With institutional investors banding together to promote investment in sustainable companies, regulators on the verge of demanding auditable numbers from firms to prove that they are meeting their often public commitments on reducing environmental impact, and consumers increasingly intolerant of anything that smells like greenwashing, the best time to start working on your environmental, social, and governance (ESG) strategy and reporting capabilities was yesterday.
Since yesterday isn’t an option, you had better start now. The general consensus we hear among our contacts in the regulatory world and the 150 clients in our account-to-report advisory programme is that ESG reports in the foreseeable future will face the same level of scrutiny that financial reports have always received – with similarly swift and onerous consequences for weak results, obfuscations, and mischaracterisations.
Within two to five years, we expect major companies in many jurisdictions will be required to file ESG reports that include auditable numbers. European regulators are leading the way on this, but the SEC is close behind. They will likely begin with reporting requirements that are built on the Task Force on Climate-Related Financial Disclosures (TCFD) which recommends 11 disclosures across governance, strategy, risk management and metrics. The initial focus is on climate change but this will likely expand in scope to include other environmental concerns such as biodiversity, as well as wider social themes such as inclusion, diversity and equality.
Finance to the rescue
This combination of regulatory and institutional investor scrutiny is part of why the logical clearinghouse for ESG data in most companies – when they recognise the need to operationalise this – won’t be a sustainability task force or procurement office, but the same people who have always provided regulators and investors with the numbers they need: the finance function.
One reason why there has been a degree of wait and see and perhaps some apprehension is that it is still a little bit early to consider what the operational steady state of this process will look like. ESG reporting standards are still going through consultation phases and the final interpretation of these into detailed accounting is going to take time to fully evolve. But one thing is for sure… it is definitely coming.
The messaging we are hearing is these sustainability standards will take shape faster than traditional accounting standards. The new standards are built on some pretty strong foundations, as there has been a large investment over many years by bodies like the Sustainability Accounting Standards Board (SASB), Climate Disclosure Standards Board, Global Reporting Initiative (GRI) and the GHG Protocol, so the thinking is already very well evolved and thus it is easier to have a good idea of what we are likely to see in the years ahead.
Chief financial officers (CFOs) will need to play a role wider than just the custodian of the delivery of disclosures but also will need to help coordinate the integration of environmental concerns into the larger business strategy. This will include a reboot of enterprise risk management, strategic planning, and investment appraisal. Perhaps, most importantly, it will be necessary to redefine the performance management processes to reset incentives to guide management behaviour toward ESG priorities. A further area requiring the attention of finance is the need to address additional accounting. As we enter a transitional phase, companies are needing to manage their carbon footprint via the purchase of energy attribute certificates and may also invest in carbon offsets, and engage in emissions trading activity. It is also likely that there will be additional taxes and regulatory reporting requirements at the country level.
Finally, it is worth underscoring that transparency, honesty and integrity are going to be incredibly important. Companies that appear to not be acting in good faith will likely see an impact on shareholder value. If a lack of rigour and diligence in the accounting is discovered, the punishment is likely to cause a severe dent in shareholder value and also have reputational impacts that will be difficult to recover from.
The first three steps
Although most major companies at this point have made ESG-related resolutions, few have been clear about how they are going to make good on those promises. Fewer still are clear about how to report on their progress. At a minimum, you need to do three things:
1. Implement the recommendations of the TCFD. The TCFD framework is built on four pillars – governance, strategy, climate risk management, and metrics and targets. It provides specific guidance via 11 disclosure recommendations. At a minimum, your organisation should seek to ensure that each of these is being adhered to.
2. Be aware of developments that will affect your carbon accounting. If you follow US GAAP, you should monitor what the SEC and Financial Accounting Standards Board are saying. If you observe International Financial Reporting Standards, you should look at your country’s regulatory position and the position taken by the European Union and in particular the European Financial Reporting Advisory Group’s work on the refreshed Climate Sustainability Reporting Directive. On top of that, you will also want to review the ISSB draft standards and monitor their progress through consultation phases, become familiar with the GHG Protocol corporate accounting and reporting standards, and drill into the work completed by standards bodies like the GRI and SASB.
3. Remind your colleagues that you will need to walk the talk. If you made a public sustainability promise, such as going carbon neutral by 2030, be sure you have an actionable plan to pursue it. You will need to have a detailed road map with achievable milestones that can support those earlier promises – and, most importantly, you will have to hit those milestones.
About the author: Stephen P. Ferguson is the leader of The Hackett Group’s Account-to-Report Advisory Programme in Europe – an advisory service that includes members from 150 major companies.