Internal audit has a key role in the corporate governance structure to assure on the effective management of risk:
The board provides direction to senior management by setting the organisation’s risk appetite. It also seeks to identify the principal risks facing the organisation. Thereafter, the board assures itself on an ongoing basis that senior management is responding appropriately to these risks.
The board delegates to the CEO and senior management primary ownership and responsibility for operating risk management and control. It is management’s job to provide leadership and direction to the employees in respect of risk management, and to control the organisation’s overall risk-taking activities in relation to the agreed level of risk appetite.
To ensure the effectiveness of an organisation’s risk management framework, the board and senior management need to be able to rely on adequate line functions – including monitoring and assurance functions – within the organisation.
1. First line of defence
Under the first line of defence, operational management has ownership, responsibility and accountability for directly assessing, controlling and mitigating risks.
2. Second line of defence
The second line of defence consists of activities covered by several components of internal governance (compliance, risk management, quality, IT and other control departments). This line of defence monitors and facilitates the implementation of effective risk management practices by operational management and assists the risk owners in reporting adequate riskrelated information up and down the organisation.
3. Third line of defence
Internal audit forms the organisation’s third line of defence. An independent internal audit function will, through a risk-based approach to its work, provide assurance to the organisation’s board of directors and senior management. This assurance will cover how effectively the organisation assesses and manages its risks and will include assurance on the effectiveness of the first and second lines of defence. It encompasses all elements of an institution’s risk management framework (from risk identification, risk assessment and response, to communication of riskrelated information) and all categories of organisational objectives: strategic, ethical, operational, reporting and compliance.
The role of the three lines of defence
Internal audit is uniquely positioned within the organisation to provide global assurance to the audit committee and senior management on the effectiveness of internal governance and risk processes. It is also well-placed to fulfil an advisory role on the coordination of assurance, effective ways of improving existing processes, and assisting management in implementing recommended improvements. In such a framework, internal audit is a cornerstone of an organisation’s corporate governance.
The use of the three lines of defence to understand the system of internal control and risk management should not be regarded as an automatic guarantee of success. All three lines need to work effectively with each other and with the audit committee in order to create the right conditions.
In some organisations the role of internal audit is combined with elements from the first two lines of defence. For example some internal audit functions are asked to play a part in facilitating risk management or managing the internal whistle-blowing arrangements. Where that happens, boards need to be aware of potential conflicts of interest and ensure they take measures to safeguard the objectivity of internal audit.
Source: IIA UK