Is ESG a defining moment for Accounting & Finance?

Environmental, Social and Governance (ESG) issues have emerged in recent years as key factors to influence the future of the Accounting and Finance profession – but are they going to be a real game changer?

That was the question asked to the participants of the closing panel at the CFO Strategy and Innovation Summit 2022 organised by Chartered Institute of Management Accountants (CIMA) and Rzeczpospolita on 20th October 2022. Lead theme of the event this time was “Creating Value for a Sustainable Future”. I had a pleasure to be one of the panelists alongside Dr. Jeremy Osborne (Global Head of ESG, AICPA & CIMA), Simon Bittlestone (CEO, Metapraxis) and Piotr Rówiński (Partner, PWC Poland).

I was going to agree with that statement anyway, however, the conference itself throughout the day had given many more reasons to concur. Let me call out a couple of them I see as key:

• Desire to re-evaluate the meaning of the true objective for a business to exist
• Evolution of the doctrine explaining the mechanism of value creation or erosion in the business
• Landscape of upcoming regulations
• Critical role of Finance & Accounting in the business storytelling – to both internal and external stakeholders

Finance & Accounting professionals need to expand their competences and learn how to communicate the concepts of broader impact framework.

The Milton Friedman’s economy of 1970s indicated that the social responsibility of the business is to increase its profits and as such, was heavily focused on shareholders as key stakeholder group the business should benefit. Whether Friedman was slightly misunderstood or not in terms of his view on ethics and morality, the concept of shareholder primacy grew stronger and led global markets for many years after, until recently, when more of purpose-led companies started to emerge.

In his book ‘The infinite game’ Simon Sinek promotes a concept of an infinite game[1] of business where a number of players isn’t fixed or known, rules are changeable during the game itself and there is no defined endpoint. You can’t win an infinite game – its objective is to advance the game for as long as possible. According to Simon, companies need to develop five key features to be able to stay ahead of others: have a just cause, observe worthy rivals, create trusting teams, demonstrate courage to lead and develop existential flexibility. This book was where I first came across the concept of a business purpose (called by Simon ‘a just cause’) and it has resonated with me ever since. It adds a lot to my professional fulfillment to be part of a purpose-led organisation like NatWest, where Colleagues are taking every effort to deliver on the bank’s purpose statement: ‘We champion potential, helping people, families and businesses to thrive’. And it is so encouraging to see more and more purpose-led organisations leading the way in the market. Kosala Hewamadduma (Global marketing head and CMO for Asia pacific, NAMET and Africa in Upfield and global marketing head for child nutrition and heart of life platforms) also talked to this in his great keynote speech on the day entitled ‘Re-engineering business models for sustainable value creation’[2]. According to a survey by Kantar, the results of which he referred to, 64% of global consumers find brands that actively communicate their purpose more attractive, 62% want companies to take a stand on issues they are passionate about, and 52% say they are more attracted to buy from certain brands over others if these brands stand for something bigger than just the products and services it sells, which aligns with their personal value. What differentiates purpose-led companies from the crowd is the way they look at generating value for a more diversified range of stakeholders. In NatWest, a BluePrint for Better Business framework[3] is used to look at impacts of the bank’ activity on:

• customers
• communities the organisation operates within
• bank’s employees
• the future generations
• shareholders and regulators

Finance & Accounting professionals will need to adjust their thinking and models to incorporate non-financial drivers of value creation and erosion for their companies as well as stakeholders external to their businesses.

Traditional value creation and erosion assessment mechanisms tend to refer predominantly to produced or manufactured capital, expressed usually in financial terms. What they don’t reflect well enough is the change we’ve seen in the last 50 years in terms of where the value is really coming from. Ash Noah CPA, FCMA, CGMA (VP & Managing Director CGMA learning, education & development AICPA & CIMA) showed this very clearly in his welcome speech on the day, referring to the components of S&P 500 companies market value[4].

A shift in valuation towards intangible assets such as goodwill, trademark, logo, brand value, reputation, relationships, copyrights or patents is evident. Discounting future opportunities and risks surely also played part. The next step, however, which we can already see on the horizon, takes us even further. Analysis of double materiality will require businesses to assess how they create and erode value across other types of capital such as human, social and environmental, and it’s not only about the value for the company itself, but also to the world outside. Both internal Management Information (MI) reporting as well as external disclosures will need to capture a wide range of concepts that we don’t currently neither measure, nor report on.

Regulations are coming in to help Finance & Accounting professionals address ESG-related challenges.

