CFO Chapter 2: Leveraging ESG
Finance is often defined by numbers which are calculated by ins and outs. This isn’t surprising considering it is how business typically works too: resources or services are continuously exchanged. Or in other words, something is taken from one party and given to another.
However, there are growing calls for how business is conducted to change. ESG can be held responsible for this. Compared to the linear business world which CFOs are familiar with, an ESG driven economy becomes more circular in shape.
With the entire wireframe of business potentially being remodeled, it is right for CFOs to wonder about how they are meant to drive growth and calculate returns in a circular economy. After all, it is confusing to think that going round in circles will attain growth.
Increasingly though it is becoming clear that adopting a strong ESG model is in fact crucial for business success, placing it firmly on the agenda of CFOs. In this first CFO Chapter we will therefore define ESG, explore why it is important, explain how to achieve growth with it, and discover ways to calculate ESG initiatives.
What is ESG?
ESG stands for Environment, Social and Governance. Like Corporate Social Responsibility (CSR), it is growing in importance due to the more aware and inclusive society we are living in, and the current environmental state of our planet.
With regards to reporting, ESG goes two ways – businesses must proactively reveal how they are impacting the planet and society, whilst also stating how they will react to disruptive environmental and societal activities which could drastically disrupt their business.
Despite its importance, ESG reporting is still in its first iteration for most financial professionals with few defined procedures in place. However, with 75% of financial professionals recently suggesting that questions over ESG reporting are being voiced by audit or other board committees within their companies, it appears that ESG reporting is set to undergo an imminent evolution.
Why is ESG important to CFOs and businesses alike?
Currently, finance professionals exhibit a high level of internal ESG involvement within their companies. This is the case despite only 7% of chief accounting officers (CAOs) and 3% of CFOs “owning” the ESG reporting process. Whilst CFOs might not currently be leading ESG reporting efforts, EY recently discovered that more than 60% of individuals surveyed believed that that the CAO, CFO, Head of SEC Reporting, Head of Internal Audit, and audit committees are either highly or moderately involved.
Moreover, with McKinsey revealing the positive financial ramifications of ESG on corporate returns, and the increasing scrutiny upon ESG reporting, it is not farfetched to believe that CFO involvement could grow even greater. After all, ESG is now a money maker. CFOs therefore require accurate numbers to direct new ESG initiatives and consider if other departments are optimally leveraging ESG; produce reports with a high level of accuracy which is devoid of fraud; and recognise why ESG is important to their business and various stakeholders such as:
- Customers – typically customers would determine the pricing and branding of a business but now their influence reaches values too, especially when it comes to ESG. This shift has been taking place since millennials began to assert their buying power, but the rise of ESG over branding has never been so prolific as now. This is demonstrated by how 75% of Gen Z view the sustainability of a company more important than their brand name when making a purchase.
This trend however isn’t exclusive to Gen Z. In fact, Gen Z’s principled buying decisions are influencing older generations too. For instance, in the space of 2 years (during which Gen Z really came of age) an additional 23% of Generation X suddenly preferred to make sustainable purchases.
To ignore such trends would be enormously naïve by any CFO. Gen Z’s buying power is currently estimated at $323 billion and is only moving in one direction – upwards. To drive sustainable growth in every sense of the term, CFOs should therefore be loosening their purse strings to initiatives with environmentally and socially conscious consumers in mind like Gen Z.
- Employees – always trying to wrestle away from customers the coveted title of the most important demographic to a company, employees also are forging a special relationship which ESG.
Like the undisputable fact that Gen Z are gaining a greater proportion of the world’s spending power, they are also coming through the ranks into the workplace to dominate it alongside millennials. Despite the job market being extremely competitive, 76% of millennials state that when seeking work, companies’ sustainability agenda is a big factor. Collectively, millennials and Gen Z are a principled generation, potentially sparking the talent war to get even fiercer. CFOs know better than most the cost of poor recruitment, and now good ESG can be one of their most effective weapons.
