A wave of ESG-related disclosure obligations has CFOs struggling to keep up with new reporting requirements. Reporting is no longer just about providing quarterly financial performance. These new requirements have made nonfinancial disclosures a part of business and the long-term investment thesis. Clearly, CFOs and the finance function have a big role to play here.
To thrive in this evolving regulatory landscape, CFOs must expand their function’s operating models beyond financial statements and construct a more holistic view of their organisation’s sources of value — one that measures and monetises financial and nonfinancial capital.
The balance sheet, income statement, cash flows and stockholder equity have traditionally communicated how — and how much — companies create value. Yet, traditional financial statements tell an increasingly smaller part of the story that stakeholders want to hear.
Regulators, investors, customers, and employees want to understand the impact an organisation has on the environment and society, with insight into how an organisation’s impact is being decided and governed.
Sustainability disclosures need to be in a common language that business and investors understand – a language that describes company performance holistically. To deliver sustained profitable growth and meet new disclosure obligations CFOs will have to embed sustainability into business decisions by connecting material issues to value creation and risk management.
This means prioritising sustainability activities based on business outcomes that are achieved by integrating sustainability metrics into key decision-making processes and the business strategy.
Integrated financial sustainability reporting is here
In June 2023 the International Sustainability Standards Board (ISSB) issued its first two IFRS Sustainability Disclosure Standards, IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures.
These standards bring together the financial performance measures that capital markets have traditionally relied on and the sustainability-related financial information that complements them. They will act as a global baseline for providing, a more holistic picture of corporate performance.
Yet, many companies currently lack the systems and data needed to report on a broader definition of performance. CFOs will need to navigate modernising financial sustainability-related reporting and materiality to remain compliant with their organisation’s regulatory obligations regardless of where they are based or operate.
A common initial barrier is agreement on what is material in the context of sustainability reporting. Assessing materiality is not easy in a financial reporting context especially for EU-based entities and non-EU-based public and private entities with operations in the EU, subject to the Corporate Sustainability Reporting Directive (CSRD) that requires companies to report through double (financial and impact) materiality assessments.
- Financial materiality refers to the effect of sustainability matters on the company’s current or future cash flows, development, performance, position, cost of capital, or access to external finance mechanisms.
- Impact materiality, on the other hand, refers to the impact—actual or potential, positive, and negative, over the short-, medium-, and long-term time horizons—that the company has on a sustainability matter. Impacts include those caused and/or contributed by the company’s operations, products/services, and value chain.
Gartner research has found that leading enterprises link their material nonfinancial issues to their executive compensation in their proxy filings. These companies use annual environmental, social, and governance scorecard metrics and weighted modifiers to clearly communicate to stakeholders that executives must deliver on results.
To achieve similar results, CFOs can structure and report sustainability information similarly to the organisation’s financial filings. Demonstrating stakeholder accountability can be achieved by producing an audited ESG report outlining risks, opportunities, and performance against goals.
Strengthen internal controls in support of ESG reporting
Most organisations already have established internal controls to handle financial reporting and operational risks. But collecting ESG data and mitigating related risks is changing rapidly across jurisdictions and control environments for ESG-related risks and reporting varies significantly among organisations. Controllers globally seek guidance for preparing and complying with integrated reporting standards.
To improve transparency and efficiency in corporate disclosure, controllers should scale their reporting through:
- Pre-readiness assessment to understand which legal entities are in scope for ESG reporting.
- Materiality assessment to determine organisational priorities and focus areas. Either single (financial) or double materiality (financial and impact).
- Gap analysis to validate the specificity of material topics against jurisdiction reporting requirements either through consolidated or stand-alone reporting.
- Robust internal control procedures that prepare reliable, accurate, and timely ESG reporting with qualitative and quantitative data.
- Assurance readiness either through limited or reasonable assurance evaluating ESG data, controls, and identifying inconsistencies.
By taking an integrated reporting approach, controllers can make the process of corporate disclosure more efficient and ensure that stakeholders have the information they need to form an opinion on the organisation’s overall performance.
Communicate how you create value
These new reporting standards are pushing CFOs to restructure their organisations’ business models and materiality assessments to take a more holistic view of sources of value, while embedding ESG-related topics into their accounting practices and annual disclosures.
Yet just 38% of business leaders in a 2023 Gartner survey indicated that environmental sustainability is embedded in their organisation’s decision-making processes. Additionally, there are insufficient reports on water, circular economy, and biodiversity despite increased regulation.
CFOs should see these market changes as an opportunity for innovation. Constraints such as climate change impacts or natural resource availability can be a catalyst for new growth opportunities and generating revenue. High-growth companies drive low-carbon investment and provide seed funding for broad climate research, environmental sustainability M&A through internal carbon pricing significantly more than low- and moderate-growth companies.
CFOs must assess skills and capabilities to develop and scale new technologies, while identifying triggers for additional pilot investment because lack of innovation compromises long-term profitability.
Organisations can drive revenue by scaling innovative sustainable solutions anticipating market needs for sustainable products and services. They must assess innovation pipelines, capabilities, and risk appetite, while evaluating how incumbent technologies and organisations will respond to low-carbon technologies.
