ESG Is Not ‘Merely An Expensive Compliance Exercise’

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Finance chiefs need to take sustainability seriously to properly anticipate risk and judge organizational health, says Shari Littan of the Institute of Management Accountants.

Companies truly committed to achieving their environmental, social and governance goals ultimately perform better, argues Shari Littan. And finance professionals can get ahead in that endeavor by adopting sustainable business accounting practices as part of a broader sustainable business strategy.

The director of research and corporate reporting policy at the Institute of Management Accountants in Montvale, New Jersey, spoke with StrategicCFO360 about how CFOs can do just that, the risks of not taking ESG seriously and why you don’t want to be “the last entity holding unrecoverable brown assets.”

How can a successful sustainable business strategy deliver long-term value for your business?

The crux is the organization’s purpose. An organization encourages a range of stakeholders, including investors, employees and customers, to contribute resources so that it can achieve its overall mission. Stakeholders are all contributing valuable resources, and a commitment to act ethically and create value. By looking at this overall purpose, the organization sets various objectives such as financial, operational and sustainable business objectives.

We are seeing a worldwide acceleration on ESG reporting—from the SEC, the International Sustainability Standards Board and by the European Commission. Yet, we see some leaders who view ESG reporting as merely an expensive compliance exercise. Sustainable business management, however, is really a broader endeavor that speaks to understanding risks to resources and responding by building strategies to meet objectives—relying on quality information. For finance professionals, the strength of a company’s sustainable business information has become a significant barometer of organizational health—over the short and longer term.

I think about sustainable business accounting in terms of a hidden balance sheet. There’s a whole lot of intangible value that an organization nurtures and preserves through investment, but doesn’t account for as an asset until a company is acquired. Yet, today, the market trades overwhelmingly on this value. It represents expectations about the future and risks, and our relationships with our stakeholders. The more solid these relationships, the lower the risk and cost of capital. It shows good management and stewardship of resources.

Now, imagine we considered this value and managed it. It’s the value of loyal customers, engaged employees, committed investors and relationships with a community that likes what an organization is contributing to the world. The challenge is that it’s new, and we are still learning—first, what to account for and second, how to build the right systems and processes to do this in a reliable way. 

What are some potential risks businesses should be aware of when embracing sustainable business management? 

There’s the risk that an organization simply ignores emerging trends and changes regarding sustainability, such as buyer preferences, the need for talent and the competition for capital, which represents competitive disadvantages. Some have compared these trends with 1990s technology trends when companies didn’t adapt and put themselves at a disadvantage.

To me, the highest priority item for regulators and standard setters is stranded assets. As the economy continues to transform from one that is dependent on fossil fuels to one powered by renewable energy sources, assets, operations and investments will become impaired as productivity diminishes. Some of these will be completely unrecoverable, and much of this financial risk is hidden and challenging to estimate.

Everyone knows the market will continue to transform, but the key factor is how fast. Everyone is concerned about being the last entity holding unrecoverable brown assets. Companies with fossil fuel-dependent business models will need to shift their business models before they are adversely affected in a major way.

What are some key areas of sustainable business strategy that CFOs of large companies should be turning their attention to right now?

CFOs should be working with their management team and hearing feedback from constituents to consider purpose, and then reconsider and balance objectives. It also means working across the organization including human resources, operations, facilities and investor relations.

We also need to reevaluate talent within the finance and accounting function. The competition for talented professionals is fierce, but it’s critical to hire and train teams with innovative mindsets that go beyond the quarter-to-quarter checklist. An excited and engaged team will take the extra steps to identify risks, and develop strategies and techniques to manage changes. 

All this culminates in the delivery of relevant and reliable information. It means considering whether the right structures exist and whether there are controls and oversight functions over the necessary data. There’s a lot of attention on what a company should report for sustainability purposes, but we need to focus just as much on process. 

For smaller businesses with less advanced sustainable business strategies and ESG reporting processes, how would you advise them? 

In accounting, standard setting around ESG seems to be predominating, and this will likely directly affect the largest global public companies. Many private and small business managers think it doesn’t apply to their organizations, but they will also be impacted.

First, in the supply chain, large companies—after making commitments to ESG—may be looking to source from suppliers that can deliver goods and services in a sustainable way as evidenced by reliable data. Second, there is a growing use of ESG-linked or GHG-linked lending in which a lender will adjust the interest rates if the borrower meets certain ESG or GHG metrics. Third, in the insurance space, many companies, particularly smaller companies, may be at risk of losing insurance coverage for certain climate-related risks. On the other hand, they may be able to lower insurance costs for addressing risks that fall under the ESG umbrella.

Now, these new types of arrangements have a compliance aspect dependent on reliable data. Therefore, even private companies may find real savings by getting ready, implementing new systems, and setting targets and strategies. 

The time is now for companies of all sizes to take sustainable business management seriously and devote their attention and resources, so they aren’t left behind.

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