Whilst ESG principles are growing in importance for most employees, a position where it is particularly vital from the perspective of a CFO, is that of the Chief Procurement Officer. Given that it is well known that ESG can boost returns and develop customer loyalty with younger generations, CFOs need their CPO to be on the same page when it comes to accepting the extra costs which come from acquiring sustainably sourced materials or services.
- Investors – funding an enterprise is never a quick move, it requires concerted investment over the long-run. The current condition of planet Earth is therefore worrying. This might sound drastic but the pandemic proved that anything can happen. During this time, companies with higher ESG scores far outperformed their counterparts. Furthermore, many companies are now accepting that climate change is going to have a significantly negative impact on their bottom lines.
Whilst price-to-earnings ratios undoubtedly remain the number one metric which investors look for, they are also increasingly becoming concerned with ESG credentials. Why? Firstly because those with stronger ESG ratings are likely to be producing innovations which promote a better planet and will be successful in centuries to come, unlike those which continue to drive the fossil fuels economy. Also, because companies which align with customer priorities like ESG are nearly always more successful.
The latter influence on investor decisions is once more driven by Gen Z. This comes not just through their growing spending power but also the work they are doing to promote awareness of ESG principles. From large scale activism to dinner table conversations, Gen Z has made other generations question what their investments are fueling, and what planet their money will be leaving to future generations. As a result, many portfolios now include ESG options.
These ESG offerings, such as Wealthify’s Ethical Plan, are growing in popularity every year. In fact, between 2005 and 2015, European investment in them increased by 2052%. It’s also true for European ESG-linked loans which have more than quadrupled from roughly $28.5 billion in 2017 to $108 billion in 2019. Any CFO hunting for a strong investment round will therefore be wanting to share positive ESG credentials.
- Regulators – CFOs are no strangers to regulations. Their work is extremely important and therefore must be held accountable to strict protocols. Reporting upon ESG initiatives is another activity which demands equal transparency and accuracy.
Although ESG reporting is still nascent, producing comprehensive ESG results is becoming increasingly crucial for CFOs as regulators come to demand standardized reporting. For instance, the US Securities and Exchange Commission (SEC) are aiming to impose rules upon organizations to guarantee that organizations:
- Describe how climate-related events and transition activities would affect individual line items and their financial statements
- Disclose their board members’ climate-related expertise
- Share how they intend to meet their climate related goals, how they measure their success and whether they are on track
- Reveal greenhouse gas emissions caused by their operations and indirect operations due to services and goods they procure
This list is not exhaustive of the SEC’s aims but the breadth of it illustrates the detail which ESG reporting will soon consist of. This might seem overwhelming for some companies; however, since July 2020, roughly 90% of S&P 500 companies produce annual ESG reports, reflecting their commercial benefits.
Overall, it is undeniable that ESG is a consideration which is viewed as crucial by many stakeholders who CFOs are very familiar to catering for, making it their priority too.
How can CFOs deliver growth through ESG?
Whilst the importance of ESG continues to grow for many corporate stakeholders, including CFOs, the latter’s main priority will always remain dedicated to growth. However, ESG and growth are not mutually exclusive. Even through promoting a more circular economy, CFOs can grow their businesses. One of the most conducive ways to do this through the promotion of ESG is by expanding their circle. After all, ESG is something which most people want to promote, and other companies wish to be part of.
However, to achieve ESG driven growth, CFOs will need to get the following right:
- Invest in the right technology – due to ESG reporting being a relatively new activity, when doing so, it looks as though finance professionals have on the whole defaulted to using their favorite spreadsheet tool. EY reported in 2022 that 55% of respondents used Excel along with various other resources to conduct their ESG reporting. The fact that individuals are using collections of software alongside Excel show that it is not capable of doing a sufficient nor specialist job for ESG reporting.
