Creating long-term value through ESG

Feb 09, 2021
Dr Rodney Irwin explains how Chartered Accountants can fulfil their professional duties by strengthening company value through environmental, social and governance criteria.

The COVID-19 pandemic has its origins in nature, and through poor biosecurity, it made its way into the human population. Everyone has been impacted to some degree, but how many have considered the pandemic an issue of sustainable development and, perhaps, only the tip of an iceberg?

Sustainability is sometimes seen as a cost, but this is not the case. A report by the Business & Sustainable Development Commission estimates that at least $12 trillion in business opportunities would come with the realisation of the United Nations’ Sustainable Development Goals (UN SDGs) by 2030. So, it is not hard to understand why many companies are setting ambitious strategies and targets to reap the benefits. Examples include PepsiCo pledging net-zero emissions by 2040, Stora Enso issuing a €500 million green bond, and Unilever building its successful strategy around making sustainable living commonplace. Companies are increasingly shifting towards more sustainable strategies and stakeholder capitalism by moving away from short-term shareholder primacy.

Financial and accounting systems influence decision-making, the assessment of corporate performance, and the value attributed to it. Therefore, financial and accounting systems play an important role in helping management and others evaluate a company’s ability to identify and manage environmental, social and governance (ESG) risks and create sustainable value over time.

As accountants, we are expert in financial capital, management information, and accounting standards. But I would strongly argue that the stocks and flows, impacts and dependencies of other forms of capital are equally – if not even more – important in the 21st century to understanding value creation.

I argue that we are not accounting for sustainability, value, equity and, ultimately, survival. Sure, we might be compliant with the letter of the existing rules as professionals, but we have a duty to act in the public interest, and I feel that today, we are failing in this fundamental duty.

With that in mind, what can we do in our day-to-day lives to fulfil our professional duties?

Keep abreast of the ever-changing landscape

2020 marked the five-year anniversary of the Paris Agreement and UN SDGs, and the three-year anniversary of the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). These are fuelling many governments to set out expectations for companies to adopt accounting, financial and reporting approaches designed to support the transition to a more sustainable future. For example, the EU’s non-financial reporting directive (NFRD) update is planned to be adopted by the European Commission in Q1 2021. In a significant move, Canada, New Zealand and the UK are looking to make climate disclosure mandatory for large companies and financial institutions.

Work is also underway to harmonise the so-called non-financial reporting landscape: the big voluntary standard makers announced their intention to work together; the World Economic Forum launched streamlined ESG indicators; and the IFRS and IOSCO expressed strong interest in taking a role in sustainability. Chartered Accountants must stay ahead of the curve to ensure that compliance does not create a burden, but unlocks insights into the company’s ability to create value for all stakeholders.

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Identifying risks, opportunities and strategies

Companies need to understand and manage ESG-related risks. As well as maximising the potential for $12 trillion in business opportunities, we have seen companies issue profit warnings and file for bankruptcy due to ESG-related events. BASF issued profit warnings due to low water levels in the Rhine river, which affected transportation and production in 2018 impacting Solvay, Shell and many other companies as well. Said to be the first known climate change bankruptcy, PG&E filed for bankruptcy in 2019 following California’s drought and forest fires.

However, 44% of companies show some alignment between what they say is material in their sustainability report and what they disclose in their legal risk filings. In practice, this means relevant risks are not being properly disclosed or considered in strategic decision-making.

As trusted advisors, Chartered Accountants must provide decision-useful information for both management and investors to make the right resource and financial allocations.

Focusing on materiality

The misalignment in reporting mentioned above is just one indication of the dilemmas companies and others face in determining which ESG matters represent sufficiently serious impacts and dependencies, and over which time-scales, to threaten corporate performance.

The concept of materiality is developing. The EU has introduced its double-materiality that takes account of the significance of ESG issues affecting the company’s development, performance and position (sometimes known as “outside-in” materiality) and the significance of the impact of the company’s activities on the environment and society (sometimes known as “inside-out” materiality). We are in a crucial position to ensure that both types of material information get captured, managed, and demonstrated to our key stakeholders.

