How accounting leaders can embrace ESG for a strategic advantage

Not that long ago, the integration of environmental, social, and governance (ESG) factors into operational and investment strategies appeared to be a niche approach, and corporate sustainability reporting was not the norm.

Today it is clear, ESG strategies and investing and sustainability reporting have arrived on the main stage. Institutional investors are driving this shift with their investment priorities and allocation of capital. Forward-thinking companies are recognizing the opportunity to proactively embed ESG into their strategy to attract investors, retain talent, and appease customers while striving for long-term growth. In addition, previously fragmented and voluntary frameworks are being prioritized and aligned worldwide. (See the sidebar “Sustainability Standards Issued and In Development.”)

As regulators move to standardize an approach to ESG reporting, the fundamental building blocks of most regulation will allow for cross-border comparability and transparency across key ESG factors and data points.

New standards will also have a broader impact across more environmental and social topics, as well as a trickle-down effect on other companies that do business with these large global enterprises.

THE NEED FOR FINANCE AND ACCOUNTING LEADERSHIP

Investors are seeking more information on sustainability risks and opportunities, so companies must properly assess their business strategy and enterprise risk management (ERM) to determine the long-term risks and opportunities that affect their growth and performance.

As strategic allies to the executive team, the CFO and the accounting leadership team can bring a measured perspective on the ways companies can unlock financial value and mitigate enterprise risk through ESG investments.

A strategic view on ESG can bring a variety of market opportunities. With specific ESG metrics or KPIs identified, companies can access capital at lower costs and preferential rates from traditional lenders in addition to sustainability-linked bonds tied to KPI performance. A thorough assessment of ESG performance across a set of ESG rating agencies and scoring methodologies can help companies identify gaps and material topics that can be addressed to enhance ESG disclosure and scores. By achieving improved rating scores, companies are more likely to be considered for inclusion in exchange-traded funds that require baseline ESG scores.

The finance function also has a unique opportunity to focus on traditional business practices, such as more effectively managing costs related to energy efficiency and resource management.

The role of accounting and finance will be critical to ensure the quality and consistency of ESG reporting. This will include establishing rules for ESG data governance, assigning responsibilities across finance and sustainability teams (among others), and designing the necessary internal controls to implement on the sustainability reporting process.

Internal audit teams can be invaluable partners in driving ESG reporting efforts regardless of whether the team has specific ESG expertise or not. Internal audit professionals know how to dive into data and ask challenging questions that will help identify gaps in process and controls.

Companies may also implement a recurring data aggregation and consolidation process for ESG data that aligns to financial reporting cycles. For this investment to be useful, organizations need to consider the tools, processes, and people that can help execute an effective ESG reporting process from initial sources of data through to external reporting (see the sidebar “Building the Infrastructure for Assurance- Ready ESG Data”).

HOW TO TAKE THE LEAD ON ESG

Organizations can take four first steps to guide their ESG strategy and road map, with accounting leaders and experts playing a pivotal role:

1. Engage with a cross-functional ESG oversight committee

Companies that have successfully embraced ESG have created a cross-functional steering committee. Typically, the group includes the CEO, CFO, and general counsel in addition to leaders from accounting, investor relations, sustainability, and across the business.

The CFO’s leadership is critical to determine where investments can be made to create value with ESG and to consider relevant sustainability risks and minimize financial exposure. In collaboration with accounting leadership, the CFO also helps to ensure compliance with regulatory and investor demands, and to co-develop an investor-grade reporting process.

Executive compensation targets set by boards and leadership teams have begun to link sustainability performance and financial performance. Companies can be most successful when executive decision-making is incentivized to consider ESG goals aligned to business strategy, financial growth, and long-term sustainability.

To execute the steering committee’s ESG program, senior leaders from these functions are nominated to help drive cross-functional implementation.

This is where leaders from the controllership, internal audit, financial reporting, and investor relations can implement best practices from financial processes.

2. Benchmark against industry peers and investor priorities

As in any endeavor, it is wise to start with understanding your business in relation to your industry peers and the priorities of your key stakeholders.

Company leaders should ask: What are my competitors doing in the ESG space? How do I rank relative to my peers across various ESG rating agencies? Are there opportunities to differentiate in a way that is meaningful to customers, employees, and investors?

