ESG used to be seen as an add-on. Now, it’s the data-driven way to understand long-term value. Deloitte’s Kristen Sullivan and Veronica Poole explain what companies can do to embrace this changing perception.
Veronica Poole: To be authentic and credible, reporting needs to reflect what is actually happening in the business. And this really means integrated thinking. Does the business integrate the consideration of people, planet, prosperity, all those ESG factors, into the core of the business?
Tanya Ott: ESG is having a moment. What it is and why taking it seriously is a business imperative, today on the Press Room.
Tanya: Thanks for joining us. I’m Tanya Ott. Climate change; natural resources; employee health and safety; diversity, equity and inclusion—these fall under the heading of ESG, or “environment, social, and governance.” Corporations are facing a lot of challenges these days and responding to them isn’t easy. But we’re not starting at square one to transform our global economy. There’s been tremendous progress over the last two decades in ESG, and today I’ve got two guests who are deeply embedded in this space. Veronica Poole is a vice chair of Deloitte UK and Global IFRS [International Financial Reporting Standards] and Corporate Reporting leader.
Veronica: Which basically means that I’m Deloitte [UK]’s voice on all matters on corporate reporting.
Tanya: And Kristen Sullivan is a partner in Deloitte & Touche LLP.
Kristen Sullivan: I lead our sustainability and ESG services and also serve as our global audit and assurance, climate, and ESG services leader. ESG has become the language of the capital markets and it’s increasingly being referred to as a data-driven way to understand long-term value. [It is creating] this recognition that organizations really need to expand their aperture of understanding of the impacts and the dependencies that businesses have on the environment and society around them toward that lens of driving value into the future in the face of continuous disruption that every organization is navigating. So really become a central theme in the capital markets.
Veronica: You’re quite right. Traditionally, these issues have been considered separately from the business model and strategy. But now it has become very much the focus of understanding of how a business is going to build, protect, [and] enhance enterprise value over time. So quite a long journey that ESG has traveled from [idea that it should] sit on the side, be the subject of a stand-alone sustainability report, focus on the impact of a company on the environment, people, and the economy, to being something that is directly enterprise-value relevant.
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Tanya: How have you seen this space evolve beyond the idea of it being separate to begin with and then being brought together under that value proposition?
Kristen: There’s a much clearer recognition that ESG issues are business issues. ESG opportunities are business opportunities. This [is the] sort of transformation we’ve seen in the market. Organizations historically had viewed this concept of sustainability, citizenship, responsibility as an exercise in communicating a lot of really positive and more philanthropic activities, [and] there’s been a clear pivot to this recognition that environmental and societal impacts and risks and disrupters are very central and over a very much clearer time horizon and therefore require an established governance structure no different than other emerging and other types of risks to the business to really understand, manage, and then ultimately understand and communicate and measure the value and the mechanisms in place to protect for downside risk as it relates to ESG topics and performance areas.
Veronica: Indeed, there is a growing realization that these issues can significantly impact the business. What I mean by that [is their] impact on its financial position, performance, reputation, and ultimately its ability to create that enterprise value over time. There is a further driver here, a growing awareness among the business leaders that there is a relationship between purpose and profit. There is a growing expectation among stakeholders that companies should deliver value to a broad range of stakeholders in order to earn their license to operate. So ultimately, that is redefining the social contract between business and society.
Tanya: So you’re talking about corporations. You’re using the word business leaders. But I wanted to get a sense of the landscape in terms of who’s really paying attention to this. Who cares about these issues?
Veronica: We already said that there is a direct link between ESG and performance over time. So investors are increasingly factoring these matters into their investment analysis and in their investment decisions. We have seen a significant inflow of investments into sustainable funds. According to the latest report by the Global Sustainable Investment Alliance, sustainable investment globally has now reached $35 trillion. [That] is pretty much a growth of 15% in two years, according to that analysis, and in total equates to 36% of all professionally managed assets covered in their report. It’s not really surprising that these issues are at the top of the agenda for business leaders, investors, policymakers, and stakeholders alike.
Tanya: We hit an inflection point in the last couple of years where this conversation around reporting has really changed significantly, as you alluded to. First of all, what’s prompting that and what are we hearing at different levels of the discussion?
Veronica: Boards of directors are increasingly recognizing that transparency and accountability are essential to enhancing trust and to translating their purpose, their business purpose into actions. We’ve seen that with the WEF [World Economic Forum] project, which was on stakeholder capitalism metrics, on reporting and measuring what’s relevant to business. WEF IBC [International Business Council] companies identified 21 core metrics that they felt important to report on value creation, and many are committed to reflect this in their reporting. That project was really designed to act as a catalyst toward global sustainability standards and to bring the voice of the business to the table, making it clear that these issues are important to business and business wants to be part of the solution. So that was the move by business.