Whilst the emphasis on sustainability concepts to be reported on has been growing for more than 20 years now, it’s only been the last couple of years when we’ve started to notice the real paradigm shift. It is fair to say through that we still lack necessary consistency and transparency, even though the landscape of regulations is quite wide now with a number of requirements already in force, announced or expected to come up, in example:

• EU Sustainable Finance Disclosure Regulation (EU SFDR)
• EU Taxonomy
• UK Green Finance Taxonomy
• Corporate Sustainability Reporting Directive (CSRD)

You can find out more about some of these and see opinions of leading industry experts from Climate & ESG Capital Markets team in NatWest Group under the links below:

https://www.natwest.com/corporates/insights/sustainability/eu-green-taxonomy.html

https://www.natwest.com/corporates/insights/sustainability/esg-disclosures-and-labelling-rules.html[5]

Financial disclosures, with statutory accounts being published as part of them, have been well standardized in recent decades. Finance & Accounting professionals are surely familiar with concepts of International Financial Reporting Standards (IFRS) or International Accounting Standards (IAS) overseen and published by International Accounting Standards  Board (IASB). Ash Noah took time in his welcome speech to introduce us to great efforts being undertaken by Task Force on Climate Related Financial Disclosures (TCFD), Value Reporting Foundation (VRF) and Climate Disclosure Standards Board (CDSB) who are joining forces to collectively form International Sustainability Standards Board (ISSB) in efforts to standardize sustainability reporting requirements in a similar way to what IFRS and IAS helped to achieve in terms of financial reporting and accounting. Next steps will include socializing the proposal and supporting the process of embedding it into relevant national regulations.

Storytelling[6] coming from Finance & Accounting professionals needs to evolve.

We’ve been shared a simple, yet powerful message in the presentation delivered by Simon Bittlestone – the need to be mindful of the importance of dialogue in the wider concept of data analytics. At the end of the day a success of a project will rely not solely on how deep our analysis is and how insightful our recommendations are, but also on our ability to socialize outputs with stakeholders and get their buy-in. The role of Finance & Accounting professionals has long ago evolved beyond financial analysis, modelling, reporting, and explaining variances. For management accountants it’s also not limited to forecasting, budgeting and performance analysis vs targets. Balanced scorecards, Key Performance Indicators (KPIs) or Objectives and Key Results (OKRs) are integral parts of messaging delivered by Finance teams to both inside and outside of the organisation, however, they’re still very often focused heavily on GBP/USD/EUR/PLN or other monetary values. And going forward they’ll need to become much broader than that. Quite often it starts with the right questions being asked to begin with, which can include:

• What impacts is our activity having on climate – quality of air, water, soil or biodiversity? Are we contributing to deforestation?
• Have we created new employment opportunities through our activity? Have we contributed to job losses?
• Are we building a fair, diverse and inclusive workplace?
• Are we creating learning opportunities for our employees?
• How are we sharing the wealth we produce with our customers, employees, and communities around us as well as shareholders?

Answering these questions will, increasingly often, require us in Finance to assess intangible values and measure what we had not measured before. To get there, a variety of new datasets will need to be collected, new methodologies and models will need to be developed. In the ‘E’ element of ESG in example, a bank can measure its carbon footprint in tons of CO2 equivalent. Current industry standards set by Partnership for Carbon Accounting Financials (PCAF) or Science-Based Targets initiative (SBTi) utilise climate science coming from Greenhouse Gas (GHG) protocol to translate each 1£ of on-balance sheet exposure into CO2e, depending on type of activity this lending supports. It opens a completely new layer of discussions to be held in terms of strategic direction for the business and implications on plans and objectives to be achieved. Therefore, it is essential for the Finance function, which is largely responsible for preparation of external disclosures, as well as financial planning processes in the organisation, to adopt the language of non-financials. If you want to see how NatWest are attempting to follow that path you can look into the 2022 Climate-related Disclosures Report or 2022 ESG Disclosures Report under the links below:

https://investors.natwestgroup.com/~/media/Files/R/RBS-IR-V2/results-center/17022023/nwg-2022-climate-related-disclosure-report.pdf

https://investors.natwestgroup.com/~/media/Files/R/RBS-IR-V2/results-center/17022023/nwg-2022-esg-disclosures-report.pdf[7]

It is as such likely that modern CFOs will become key ESG Business Partners, helping to drive the sustainable agenda for the organisations and to do so, they will inevitably need support from their Finance and Accounting functions. Whilst it may be difficult to embark on the journey and transform organisations to broaden a range of success assessment criteria, I’m sure it will allow to capitalize on massive opportunity behind this transformation. One of the ways to advance this agenda is through integration of Climate Transition Planning (CTP) into traditional budgeting, target setting and forecasting processes, which I may write about another time, sharing some of my personal experience in NatWest.

Author: Mariusz Gryz

Photo source: Unsplash