2023 is going to be a pivotal year for Chief Financial Officers and corporate finance as sustainability (or E.S.G.) metrics are integrated into financial reporting packages.

The obvious drivers are regulatory, including:

• The U.S. Securities and Exchange Commission (SEC) is expected to finalize its new rules requiring certain climate-related metrics to be included in the audited financial statements of publicly traded companies.
• The European Union (EU) brought the Corporate Sustainability Reporting Directive (CSRD) into force, modernizing and strengthening the rules around social and environmental information that companies have to report.
• The IFRS Foundation, known for defining global financial reporting and accounting standards, has absorbed the major sustainability reporting standards of the International Sustainability Standards Board (ISSB) and is actively working on connectivity between them.

However, limiting sustainability to a compliance and financial reporting function puts a ceiling on what can be achieved. Corporate finance can drive value for the company by embedding sustainability into its financial processes and addressing investor concerns about climate risk, consumer preferences and the competition for talent.

This is also showing up in changes in the C-suite: The July-August 2023 edition of the Harvard Business Review reports on how the Chief Sustainability Officer (CSO), formerly designated to a PR role, is becoming a central player in investor relations and setting corporate strategy as a senior member of the C-Suite

Driving Forces: Investors, Customers & Employees

Investors: Growing investor interest in sustainability is driven primarily by hard-nosed pragmatism and concerns about long-term financial performance. Looking at financial performance through a sustainability lens opens new perspectives on old questions like, “What should we invest in?” and “Where can we save?” Examples abound: In January 2023, Bloomberg reported that Replacing US Coal Plants With Solar and Wind Is Cheaper than Running Them, while companies like Nike are redesigning entire supply chain and manufacturing processes around innovative new products. Nike Flyknit shoes made from polyester yarn recycled from plastic bottles are a poster child for this effort, generating an estimated $1 billion of new sales while also reducing waste.

Customers: Data showing the evolution of consumer preferences is also becoming more available. These range from surveys (like this one from Forbes) indicating that consumers are demanding sustainable products to actual results like these in The Sustainable Market Share Index^TM published annually by the Center for Sustainable Business at NYU. The latter reported that in 2022 products marketed as sustainable grew almost two times faster than products not marketed as sustainable, achieving a 5-year CAGR (Compound Annual Growth Rate) of 9.4% vs. 5.0% for its conventional counterparts. McKinsey and Nielsen IQ looked at different data and came to the same directional conclusion (albeit arriving at different percentages).

Talent: Meanwhile a new generation of workers is entering the workforce with different expectations of their employers and their workplace experiences. In 2021, the New York Times reported that 51% of 2,000 students from 29 top business schools would accept a lower salary to work for an environmentally responsible company, up from 44% just a few years before.

This will matter more and more as competition for workers is likely to continue and intensify over the next two decades. Other contributing factors will be the normalization of remote work arrangements (both an opportunity and a risk depending on how attractive an employer is) and dropping fertility rates across the globe. Sustainability reporting, especially the “S” (Social) and “G” (Governance) metrics of E.S.G., can help companies measure and manage these trends and assess their financial impacts as part of their long-range planning processes.

Profit: McKinsey has reported that companies that have adopted systematic, business-led approaches to inclusion and diversity achieve significantly higher profitability than those that don’t. Since well-executed diversity and inclusion practices lead to higher levels of employee engagement, Gallup’s research findings that increased engagement in turn leads to higher earnings per share should come as no surprise. It makes intuitive sense operationally too:

• Less turnover means fewer job vacancies, less capacity loss and lower training costs
• More engagement can mean more attention to quality, less absenteeism, better customer service and myriad additional benefits.

So, what’s new?

Sustainability reporting has been around for a long time, in both voluntary and mandatory forms. It shows up under different labels such as corporate social responsibility (CSR) reporting, greenhouse gas (GHG) emissions reporting, among others. Many companies already have teams with carbon accounting (for GHG reporting) and data analysis skills that prepare and publish reports in accordance with one or more of the reporting frameworks and standards in common use.

What is new is investors’ growing need for comparable, verifiable and decision-useful information on how companies are managing and measuring the financial impacts of environmental, social and governance risk. In most companies, sustainability reporting teams have hitherto operated separately from financial reporting teams, meaning that they have been on the periphery of influencing strategy and spending decisions, while also having broad discretion as to what was reported and how.

2023 marks the beginning of integrated financial and sustainability reporting as a step toward fully integrated financial and sustainability performance management, by which we mean integrated planning, forecasting and what-if scenario analysis. It will require teamwork, and likely organizational changes, to bring sustainability under the aegis of the CFO. The sustainability team will typically have deep expertise in their data, metrics and reporting standards, while the finance team will likely add experience in the discipline of regulatory filings, managing audits, data governance and financial modeling.

Making good, informed data management and technology choices for the combined effort will be a key to success. Financial data from the ERP system will need to be combined with emissions and other sustainability data on a regular schedule. The greatest challenge to any reporting effort relates to acquiring, organizing and cleansing data (as explained here), and then turning it into a reproducible automated process. The right technology decisions will ease the stress of learning something new by supporting the work, while rushing to a “magic bullet” solution may backfire. There is no software solution that can substitute for a well-designed data strategy.

Summary

Corporate finance teams, including financial planning & analysis (FP&A) functions, need to get ready to integrate GHG emissions and other sustainability-related financial metrics into their regulatory filings for the SEC and EU as soon as 2024. While this may be viewed narrowly as an additional reporting burden, forward-thinking companies are leaning into sustainability management processes to achieve growth and profitability financial goals. This in turn leads to exciting career and learning opportunities for finance professionals as investors require CEOs and CFOs (and their teams) to be as fluent in sustainability-related risk analysis and mitigation as they are in the details of their strategies and financial disclosures.

Want more on this topic? Join A.G. Tan and Zsolt Badics at AFP 2023 for their session “How Sustainability Programs Could (and Should) Transform FP&A.” Visit the AFP 2023 Session Explorer to learn more.

More information:

• What is the Difference between Sustainability and ESG?
• Commonly used Standards and Frameworks for Sustainability Reporting
• Sustainability Data Strategy: Three Tips for Finance

About the Author

A.G. Tan is a Principal at Tensor Research, a consultancy which advises FP&A teams on data and modeling strategies for integrated financial and sustainability reporting and performance management. You can reach A.G. at [email protected].