But we also have seen a move from investors who very much brought us to that inflection point. They have set out their clear expectations for companies to report in the mainstream on ESG matters that affect enterprise value, whether it’s on climate or other aspects of people, planet, and prosperity. Regulators [and] policymakers around the world started making the moves by introducing mandatory ESG reporting requirements. So here you go. Different forces fundamentally changing the landscape.
Kristen: I would just add that sort of this confluence of developments that we’ve seen in another notable milestone that we anticipate every year—the WEF’s annual Global risks report that comes out each January that has, over the past many years, continued to demonstrate and show that the significant risks to the capital markets are really concentrated from a climate perspective, increasingly from a social dimension perspective, clearly accelerated given the economic health crisis that we’ve experienced over the past 18 months. It is this confluence, again, [of] the fundamental disrupters, as well as opportunities that companies are navigating, the way the regulatory and standard-setting regime is taking shape to help provide greater transparency to the market. At that intersection is the role of business in society and this concept of moving from defense, defending value, to offense, leading with how do you create value and demonstrate and really deliver on that trust that Veronica mentioned. That convergence of the pressure points externally [may trigger] an opportunity mindset that many businesses are taking as they look at their long-term strategies. How are they going to drive from a resilience perspective in the face of changing dynamics in the market, but also leading with that trust from a customer and employee perspective?
Veronica: Kristen, you mentioned about all these forces that are moving in the same direction. We have [also] seen the move by the IFRS Foundation last autumn—the IFRS Foundation sets financial reporting standards, which are now adopted in 144 jurisdictions–that went out with a consultation on establishing the International Sustainability Standards Board [ISSB]. The intention is very much to put a sister board alongside the existing IASB [International Accounting Standards Board] that sets financial reporting standards. Now we know that the IFRSF is on track to announce the creation of ISSB [and] the new standards [board] by COP26 [UN Climate Change Conference] this November. To accelerate the progress, they’re doing a lot of work in the background. They have committed to build on the work of the existing sustainability standards-setters and framework providers, and they have set up a technical readiness working group to give them a running start. We know that they’re moving fast. We know that they will be prioritizing climate. We know that they will be moving to other issues without delay. So they are creating that momentum in the system around which all these different forces now have an opportunity to consolidate around.
Tanya: What is your advice for those who have not yet started down this path, for businesses that are just looking at it and watching it, but haven’t really made any big steps yet?
Kristen: There’s an increasingly diminishing universe of companies who haven’t begun to move in the direction of understanding the developments, understanding ESG through a traditional risk and opportunity mindset, but the time is now to act and to mobilize quickly. We’ve seen directors [and] audit committees become much more engaged, and that’s really helping to serve as a catalyst to advise and challenge management around how they’re understanding their long-term strategy through the lens of future scenarios of these environmental disrupters, in particular that we’re seeing from a climate perspective. But very much, to Veronica’s point, the infrastructure within the market to enable more effective data transparency—ESG performance transparency—is setting a very clear direction for companies to move quickly toward putting that infrastructure in place, that governance structure, understanding disclosure objectives, and how to create an ESG controls framework to position for readiness as the regulatory regime takes shape and really not wait. This is all taking shape very quickly. Transparency is [a tool to] to drive value and trust, and so mobilizing quickly around those areas [is] starting to enhance the level of disclosure. Importantly, what we’re seeing is a rapid shift in not just the expectation or the demand for increased disclosure through a number of different avenues, the different disclosure mediums that organizations use to communicate with stakeholders, but a particular emphasis given this investor appetite and expectation for enhanced disclosure, meaningful disclosure, financially relevant disclosure around how ESG factors, climate in particular, impact the financial reporting and the results of operations from an organization.
Kristen: As this new standard-setting body begins to take shape and brings together some of the leading thinking from the standards and frameworks that exist today starting with a climate-first approach, it’s a really important opportunity for companies to not only accelerate the discipline and rigor around the internal infrastructure, the governance, but start to think more intentionally around how to deliver that more meaningful disclosure through the avenues that enable them to meet the information needs of their stakeholders [and] investors in particular groups.