Unfortunately, using various applications only makes ESG reporting an overcomplicated and lengthy process. In other financial activities like reconciliation, extracting data from various sources has become less problematic thanks to the likes of Aurum’s vast integration capabilities. Hopefully, as ESG becomes more mainstream, companies will adopt more comprehensive tools to tackle one of the largest issues when it comes to ESG reporting – collecting and standardizing data from so many sources. This will in turn make it a more efficient process which becomes easier to draw valuable insights from.
- Get the right people on board – ESG initiatives are people initiatives at the end of the day. For them to come to life, they must have the buy in of individuals within a company. Although ESG’s prominence is predominantly being driven by younger members of staff, for it to be a true success, leadership must come from the top.
This is especially true for some senior positions within companies such as HR, CPO, Chief Sustainability Officer and CFOs themselves. These individuals have roles which are intrinsically related to the aims of ESG and therefore have a big influence upon a company’s actions.
Beyond internal staff members, CFOs should also be shrewd when considering who to partner with. Whilst a company’s reputation is predominantly defined by their own actions, in the past there have been both great successes and horror shows when it comes to corporate partnerships. For instance, no ESG conscious CFO would sign-off today on a partnership like LEGO’s and Shell’s. Following public outcry and a campaign by Greenpeace based on the conflict between LEGO’s primary audience of children, and Shell’s questionable environmental actions, it collapsed in 2014.
- Make sure that reporting is right – this might sound obvious, but it is an important topic. Given all the benefits of ESG reporting and initiatives, it could be tempting to present fraudulent figures to improve the perception of a company. Deception however is anything but synonymous with the values of ESG.
Not only can producing false ESG reports harm the perception of a company, they can also cost them. For instance, the US SEC charged the Bank of New York Mellon Corp’s investment management arm $1.5 million for their misleading claims on how they pick stocks informed by environmental and social criteria. As a result, when it comes to driving growth through ESG, it is important to get it right. Any discrepancies – even if accidental – can be extremely costly, moving businesses away from growth and towards losses.
- Get the right reports on time – ESG is a sensitive topic. Not just due to the real-life implications it has on everyone but also because it can alter significantly depending upon various factors. From increases in temperature to the disruption of new renewable energy sources, or shifting political policies to revoking of laws, ESG can be extremely volatile.
CFOs experience this day in, day out when handling financial markets. To counteract these changes, they make themselves and their businesses as prepared as possible through diversification and timely reports. The latter means that they have contemporary data at their fingertips to forecast far into the future and react agilely in the immediate.
Achieving this is easier said than done but once more, inspiration can be taken from the best practices of existing financial activities. For example, financial forecasting is vastly improved by frequently receiving reports of verified data. The likes of Admiral Insurance, Octopus Investments and many others achieve this through Aurum’s automated reconciliation software which can be scheduled to deliver reports for whenever they like in seconds.
With CFOs having first-hand knowledge of how automation can not only save time but also assist with industry fluctuations by being better prepared, hopefully they will seek to rectify the fact that ESG reporting is currently only ranked as 3.5/10 when it comes to automation.
- Taking action is right – ESG reporting is important to regulators in particular; however, CFOs should ensure that outcomes from reports lead to tangible action. Beyond regulators, the attitude of ESG supporters such as customers and employees is very much, “actions mean more than words”.
The extent to which this is true is strongly reflected by how Rockefeller Asset Management revealed from a study over 10 years that merely reporting upon ESG metrics does not drive financial benefits, they must be supported by action. This unequivocally demonstrates the importance of proactive, positive action if CFOs are to use ESG as a method to drive growth.
Ultimately, there are many ways which CFOs can influence a company’s dedication to growth through ESG. However, this appetite doesn’t necessarily have to be driven by CFOs. In fact, between May 2021 and May 2022, EY uncovered that the majority of the companies which they surveyed had invested more time than ever before in supporting their finance functions address ESG data collection, aggregation and disclosure.
How can CFOs calculate ESG initiatives?
