AMID increasing scrutiny, the future success of a business is now more than ever based on embracing and reporting sustainability practices – but the pressure, opportunity and rationalisation found in this classic “fraud triangle” could allow greenwashing to spread unchecked.
The fraud triangle is a three-factor model that auditors use when explaining the reasons why a person may decide to commit a certain fraud.Greenwashing involves making an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly or have a greater positive environmental impact than they actually do.
As companies face increasing pressure from stakeholders on ESG and make bolder commitments, especially around climate change, there is a greater risk of companies’ carbon neutral/ net-zero claims being questioned by media and other stakeholders.Increasingly corporations face similar challenges across a host of other ESG (environmental, social and governance) topics including supply chains, data privacy, packaging, equal/ fair pay, diversity and inclusion, workplace safety and social justice.
The lack of global agreement on standards in all areas of ESG leaves corporate leaders and in-house counsel in a challenging position – forced to set targets and make decisions without reliable data and without priorities and guidance from regulators or lawmakers.
In the absence of clear metrics and global standards underpinned by strong assurance requirements, companies are often left to construct their own reporting mechanisms, which may open them up to censure.
In South Africa, whilst King IV, integrated reporting and the voluntary JSE sustainability/ climate change disclosure guidance have provided some basis for reporting, we continue to see a very fragmented reporting/ disclosure landscape on ESG.
The weak regulatory environment, combined with stakeholder demands around ethical and environmental performance, leaves organisations under huge pressure, resulting in the rise of so-called “greenhushing.” Corporates fearful of being accused of greenwashing instead opt for silence on their ESG ambitions.There is a governance bubble in which expectations about “greenness” are accelerating and the governance layer within organisations is struggling to keep up.
How can companies leverage good governance to put sustainability at the heart of their strategy and report on progress in a transparent and authentic way?
THE INCENTIVE PRESSURE COOKER
The first component of the fraud triangle is leading to confusion and chaos for organisations looking for a solution.In the case of sustainability, pressure is intensifying as investors, activists, customers, consumers, employees, suppliers and regulators all have heightened expectations of a company’s strategy and reporting in this area. But how should companies respond?Traditionally they’d look to either regulation or competitors, but neither currently offers clear guardrails when it comes to ESG outcomes. Promises are therefore quickly made, and internal practices along with current structures of systems, processes and controls that allow an organisation to govern itself often don’t seem to be fit for the challenge.Take net-zero targets. The plans of the so-called pioneers – now being picked over by activists, investor groups and non-governmental organisations, among others – may well have been set in good faith but not backed by the necessary due diligence, data and processes.
Much like climate and social impacts, greenwashing doesn’t stop within an organisation’s four walls. Delivering against ESG targets means lifting the lid on supply chains and digging through the detail. However, accurate data on climate risk, greenhouse gas emissions, biodiversity impacts, employee treatment, human rights, tax transparency, anti-corruption and anti-bribery, board diversity and many more aspects of ESG isn’t often readily available and requires companies to collaborate and if necessary, investigate across the entire supply chain to source it.
OPPORTUNITY KNOCKS
Opportunities to commit fraud in the ESG space are also plentiful and can be profitable. In financial accounting you state your position and make representations, but these can be substantiated by accounting rules. But when it comes to environmental accounting, there are few such assurances and there could be opportunities for fraud. You’re currently expected to rely on data that may have some significant limitations when placed under testing scrutiny.ESG data may be manipulated, with employees relying on the inherent weaknesses and ambiguity of sustainability reporting.It’s no surprise, then, that 76 percent of investors accuse businesses of “cherry picking” on sustainability activity according to the EY global survey of senior finance leaders and institutional investors. A resounding majority (88 percent) of investors said “unless there is a regulatory requirement to do so, most companies provide us with only limited decision-useful ESG disclosures.”
THE RATIONALISATION OF RULE BREAKING
Not all employees are environmental evangelists.From top to bottom, the EY Global Integrity Report 2022found ethical standards to be slipping in the aftermath of the pandemic.Among a list of fraudulent activities, including falsifying financial records, taking or offering bribes, and misleading regulators or auditors, 43 percent of board members and 35 percent of senior managers would do at least one of these for personal gain. Thirty-nine percent of employees would be willing to perform an illegal or unethical activity for their own benefit or at the request of a manager.
Employees will justify their actions in committing ESG fraud the same way they do when committing financial fraud. “No one gets hurt;” and “it’s for the greater good of the company” are common rationales. And with remuneration increasingly linked to ESG performance, personal hardship is a potential fraud risk factor at every level of an organisation.Greenwashing leads to damage to the brand, loss of customers, reputation-damaging headlines and a struggle to recruit and retain staff from an increasingly climate-conscious workforce.
SO WHAT DO COMPANIES DO ABOUT IT?
A record 97 percent of respondents to the EY Global Integrity Report 2022 agree that integrity is important. However, senior management is often overconfident in the effectiveness of corporate integrity programmes, with a growing ‘say-do’ gap emerging between rhetoric and reality. This has implications for an organisation’s ESG aspirations and increases the opportunities to greenwash.Senior management and board members should make sure they can back up what they are saying and consider the potential commercial, reputational, legal and financial risk of making statements they cannot support.
Otherwise, they can be held accountable for violating a basic principle of stewardship and corporate citizenship, namely corporate integrity. – NEWS24.
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