A thorough look at the industry’s landscape through the ESG lens can help uncover material factors and potential strategies to unlock financial value and strategic positioning in the market. A formal materiality assessment may help map business priorities with internal and external stakeholder priorities to focus the ESG program.

The CFO is uniquely positioned to think through value creation with the executive team and must lean on accounting professionals to develop new policies and procedures that manage sustainability risks, operationalize ESG reporting infrastructure, and collaborate with investor relations to craft the company’s ESG narrative for investors.

3. Build a strategic ESG road map

With a shortlist of priorities and key programs identified, successful companies can invest in building a strategic road map to improve ESG communications, risk management, and reporting processes.

Companies can begin by assessing voluntary frameworks that align to regulatory requirements in an effort to start building the foundational processes and datasets for regulatory reporting. Focusing on frameworks like the ones developed by the multinational Task Force on Climate-Related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB), which are the basis of the new IFRS sustainability standards and the most adopted frameworks within the investor and business community, is a great starting point.

Similarly, the Carbon Disclosure Project (CDP), established more than two decades ago with the aim to get companies to disclose climate related information, will incorporate IFRS S2 into its global environmental disclosure platform in the 2024 disclosure cycle. That means, CDP’s 17,000+ voluntary users will disclose data structured to IFRS S2. Until regulatory requirements are effective for companies, these frameworks require quantitative and qualitative disclosures that will benefit from accounting and finance expertise.

For example, with the SEC’s climate disclosure rule expected to have a sequenced adoption timeline, companies are preparing by building an inventory of greenhouse gas emissions and drafting qualitative disclosures on risk management and strategy that align to the TCFD framework. Under the SEC climate disclosure rule, assurance must be provided over greenhouse gas emissions data—initially, with limited assurance in the first two years following disclosure, and then through reasonable assurance, which involves more substantive testing of data. Similar mandatory assurance will be required in the European Union, and assurance requirements under the SEC’s proposal may change in the final rule.

The SEC’s proposed climate disclosure rule itself is largely based on TCFD, and building the infrastructure for baseline data collection at inception will enable the company to be prepared for assurance over the climate data reported in the 10-K. This is where accounting leadership is essential.

4. Focus on quality

After companies have tackled what ESG information to report and where to report it, it’s essential for quality and auditability to be a top priority. In the US, companies are initially focusing on climate data and disclosures, given the SEC rule timeline.

Currently, very few public companies disclose climate data in the Form 10-K, but many organizations — public and private — are including such information in corporate sustainability reports (CSRs), reporting packages to institutional investors, and in response to information requests from significant customers. In these cases, the relative infancy of the disclosures and the diversity in practice used to source and report the data suggest that few organizations have reached the status of assurance-ready climate reporting.

In the US, for public companies, as climate data from the CSR is incorporated into a company’s Form 10-K, it will be subject to disclosure controls and procedures. For private organizations reporting on this information, the expectation that any reporting of data is complete and accurate is no different than financial reporting information. It will take significant effort for most companies to identify, collect, and evaluate the right data, to properly segregate duties across accounting, legal, and sustainability teams, and to ensure disclosures are complete, accurate, and supportable.

In March, COSO’s paper Achieving Effective Internal Control over Sustainability Reporting (ICSR): Building Trust and Confidence through the COSO Internal Control – Integrated Framework outlined how to apply its framework for financial reporting to the emerging areas of sustainability and ESG reporting, reinforcing the unique role for accountants in ESG.

Accounting leaders can drive ESG data quality control by analyzing the design of current reporting processes to identify where procedures can be enhanced to a rigor more akin to financial reporting. This is where accounting professionals will thrive in transforming ESG reporting processes and ultimately producing outputs that are ready for assurance by auditors applying the requirements of the AICPA and IAASB.

HOW BIG A RISK IS IGNORING ESG?

As advisers observing ESG reporting transformations across a wide range of industries, we believe it’s apparent that companies are just beginning to scratch the surface of the level of effort and complexity that the integration of sustainability disclosures into financial reporting presents.

Focusing on your company’s priorities and key stakeholders’ needs will help you be prepared when reporting is required in the US or for American companies with global operations in other markets, such as the EU or UK. While your preparation now will create enhanced reporting processes, a strategic approach to ESG might unleash a company’s next phase of success and drive financial value for the company over time.