Despite CFOs being in the numbers game, few might have expected that they would be concerning themselves with numbers regarding environmental and social issues. However, how they handle them does not need to deviate from how they go about their usual business.
As a result, whilst the development of controls and processes to gather data are certainly under the remit of CFOs, knowing the nuances of climate and human capital metrics shouldn’t be. Measuring ESG initiatives therefore require high levels of collaboration between CFOs and their colleagues in different departments, especially when first creating reporting infrastructure.
The insights which these other professionals offer will be invaluable. CFOs’ contributions to ESG reporting will be too, and can be excelled by asking these important questions:
1. What is our aim?
On the surface, ESG has pure intentions but for companies they can deliver much more. When designing ESG reports to measure initiatives, CFOs should therefore not feel that they are doing anything wrong when adding a commercial aspect. It should also be noted that the mere collection of ESG data can be commercial in nature. For instance, reviewing the number of diverse new hires could directly impact future recruitment efficiencies and costs.
Depending on the aim of ESG reporting, below are some example metrics which could form part of ESG reporting:
- Carbon emissions
- Office energy rating
- Uptake of cycle to work schemes
- Career progression
- Awareness training
- Flexible working policies
- Tax transparency
- Internal controls
- Board diversity
2. How do we make our data useful to us?
Reporting upon data gives an insight into the past by default. At its very pinnacle it can deliver real-time information. Basic ESG reporting is no different; however, the best ESG summaries are able to inform future activities as well.
CFOs should therefore draw on their forecasting capabilities to demonstrate to stakeholders how their corporate ESG efforts will impact the future. After all, ESG is a long-term strategy and one which customers expect to see commitment to in order to establish a healthier planet and a better society.
To ensure that ESG data doesn’t merely serve regulators, customers, and potential employees who wish to make informed decisions, CFOs should ensure that their data is extracted in a format which is suitable for them to analyze. Not only will this result in them being able to think critically about their ESG initiatives, it will also grant them an opportunity to forecast how their ESG credentials will continue to improve – something which greatly appeals to customers and investors alike.
3. How should we present our findings?
Reporting upon data is a difficult task; however, a common aim of it is to always make it easily understandable for others. Due to ESG being a concern for everyone, and it being driven by principles of inclusion, it is really important that ESG data is presented in accessible formats.
CFOs should therefore ensure that they consider how they will document their ESG findings. Typically, infographics and visualisation tools are popular. In addition, they should also always include comparisons to previous ESG results. Doing so guarantees that readers are given continuity and complete context regarding a company’s ESG efforts, delivering full transparency.
Overall, successful ESG calculations should always include the input of many individuals within a company. Bringing diversity of thought to such an operation is again in keeping with its principles. However, CFOs and their finance teams will undeniably play a larger role than others.
Already this is being seen with 72% of organizations currently formalizing a process owned by the finance function for collection, processing and reviewing data. Yet, to reflect the diverse input of ESG, 35% of these organizations indicated that they were considering implementing formalized processes led by another function, while 37% were considering implementing formalized processes led by finance.
Business as usual with ESG
Introducing ESG to finance brings with it many changes. However, by looking at it a little deeper, arguably it is still business as usual. After all, ESG’s growing weight in the world of business is being driven by customers and investors; regulations are developing at an increasing rate; and timely accuracy is paramount. For CFOs, ESG therefore offers a lot of familiarities.
However, CFOs who embrace ESG will be remembered as those who didn’t stick with the status quo but delivered positive change. As an initiative which promotes creating opportunities for everyone in ways which they might never have thought possible, CFOs owe it to ESG to grab their own unprecedented opportunity of being environmental and societal champions with both hands, and progressively shape our world.
In the next installation of the CFO Chapters, we will be looking at Digital Transformation – a continuous activity for any CFO which can never stop. You can find out more about this chapter plus the others which will feature in 2023 by clicking here.
Also, if this chapter has peaked your interest in the financial nuances of ESG, keep an eye out for our upcoming blog to celebrate Earth Day 2023 later this month.