Ideagen’s official Podcast Channel. In our introductory series, we are exploring the biggest issues facing Internal Auditors across Europe and North America in 2020. In our third episode, Stephanie is joined by Kim Everitt, a Content Consultant and Environmental Specialist at Ideagen, to discuss Internal Audit and the Risk of Environmental Climate Change. Join them as they explore the risks of Environmental Climate Change and the steps Internal Auditors can take to protect their organisation.  

Transcript

Stephanie Jones:   0:00
Hello, everyone. Welcome to Ideagen's official podcast series. My name is Stephanie Jones, and I am the product manager for Pentana Audit and Pentana Risk at Ideagen. We are having this podcast series to focus on the biggest issues facing internal auditors across Europe and North America in 2020 and in each of these episodes were going to look at a specific topic identified as a key business risk by the European and American affiliates and chapters of the Institute of Internal Auditors, the IIA, and we will be evaluating the impact that these have on internal audit departments as they prepare for the year ahead. And as I said, my name is Stephanie Jones. I am an internal auditor by trade. I worked for a number of internal audit companies in North America and most recently performed all the Sarbanes Oxley testing for a manufacturing salt mining company in the Midwest. So my background is in internal auditing. I'd like to also turn this over to my colleague Kim, who will introduce herself.

Kim Everitt:   1:26
Hi, I'm Kim Everitt I am the Technical Content Consultant for the law module (QPulse) here at Ideagen. I'm from a largely industrial background mainly involved with environmental management. I'm an internal auditor for ISO 14001: 2015.

Stephanie Jones:   1:43
All right, well, thank you, Kim, very much. And today we are going to talk about environmental and climate change. So I'm so happy Kim is on here with me and one of the things that the European Institute of Internal Auditors they recently released a risk in focus 2020 report and climate change was identified as one of the fastest-growing priority risks for internal audit chief audit executives, with a 75% increase just in the last year. And almost 30% of CAEs forecast environmental and climate change as a priority risk in 2020. So, Kim, why is the environment and climate change such a hot topic for business leaders today?

Kim Everitt:   2:28
Well, evidence of the effects of climate change can't be ignored. We've seen extreme weathers,  increased flooding, very recently the Midlands, here in the UK had a very significant flood. I've experienced this myself in my working life  - at a  place of former employement, there was a huge flood in 2015. The site where I went to work was at least four feet under water. It was so bad the weighbridge, which is not a light piece of equipment,  flipped and went for a float down the road. I experienced a personal issue with flood back in 2000 as well. My flat was completely submerged. So the incidences are increasing -  the campfire in California, and that's actually been dubbed as the first climate change bankruptcy. We are seeing increases in these issues. Public awareness as a result, is growing -  demonstrations of becoming more commonplace. We see a lot of Greta Thunberg in the UK recently.  There were a lot of protests by an organisation called the Extinction Rebellion. You know, they caused quite a lot of disruption in London, particularly back in April. Concern is rising, particularly amongst the young. Pressure is being heavily placed on governments to deliver the Paris Agreement, which is to limit global temperature increase to no greater than 1.5 degrees celsius  from pre-industrial times by the end of the century. This puts increased pressure on governments to reduce carbon emissions faster and increase targets. There's currently a General Election in the UK and every single party is talking about how they will tackle climate change. Some are even seeking to become zero carbon by 2030 or 2050. The public is becoming increasingly scared about the future of the planet, and governments have to react accordingly. It's not a new thing  - I remember as a young child in the eighties public concern and publicity over the hole in the ozone layer. It was a very hot topic at the time. This brought about major changes in the use, production and types of CFCs and then following the Montreal Protocol in 1987, 140 countries agreed to cease production of CFCs entirely by the end of the nineties. HCFCs which were the CFC replacements are due to be phased out by 2030. This has obviously had a huge impact on businesses producing and using products containing these substances.  The public were concerned and governments responded.

Stephanie Jones:   5:25
So if businesses choose to ignore environmental threats like these, what do you feel are the potential impacts that they would face both into the world that we live in and also in the sustainability of those particular businesses themselves? 