Providing robust information

The number of signatories to the UN Principles for Responsible Investment (PRI) grew to over 3,000 globally in 2020. Strengthening the investment case, several studies have shown no negative impact of including ESG considerations in the investment selection criteria. Furthermore, companies are likely to generate better returns when they manage ESG issues well. With these trends, we must ensure that the ESG information produced is of high-level, decision-useful quality for internal and external decision-making and that our companies can profit from a lower cost of capital due to more robust management of risks like ESG.

Accounting for ESG matters is not a rejection of traditional accounting. It builds on concepts such as accounting for externalities, which have been in circulation for a century. Many studies in the public domain criticise accounting (at a corporate and national level) for mismeasurement, using deficient metrics that ignore ecological and social depreciation and amortisation. However, the IASB has made it clear that we have existing tools in our armoury of standards to account for ESG risks.

This is a new chapter for Chartered Accountants. We need to embrace the ESG agenda, skill ourselves sufficiently to be competent and honour our profession’s call to act in the public interest. We can be architects of the future, building on our heritage and developing a new accounting language so that new knowledge will emerge to secure both reward and survival. We should, and we must, enhance and share our unique and important skills to help decision-makers understand and act on this new reality.

Ensuring sustainability information is decision-useful: new guidance coming on assurance

Investors are increasingly looking for third-party assurance of sustainability information. The problem is that, unlike auditing financial statements, the market for sustainability assurance is unregulated and practice is inconsistent – even though standards do exist. To strengthen practice, the International Auditing and Assurance Standards Board (IAASB) is developing guidance to assist practitioners with the critical challenges in assuring sustainability information. A primary focus is on report users’ needs to ensure that they can use the information with confidence. The IAASB expects to issue its final guidance in March after an extensive consultation process. Once launched, the guidance will be promoted through the global network of over 170 professional accounting bodies, which are required through the International Federation of Accountants’ membership criteria to follow international standards.

The World Business Council on Sustainable Development (WBCSD) has been instrumental in driving greater credibility in sustainability through its assurance project. In addition to working with the IAASB, WBCSD has produced the freely available Buyers’ Guide to help companies procuring external assurance, guidance on internal controls over sustainability information, and a study of investors’ needs when reviewing sustainability assurance. These tools aim to help practitioners, companies and investors have greater confidence in sustainability reporting so that the information, regardless of what report it appears in, can be relied upon for decision-making.


Practical steps to integrate ESG to ensure long-term value creation

As the prominence of environmental, social, and governance (ESG) is growing, companies need to meaningfully integrate ESG into mainstream business processes to ensure long-term profitability and resilience. To do this, the World Business Council for Sustainable Development (WBCSD), a global and CEO-led organisation of over 200 leading businesses working together to accelerate the transition to a sustainable world, has created strategic and practical steps to understand and manage relevant ESG matters:

Step 1: Understand key risks, opportunities, impacts and dependencies by assessing the broader range of your impacts and dependencies by using the Capitals Coalition’s Natural Capital Protocol and the Social & Human Capital Protocol. Also, build your company’s resilience with the COSO-WBCSD guidance on applying enterprise risk management (ERM) to ESG-related risks in conjunction with our diagnostic tool to understand your level of ESG integration.

Step 2: Report strategically by building effective disclosure with the help of our ESG Disclosure Handbook, and uncover good practice and sustainability reporting trends through Reporting Matters.

Step 3: Give investors decision-useful information by exploring the Task Force on Climate-related Financial Disclosures (TCFD) Preparer Forum’s good disclosure practices. Strengthen your understanding of investor perspectives and dialogues and improve your data quality and credibility through the Buyer’s Guide to Assurance on Non-Financial Information.

Step 4: Prepare for change by modernising corporate governance by understanding the relationship between sustainability and governance and ensuring robust internal controls, using the latest guidance on improving ESG information quality for decision-making.

For the full list of steps and access to the resources referenced above, visit www.wbcsd.org.



Dr Rodney Irwin FCA is CFO/COO of the World Business Council for Sustainable Development (WBCSD).