Veronica: There is a further point that companies need to focus on, which is, this is not just about reporting. To be authentic and credible, reporting needs to reflect what is actually happening in the business. This means integrated thinking. Does the business integrate the consideration of people, planet, prosperity, all those ESG factors, into the core of the business? In other words, how does a business go about thinking about those issues? Is it part of the core strategy or is it just an add-on? Is this at the heart of how they do the risk management and risk response, or is that something that sits alongside and not fully integrated into the strategic response of a company to some of these challenges? And of course, integrated thinking has a huge benefit of helping companies understand enterprise value creation through a different lens that balances short- and long-term outcomes and acknowledges the diverse range of resources like natural, human, social, financials that are at play in creating the enterprise value [and] on which the enterprise really relies. It basically aims to enhance decision-making by taking a holistic view of the factors that can create value. So it’s beneficial, but it requires an organizational change—and quite a significant organizational change in many cases—because traditionally, as we said at the beginning, sustainability really sat separately in a box of its own and wasn’t integrated into the strategic and operational considerations by business.
Tanya: Let me ask, what are some of the pitfalls that companies can fall into? We already talked about not thinking about it holistically—that’s a pitfall—sort of boxing it all off. But what else should they be watching out for?
Kristen: That companies, as they progress along a maturity in this whole ESG landscape, in a lot of cases get sidetracked in trying to be everything to every stakeholder. That’s really where this progression in the landscape has moved to a particular emphasis around relevance to the business, to Veronica’s point to the business strategy. What are those areas of performance, risk, and opportunity that enable a company to effectively measure their performance against their strategy, but also communicate credibly in a meaningful way to stakeholders? There’s a whole universe of raters and rankers and analysts that are asking for lots of information in lots of different formats from organizations. In many cases, companies find themselves trying to study for every test versus stepping back, adhering to that emphasis and that discipline around the relevance to the business, the business strategy, and controlling the message versus sort of being in that responsive position.
Veronica: Another common pitfall is that companies are going out there with very brave, ambitious public commitments, and it is absolutely critical to have those commitments supported by strategic plans for implementation. Failure to set metrics and targets that relate to those commitments can be quite a significant pitfall. In terms of reporting itself, one of the common pitfalls is the lack of connectivity in reporting: Companies give you an excellent narrative around their commitments and their strategic response to those commitments, but have they considered those commitments in the context of the impact on the financial statements today? How did they reflect that in the judgments and estimates they made? That [reporting] really needs to demonstrate connectivity of thinking between what I’m doing strategically versus how is that translating into my performance today.
Tanya: You all have been at this for quite a while. You’ve watched it evolve. Parting thoughts that you have that you want to leave the audience with.
Veronica: The time to act is now. You need to start without delay. We have a real opportunity to get to a point where companies are reporting to the same sustainability standards around the world in a consistent and comparable way. It’s a huge prize, but to get to that point, it requires action by everyone, by everyone in the entire financial markets ecosystem. It requires the move by companies to be ready to report, to get their organizational infrastructure in a shape that would actually deliver those high-quality data points that investors are looking for; for investors to create the right pressure points for companies to report; for regulators to bring the requirements into their jurisdictions; and of course, for the standard-setters to set those requirements in the first place. As we’ve said, we are at an inflection point. There is a huge opportunity now.
Kristen: I would just add, as the regulatory environment takes shape, [there is] this perception of regulation as a burden. What we’re really trying to emphasize is shifting that mindset to transparency as a tool. That whole concept of the tremendous potential that more consistent, comparable, timely information that all of these developments are looking to help enable will unlock capital to be allocated effectively and efficiently to create those solutions to these major challenges that we’re facing. [The imperative is] for business to really understand and respond to this call to action, to advance their emphasis on ESG, which is supported by high-quality disclosure.
Tanya: How optimistic are you on this front?
Kristen: I could not be more optimistic. I have been working in this space leading our services for the last 10 years, and we’ve seen more activity in the last 10 months, 10 days even. I could not be more optimistic about the opportunity.
Tanya: Veronica, how about you?
Veronica: I’m very optimistic. As I said earlier, we have a real opportunity here to bring about global sustainability standards. We have a real opportunity to get better transparency into the capital markets. What is there not to be excited about it? It’s a huge opportunity for us to get to a better outcome for all of us.
Tanya: Kristen Sullivan leads Deloitte & Touche LLP’s Sustainability and KPI services, working with clients to help address their sustainability and nonfinancial disclosure needs. Veronica Poole is a vice chair of Deloitte UK and Global IFRS and Corporate Reporting leader. She leads Deloitte’s contributions to the WEF’s IBC Stakeholder Capitalism Metrics and has facilitated the work of the leading sustainability standard-setters to develop a prototype climate standard. Veronica and Kristen co-authored a new report called “Living your purpose,” which provides extensive guidance on how to enhance integrated thinking and embed considerations of people, planet and prosperity into the core of the business. It will be available on the Deloitte.com.
We’re on Twitter at @DeloitteInsight, and I’m on Twitter at @tanyaott1.
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I’m Tanya Ott. Thanks for joining us and be well.
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