Do SOC reports play a role in the preparation and audit of sustainability- and climate-related disclosures?

In today’s business environment, there is a growing need to rely on third-party vendors and their systems to collect and process data or carry out certain transactions. This reliance is quite common when it comes to some of the most traditional business activities, such as payroll processing, loan servicing, or insurance claims processing. System and Organization Controls (SOC) reports provide companies with confidence that their third-party vendor’s processes are operating as intended and produce trusted information. Just as external assurance provides trust and confidence over financial reporting and disclosures, SOC reports provide trust and confidence over systems and data processing. In the absence of SOC reports, companies accept risk that their third-party vendors and systems will produce incorrect or insecure data.

Companies are increasingly relying on third-party managed systems for reporting outside of traditional financial reports, especially climate-related disclosures. Such systems are relied upon to produce, collect, and/or aggregate activity data, and calculate environmental metrics such as greenhouse gas emissions. While these systems can provide better, more efficient, and secure information, these efficiencies come with increased risks that must be controlled.  As sustainability- and climate-related disclosures are included in financial filings, there will be heightened expectations related to the completeness, accuracy, and faithful representation of the data used to generate those disclosures akin to the expectation for financial disclosures.  Therefore, companies will have to ensure they can trust the systems leveraged in preparing sustainability- and climate-related disclosures. Here’s an example to show why this trust is paramount:

Assume Company A relies on a third-party system to measure Scope 2 greenhouse gas emissions from electricity consumption. This vendor claims the system will update emission factors (values used to convert electricity data into emissions) for each grid region annually and automatically conduct the update in the system. Unfortunately, during the most recent year’s update, there was an error in the system’s logic resulting in the incorrect grid regions and emissions factors assigned to Company A’s sites. This undetected error caused a material misstatement of Scope 2 greenhouse gas emissions and will require Company A to restate its emissions reporting in future reporting periods. This restatement exposes Company A to avoidable litigation had the third-party’s system properly updated emissions factors to calculate the company’s emissions.

In some cases, the system error noted above could be detected and corrected when the company’s emissions footprint is subject to external assurance. But what if Company A knew ahead of time that this error in the system’s logic existed and could correct the emissions footprint before undergoing external assurance or filing its general-purpose financial reports containing climate-related disclosures? Here lies the true benefit of SOC reports. If vendors hire auditors to prepare annual SOC reports for their systems and provide these reports to their customers, there will be greater confidence in disclosure, trust by users, and transparency that can be introduced into the sustainability- and climate-related disclosures of companies while also reducing litigation risk.

At Sustas, we draw on our financial and sustainability reporting expertise to draw such parallels when assisting clients. We aid in identifying and managing risks when designing reporting processes, developing accounting policies, and assessing readiness for assurance and regulatory requirements. Regarding third-party vendors and systems, Sustas can assist with evaluating vendors and systems to partner with someone our clients can trust. Sometimes our advice is simple, such as asking your system providers whether they produce SOC reports that evidence the system and corresponding controls are operating as intended. Alternatively, our advice can be complex, including how to approach the measurement and disclosure of greenhouse gas emissions when transitioning from fossil fuels to biofuels within you fleet. Regardless, of where your company is in the sustainability- and climate-related reporting journey, we can serve as your trusted advisor and are here to help.