Kim Everitt:   5:41
Well, in terms of the effect on the world we live in, natural resources are not inexhaustible. We are aware of this. Coupled with increased temperatures speeding up of the natural climate cycle, it can only lead to more extreme weather posing a risk to life, flooding, wildfires, droughts, etc. These, in turn, can lead to a lot of shortages. There's always talk of the oil crisis, failed crops affecting food supply, potential energy gaps, power cuts. We can expect to see a lot more population dispersion as more areas become inhabitable. Also, increased destruction of habitats, the potential for more species to become endangered or extinct. The world potentially could become a very different place to the world we know today.  Risks to businesses, they are numerous but to summarise... you have physical and operational concerns, business continuity, supply chain disruption, shortage of raw material, reputational (a negative customer - public investor sentiment), regulatory, legislative,  increased targets, for example, the European Emissions Trading Scheme is going into phase 4 in 2021,  that covers the target period 2021 to 2031. Reductions of emissions are set to be 43% compared to the base year of 2005. During phase three, the current phase, the annual reduction targets per installation was set at 1.74%. This is increasing in phase four to 2.2%.  Carbon reduction commitments ceased in April 2019 and is being replaced with streamlined energy and carbon reporting (SECR).  As a result of climate change, levy rates are going to increase by as much as 50% on electricity and 70% on natural gas. China, India parts of Europe are also planning to place bands on future fossil fuel car sales. I mentioned earlier about the first climate change bankruptcy that was actually Pacific Gas and Electric following the campfire in California because of the number of claims that were put in against the company. These are all big issues -  also rising energy, part costs, transport costs, water shortages are going to have a significant effect on businesses with high needs, such as beverage companies, the paper industry, the chemical industry, to name a few.  Telecommunications will be reactionary. They will have to bring, the system's back online after freak weather. It also affects utilities - the flood I talked about in 2015 actually took out the local electricity substation, so the whole area was without electricity for over a week, which caused quite a few problems. An increase in insurance claims. The company I mentioned following the flooding in 2015 saw damages run into the millions. Following that flood, it was then uninsurable against flood! Which is a huge concern for the company. The thing is, with industrial sites they tend to not want to place them too near residential areas, so they tend to be on the land that's not that appealing to domestic developers and they tend to be on floodplains and or other undesirable areas, so these problems aren't going to disappear. It's reported $160 billion of damage was caused in 2018 but only $80 billion of which was insured against.  Agriculture, droughts leading to poor cops, shortages of raw material all contribute to increasing default risk to banks and lending.

Stephanie Jones:   10:45
So Kim, given all of those challenges and events and things that have happened and that will inevitably happen again at some point, what role does internal audits departments play to either help and assist their companies prior to events and just that preparation, or maybe once an event has occurred, how can internal audit departments help their organisations?

Kim Everitt:   11:12
Internal Audit departments are going to be critical for this. Businesses have to react, they've got to adapt, they've got to plan, they've got to forecast accordingly. Sustainability is key. Much more holistic approaches need to be taken. Environmental impacts considered at every stage of the process. You and I probably know that as cradle to grave.  What influence does the business have with regard to suppliers and end-users? What raw materials are in use? Can alternatives be sought? Considering carbon footprint, energy reduction in efficiency, investment that's available, new technologies available and being developed, end of life of byproducts and can these be reused by other industries such as anaerobic digestion for energy production? Emergency response plans, increased monitoring, review efficiencies,  renewable energies, awareness campaigns -  there have been massive advances in PIR Sensors. So you know, you don't have to rely on people to turn the lights off!

Stephanie Jones:   12:22
Yeah, these are all things that internal audit can ensure and help ensure and test to ensure that they're in place for organisations?

Kim Everitt:   12:32
Absolutely, internal auditing can influence senior management strategy development. It can help evidence how climate-conscious operational strategic decisions are being linked to growth forecasting. It can ensure climate change risk has been included and scored on the risk register That an appropriate impact assessment has been completed. It can provide evidence of continuous improvement. Assess the monitoring systems are effective. Ensure insurance policies, operational contingency plans, including your emergency response plans are all fit for purpose. Also ensure that the policies and procedures in place are relevant, up to date, and effective.  It's also quite commonplace, particularly among older industries, for new developments and technologies to only really be considered if the payback is within three years. Many times in my previous employment, I've not pushed through proposals knowing a longer payback period will just be rejected. That is going to need to change quite quickly. And businesses are going to need to look much longer-term in order to survive in a carbon-neutral world and internal auditing is your tool kit for achieving that.

Stephanie Jones:   13:54
Yes, Kim and a couple of things you said really stood out to me. One thing is that sometimes internal audit can be the voice that a business area may need to just raise that attention to senior management and that could be critical as you mentioned. I think another thing around the risk assessment is one of the nice things about our software is that we do have the ability to when you're performing a risk assessment and you're looking at the likelihood of a risk occurring or the impact you can have multiple impacts, so you can say, Oh, this is an unlikely likelihood of a risk occurring. However, the impact on the environmental reputation is incredibly high. The impact on the regulatory landscape is very high. The impact on the financial risk is very high, so you can have different impact factors in place. You know when you're making those assessments, so you can then have a complete risk register just based on your environmental impact.

