A decade to deliver: CFOs’ ESG considerations

Ambrose Shannon explains how CFOs can play a lead role in limiting the future impacts of climate change during what he describes as “the decade of action”.

Throughout the summer of 2021, heat waves, wildfires, droughts, and hurricanes served as stark reminders that we should not take our planet for granted. The recently published report from the United Nations’ Intergovernmental Panel on Climate Change (IPCC) has made it very clear that unless immediate and large-scale actions are taken to reduce greenhouse gas emissions, these weather patterns, and the corresponding commercial impacts, will only become more severe.

In Ireland, like elsewhere, companies are looking at their own commitments to environmental, social and governance (ESG) objectives (see sidebar) encouraged by both regulatory initiatives and wider societal pressures. For example, the Climate Action and Low Carbon Development (Amendment) Bill 2021 is intended to achieve net-zero carbon by no later than 2050 throughout the entire Irish economy. This entails the introduction of five-year carbon budgets on a rolling 15-year basis. In China and South Korea, where similar measures have been deployed, companies have seen significant impacts on their business models, strategies, and performance. Furthermore, the required Local Authority Climate Action Plans are expected to set out ambitious measures to significantly increase renewable energy production, decrease transport emissions, and reduce the impact of agriculture on the environment.

Irish businesses have a critical role in achieving this climate-driven transition. And CFOs can play a pivotal role in areas such as leading strategic reviews, allocating capital investment, securing funding lines, protecting credit ratings and driving sustainable business performance.

According to Accenture’s 2021 report, CFO Now – Breakthrough Speed for Breakout Value:

• 73% of respondents claim that the CFO is best placed to ensure the resilience of the organisation in today’s operating climate; and
• 68% of CFOs globally are now responsible for ESG monitoring and reporting.

And momentum is accelerating. In November, the United Nations Climate Change Conference of the Parties (COP26) will bring world leaders together to accelerate movement toward the goals of the 2015 Paris Agreement. We expect agreement on ambitious goals, meaning that politicians, policymakers, regulators, and investors will need to work together with businesses to deliver on ESG objectives.

Failure to act on climate change represents an existential risk to society and the global economy and poses a clear financial risk to businesses themselves. The impetus for business to act is time-sensitive and will likely be driven by four key factors:

• Governments setting legally binding emission reductions and net-zero targets;
• Investors and financiers wanting to understand climate-related financial risks and long-term business model viability;
• Employees placing increased importance on the ESG values and actions of their employer; and
• Customers placing ever more importance on the sustainability of the products they consume – with many seeking “champion brands”. 

For business to meet these demands, CFOs and executives need to create and operationalise a comprehensive ESG strategy.

Key considerations

Regulators have for some time now warned about the threat that climate change poses to the stability of the financial system. Mark Carney, formerly Governor of the Bank of England, is leading a World Economic Forum (WEF) initiative to explore the risk posed to global financial systems associated with the energy transition. According to the Bank of England, as much as $20 trillion of assets could be at risk from climate change alone.

The progress of delivery against ESG transition plans varies greatly from sector to sector and geography to geography. A report by Arabesque S-Ray found that just 25% of public companies worldwide are on track to deliver on their ESG-related commitments.
Our research and work in this space suggest that CFOs and the wider finance team are uniquely positioned to guide their organisations in the following ways:

• Assessing the ESG impact on existing business models. CFOs can play a crucial role in assessing and measuring the potential impacts of ESG on current business operations. For example, identifying and modelling risks could include scenarios on the P&L impacts of a 1.5-degree world, the impacts of a higher carbon tax on profitability, the introduction of subsidies, or pricing signals to parts of the supply chain.
• Highlighting risks associated with ownership of certain assets. It is rational to expect the valuations of certain assets on the balance sheet to fluctuate as we progress through the transition towards net-zero. For example, we have seen large write-downs in valuations among many of the global oil majors. On the other hand, it is equally rational to expect certain asset classes to rise in value, such as those parts of the economy that support the electrification or home insulation agendas. Either way, CFOs will want to avoid holding stranded assets and will need to make more material bets on a more frequent basis over the coming decade.
• Identifying where investment will be needed to transition to a sustainable economy. Ireland’s transition to a more sustainable future is expected to have a wide-reaching impact on key sectors of the economy. For example, Ibec’s report, Building a Low-Carbon Economy, suggests that Ireland’s electricity and transport systems will need to reduce emissions from 1990 levels by up to 92% by 2050 and that buildings and factories will need to reduce emissions by up to 99%. Decarbonisation needs to go hand-in-hand with technological innovation, and CFOs will play a key role in identifying where investment is needed to ensure that business outcomes are achieved in a way that is economically and environmentally sustainable.
• Responding to investor demands and attracting investment. In the US, one-third of the $50 trillion of assets under professional management is invested in ESG strategies, according to research by the NewClimate Institute. ESG considerations are increasingly being adopted in assessing the sustainability and risk of investment decisions. At the same time, investors and pension funds are applying pressure on companies to provide products and services aligned with the UN’s Sustainable Development Goals (SDGs).
• Turning ESG commitments into action. Credibility is not a new concept to finance but is vital in the ESG space. As a profession, we can help our organisations avoid even the suggestion of ‘greenwashing’. Credibility is enabled by robust transition plans with regular and transparent disclosures on progress against them. Some CFOs are investing now to create enterprise-wide data provisioning and analytics solutions for ESG. This will enable them to model multiple commercial scenarios and inform the optimal pace and sequence of the pivot.

Conclusion

While executing a successful ESG pivot depends upon a strategy that is unique to the qualities and context of the organisation, there are a few best practices you can leverage:

• Conduct a materiality assessment. These sometimes behind-the-scenes assessments are a data-driven, holistic view of ESG risks and opportunities to identify gaps and prioritise the issues of focus against business and stakeholder importance.
• Build an effective communication method for the company’s ESG commitments and progress. This typically takes the form of a disclosure with a newly crafted framework and reporting metrics for standalone ESG disclosures, leveraging industry-leading practices.
• Formalise ESG governance. Stakeholders must be identified as explicitly responsible for new associated ESG activities. The company needs to craft a defined governance model and roadmap for execution, mobilising internal resources and data for ongoing assessment and reporting.

These three steps have helped organisations successfully navigate and focus an ESG pivot and capture the associated resiliency and revenue potential. This is the decade of action to dramatically limit the future impacts of climate change – time is of the essence, and the time to act is now.