ESG reporting: What it means for finance
Finance needs to be involved in non-financial reporting
ESG reporting: It’s not simply a number-crunching exercise.
Widespread concern about climate change has driven a transformation in how businesses account for their performance. Although prompted by climate issues, today’s reporting initiatives are broader and more holistic, embracing performance across the environmental, social and governance (ESG) realms. While some companies have been proactive, many are being prompted by forthcoming regulations, such as the EU’s Corporate Sustainability Reporting Directive (CSRD), which comes into effect from 2024. This new sense of urgency is reflected in a recent Deloitte study, which found that a full 99% of CFOs now anticipate investing in ESG reporting, technologies and tools by next year.
Until now, businesses have tried to account for their non-financial performance in a variety of ways: even where standards have been set, they haven’t been harmonised across the relevant agencies, and many different calculation models have been used. Similarly, the capture and collation of data has been patchy, often involving ad hoc measurements and spreadsheets, which could be different from one year to the next.
The advent of new regulations is now bringing to ESG reporting the sort of rigour traditionally associated with financial accounting, to provide reliable, traceable and auditable results. This isn’t simply a number-crunching exercise, but a way to assess practical action toward important sustainability targets. Indeed companies that announce targets but not practical pathways for achieving them could face legal action – as has recently happened in the Netherlands. Even though prompted by regulations, this represents a new mindset on how businesses view their own purpose and performance, leading to new internal non-financial KPIs, but will require internal standards and procedures that are already well-established in finance for financial data.
Many of these ESG indicators will require data that have never even been considered relevant to business performance, much less collected, so investment is needed to establish the mechanisms for sourcing such data (e.g., sensors or third parties), but also in its collection, processing and quality assurance. Where a business might operate, say, a ledger for dollars, comparable ways to account for carbon, waste or plastics do not yet exist: most companies rely on well-established corporate ERP systems for their financial accounting, but solutions (including add-in modules) for non-financial reporting have yet to reach the market. Although many systems providers have these in development, it remains unclear whether they’ll be ready for implementation in time to meet the 2024 reporting obligations. Indeed, the number of solutions in development is currently so large that evaluating and selecting the most suitable will involve significant effort.
In the short term, many businesses might have to meet their reporting obligations on a ‘best efforts’ basis, and might require auditors’ notes to qualify some results, which could carry significant cost. However, even without integrated systems, the process can be automated, with robust data pipelines and quality procedures. This approach can help ensure that year-on-year results don’t involve trying to make sense of (and have audited) many makeshift spreadsheets compiled in different ways over several years. In turn, that can free up time to focus on improving the quality of data and processes, and make future results and performance more compliant and easier to audit.
The investment could be substantial, but will avoid the time-consuming compilation of ad hoc internal and external reports each year, which in turns creates a complex and costly audit workload. Furthermore, the scale of investment is likely to reflect the data and systems currently available, and the scope of reporting required. In particular, identifying and measuring the many new ESG variables will be completely new for businesses that have traditionally accounted only for their financial performance.
CFOs and the finance community have an important role in this new world of ESG reporting. By definition, it’s about non-financial reporting: most sustainability impacts aren’t measured in dollars, and previous reporting responsibilities might have fallen solely to Sustainability teams. However, the current requirements will demand the standards, disciplines, audit and reporting processes that have until now only been known in finance, and can take years to develop. Although the measurement units might be different, the level of rigour will be the same. Finance needs to get involved in non-financial reporting.