Kim Everitt:   15:09
Which is an absolutely magnificent tool to have at your disposal!

Stephanie Jones:   15:13
Yes, absolutely and to share with management! Kim, the last thing I wanted to just address today was what can businesses do when it comes to climate change, to use that to their advantage? What opportunities are there and we know that there are lots of challenges when it comes to climate change. There's a lot of impact on the business, definitely on the environment. But once those things occur, is there anything that can be done whether it's through strategy or new product development, that companies can have an opportunity there?

Kim Everitt:   15:52
There are so many ways.  I'm going to be careful to try not to waffle on too long as I can get quite passionate about these things, but there are so many ways that businesses can take this risk and turn it into an opportunity. So you have sustainable and eco labelling which is becoming more and more appealing to customers, particularly supermarkets as it offers a plethora of marketing opportunities. Aswell as giving you that that extra monitoring within your own business. Energy reduction may not only reduce costs, but we have also ever-increasing utility charges. The carbon reduction schemes, the taxes involved with those that can also result in improved efficiency, the life span of machinery, and improved quality of the product, particularly within heavy industry. Increased metering can really help a company monitor and take control of their energy consumption.  An example I can think of during my time in the paper industry - the general ethos was run the machine at full speed and get as many tonnes off the end of the line as possible. This resulted in high energy use and high quarantine. So a lot of product needing to either be reworked or regraded so we submetered all different areas of the machine. We did a lot of analysis on efficiency and we managed to pinpoint optimum running speeds by product which reduced quarantine by about 50% and reduced downtime by about 60%. So it had had a huge impact that wasn't expected, and ultimately, that just resulted in slowing the machine down slightly. So there are benefits to be had. There aren't necessarily obvious when you first look at these things. Money talks, we know this and ultimately when investors speak businesses listen.

Stephanie Jones:   18:50
One thing that I mentioned was new product development, and Kim, you've mentioned a couple times the wildfires out in California last fall. I actually was on a vacation and was visiting Napa right after the fires happened, and the different wineries were telling me that they were in the process of producing a fire batch limited release of their wines as more of a novelty, you know, because the grapes were impacted by the smoke. So they were releasing this special limited edition Fire Batch that they were just anticipating to just be so well received because it was something that was so unique and special and people wanted to see what that would be like. So the winery took that environmental event that was very tragic and not a great thing, but they were able to put a positive spin on it and then be able to sell something. And, you know, it really was an encouraging thing. I thought that was great.

Kim Everitt:   20:04
That's amazing. I love stories like that. This is what businesses need to do and as you say, where things like this do happen, you have to make the most of it and take that opportunity.

Stephanie Jones:   20:22
Absolutely! So Kim, before we close out this podcast, do you have any other final thoughts or observations from other companies?

Kim Everitt:   20:29
Going back to what you were talking about with the wine company following the campfire, companies are reacting to environmental awareness. Toyota, for example, launched a hybrid Prius. Between 1999 and 2014 they sold 1.5 million of these Priuses. But that was just in the US, so they took more than 50% of the share of the hybrid vehicle market. It totally paid off for them. They are now developing a vehicle called the Mirai, which is going to be powered by hydrogen fuel cells. It's only emission will be water. I'm very excited to see this when it comes about.  I think you know, the businesses who act early and develop early stand a much better chance of holding a large portion of the market. So there's a huge uproar regarding plastic. You know, plastic is suffocating the oceans. We're starting to see it now, companies are developing and actually some of the first to do this is beer companies who are replacing the plastic rings that hold the cans together in the packaging with decomposable cardboard and even seaweed. Can holders which are not only biodegradable but if in the oceans act as fish food as they are edible. So companies and businesses are getting smart and really great developments are coming as a result of environmental awareness and climate change fears. 

Stephanie Jones:   22:36
Thank you Kim so much. This has been very insightful. And I really respect your insight and your opinions. I certainly learned a few things in this podcast. So thank you for that and  I just appreciate hearing your thoughts on what businesses could do, what internal audit departments specifically can do to help out, and hopefully that all leads to better business and not just for the bottom line, but also for our environment. So thank you Kim so much. I appreciate all your input.