The bottom line: Consumers, regulators, and the investment world are now paying attention to ESG. That’s why it’s time for companies to align finance and accounting leadership with the technical expertise of sustainability teams. Leveraging best practices from financial reporting and ERM, accounting and finance leaders can help steward their organization’s sustainability journey and financial performance.

Sustainability standards issued and in development

In the U.S, the SEC proposed rules to enhance and standardize climate-related disclosures for investors in March 2022. This is a step toward integrating into the financial reporting process climate risk management disclosures aligned with the Task Force on Climate-Related Financial Disclosures (TCFD), including greenhouse gas emissions data.

In June, the IFRS Foundation’s International Sustainability Standards Board (ISSB) — integrating leadership, technical expertise, and concepts from the Sustainability Accounting Standards Board (SASB), TCFD, Climate Disclosures Standards Board, and the International Integrated Reporting Council—officially issued its inaugural standards: IFRS S1, General Requirements for Disclosure of Sustainability-related Financial Information, and IFRS S2, Climate-related Disclosures. The organization hailed the new standards as creating a common language for disclosing the effects of climate-related risks and opportunities on a company’s outlook. The issuance received widespread support from global organizations including the G20, G7, International Organization of Securities Commissions (IOSCO), Financial Stability Board, and World Economic Forum.

Also, the AICPA Standards for Attestation Engagements provide the pre-conditions for both limited and reasonable assurance engagements that would meet the level of rigor expected by regulatory bodies like the SEC. In May, the AICPA Auditing Standards Board (ASB) approved a project to consider potential changes needed to the attestation standards for the purpose of providing clear requirements and application material for practitioners performing sustainability attestation engagements.

Outside the U.S, the International Auditing and Assurance Standards Board (IAASB) is preparing its International Standard on Sustainability Assurance (ISSA). The ASB will consider convergence with the IAASB standard (ISSA 5000) to support global alignment.

Also, the European Union Corporate Sustainability Reporting Directive and European Sustainability Reporting Standards will take effect in January 2024, which is likely to affect around 3,500 U.S. companies doing business in the EU and meeting certain thresholds.

Building the infrastructure for assurance-ready ESG data

Investment in the reporting process will include new infrastructure and teams capable of processing voluminous and new datasets in financial reports.

For example, many companies are handling sustainability reporting manually, using spreadsheets to track third-party data and other sources of company data, such as greenhouse gas emissions across the real estate portfolio and vehicle fleet. Manual processes can result in human error and inaccurate or incomplete data. In addition, this can create problems with standardization and efficiency. This is another area where accountants can flex best practices from financial reporting processes.

Led by accounting and finance leaders, more advanced companies are investing in the deployment of new tools or engaging with third parties to help execute auditable processes that automate calculations and create documentation to support third-party assurance procedures.

The third parties that provide ESG-related services need to have robust controls as well — in a similar way for vendors that provide services that impact financial reporting. Companies should consider requesting SOC reports from their vendors.

The team overseeing these systems and processes can vary by organization, but most companies leverage a cross-functional ESG disclosure committee, where accounting and internal audit have a seat at the table with investor relations to provide a final check and balance before external reporting.

About the authors

Drew Niehaus, CPA, is managing director and Matt Pelton, CPA, is a senior director at business advisory firm Riveron in the US. To comment on this article or to suggest an idea for another article, contact Jeff Drew at Jeff.Drew@aicpa-cima.com.

LEARNING RESOURCES

AICPA & CIMA ESG & Sustainability Conference

New regulations and global trends to incorporate ESG (environmental, social, and governance) data into financial reports is accelerating. Join us in December as we enter a new era for policies and regulations in sustainability.

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This executive management course developed in partnership with the University of Oxford’s Saïd Business School will provide professionals with the skills to lead their organization’s response to sustainability issues and understand how to integrate these into decision making and resource allocation.

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Kick-start your understanding of ESG (Environmental protection, Social inclusion, and Governance) issues with this course, designed to help you learn how the landscape has developed and the key role CPAs and finance professionals have to play.

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AICPA & CIMA RESOURCES

Articles

“4 AICPA & CIMA Leaders Discuss Global Sustainability Standards,” JofA, July 11, 2023

“Why Private Companies Need a Plan for ESG Reporting, Assurance,” JofA, May 17, 2023

“How Firms are Seizing the ESG Opportunity,” JofA, Oct. 1, 2022

Podcast

“The Key Role Accountants Will Play in the Shifting Definition of Value,” JofA, June 29, 2023