Auditor's expertise in climate risks affects the quality of the client's climate risk disclosures

In recent years, climate risk disclosures have become widely shaped on a global scale by several reporting frameworks and recommendations. These include the framework of the Task Force on Climate-Related Financial Disclosures (TCFD), International Financial Reporting Standards (IFRS) Sustainability Standards, and most recently the Corporate Sustainability Reporting Directive (CSRD). As the demand for high-quality climate risk disclosures is growing around the world, the role of the auditor in assuring the quality of the client's non-financial information will become more prominent in the future, since audit partners must consider the financial impacts of their clients’ climate risks also from the perspective of the audited financial statements. A new international study focuses on this question by examining the impact of the auditor on the quality of the client's climate risk disclosures.

The study was carried out in international cooperation with universities from several countries. The research group was led by Ly Pham, who received her doctorate from Aalto University last winter. According to Ly Pham, there is a great demand for research in this global situation.

‘The global economy is increasingly affected by climate change and legislators are demanding more information from companies about climate risks. We are introducing a new measure of audit partner expertise in climate-related issues into the scientific discussion. The main finding of our research is that a client company is more likely to report climate risks in its annual report if the audit partner has climate risk expertise. In addition, the auditor's climate risk expertise improved the quality of the client's climate risk disclosure. This link was stronger in sectors with material climate risks, such as energy, transport, and agriculture,’ says Ly Pham.

According to Antti Miihkinen, University Lecturer from the Department of Accounting and Finance at Turku School of Economics and a member of the research group, the results are valuable because of the topicality and novelty of the study, which makes the results highly useful for science and practice.

‘It sounds quite logical that the climate expertise of the auditor matters. However, this has not been proven by scientific methods in the past. It was a valuable finding that we were able to highlight a new area of auditor expertise alongside the auditor's industry expertise previously documented in the literature. It is important to understand the role of auditor competence in climate issues, as we are now entering a new era of sustainability reporting which is likely to increase the role of climate risk disclosures also in the financial statement audits,’ says Antti Miihkinen.

Increased auditor responsibility for the quality of climate reporting

The data used in the study included the annual reports of the 500 largest Australian listed companies in 2018 and 2019. For some years now, Australian guidelines have required auditors to take a strong stance on the adequacy of climate risk disclosure by client companies, as climate risk disclosures are gradually moving closer to the financial statements. 

In addition, the climate risk information presented in the annual report outside the financial statement needs to be assessed more carefully, both in relation to the information provided in the financial statement and the auditor's own knowledge of the situation. Therefore, the auditor's overall responsibility for the quality of the client's climate risk reporting has increased.

In addition to their scientific contribution, the results of the study have many practical applications. They show how important it is to consider the audit partner's knowledge and expertise in climate issues when selecting new and responsible audit partners for different engagements. 

In the 2020s, companies are expected to meet not only new legal requirements for sustainability reporting, but also increasing external pressures for high-quality sustainability information. Climate risk disclosures are an essential element of sustainability reporting, and it is expected that audit partners will need to carefully consider their role in the future financial statement audits. In Europe, for example, the first CSRD reports will be available from the 2024 financial year, which means that within a few months there will be early evidence of the quality of these reports.

There is currently a move to require assurance on sustainability reports, either by auditors or some other assurance providers, which raises the question of whether the assurance should be provided by a specialist auditor familiar with climate risks, by any auditor, or by some other consultant. According to the research group, it is reasonable to say that for those client engagements that have material climate risks and therefore a requirement for a deeper understanding of the client company's climate risks and how to report them, it is worth appointing an auditor with expertise in these matters. 

The research group summarises their main conclusion as follows: the auditor can make a difference, but only if they are a specialist. Climate expertise matters if a client operates in industries with material climate risks.

The research paper

Members of the research group:
Ly Pham, Head of research group (Aalto University School of Business)
David Hay (University of Auckland, New Zealand)
Antti Miihkinen (University of Turku, Finland)
Emma-Riikka Myllymäki (Audencia Business School, France)
Lasse Niemi (Aalto University School of Business)
Jukka Sihvonen (Aalto University School of Business)