ESG fraud the new economic crime that must be wiped out

The term ESG continues to show up in many corporate discussions with organisations keen to strategically position their businesses. PHOTO | SHUTTERSTOCK

The term ESG continues to show up in many corporate discussions with organisations keen to strategically position their businesses for long-term sustainable success amid growing environmental, social and governance concerns.

ESG stands for Environmental, Social and Governance and is a framework of non-financial factors that organisations are adopting to drive and measure the sustainability of their businesses and respond to stakeholder pressures.

We must appreciate that there are growing concerns about climate change, diversity and inclusion, financial misreporting, cyber security, unpredictable technological shifts and social injustice among others.

In an effort to respond to these issues, organisations are faced with the inevitable task of adopting the ESG framework as this is key for long-term success and continued existence. There are, however, two major problems: – lack of a uniform reporting standard and general lack of understanding of ESG.

While there are some standards that have been developed by bodies such as the European Financial Reporting Advisory Group, the International Sustainability Standards Board, and the Sustainability Accounting Standards Board, there is no current requirement for organisations to follow a particular standard.

This, coupled with the general lack of understanding of ESG and how it impacts businesses, creates variations in how organisations interpret and apply ESG in their day-to-day operations. It also affects how they report on their ESG agenda.

Areas of ESG fraud risk are now emerging in relation to misreporting, corruption and bribery to bypass incoming requirements or obtain falsified documentation, and carbon credit market abuse, among others.

One of the most considered areas of ESG fraud involves intentional misreporting or misrepresentation of an organisation’s achievements in relation to ESG. This is an intentional act of deception committed to benefit the organisation or specific individuals related to the organisation. It could be done to meet the expectations of investors, lenders, regulators, and customers or to meet individual performance goals. This is commonly referred to as ‘greenwashing’.

For most countries, the regulatory frameworks in relation to ESG are still in the development stage. When coupled with a limited understanding of the subject, this creates an environment that could facilitate the materialisation of ESG fraud risks.

As per the 2022 PwC Global Economic Crime Survey, respondents in Eastern Africa indicated that the greatest challenges they face in managing ESG risks are: failure to define ESG objectives for the organisation, inability to prevent or detect ESG misconduct and general lack of understanding of ESG.

If individuals see an opportunity to take advantage of the lack of understanding in order to ‘get away with’ manipulation of reporting, the risks become greater and the chance of detecting such instances of fraud is relatively low without enhancements to controls.

Organisations need to be aware of ESG fraud as an emerging form of economic crime as they embed ESG practices into their business operations.

The writers are PwCs, Senior Associates in the Forensics team