ESG Best Practices Are Evolving Fast

Management accounting and finance professionals involved with nonfinancial reporting and disclosure have been on a long journey of navigating an alphabet soup of sustainability and environmental, social, and governance (ESG) regulators and standards setters over years of shifting compliance, reporting, and disclosure paradigms. Today, global corporate executives want a simplified, clear set of shared standards and guidelines not just dictated by the regulatory regime, but also based on the impact on stakeholders, including investors, employees, communities, and ecosystems.

Liv Watson is a digital adviser at Capitals Coalition, where she leads the Digitalizing Sustainability Data project bringing together standards setters, regulators, data specialists, ratings agencies, technology companies, preparers, users, and other key stakeholders to resolve technical-alignment issues and streamline globally integrated and interoperable sustainability data flow by transforming disclosures into machine-readable data. She’s also a member of IMA’s Sustainable Business Management Committee and Des Moines Chapter, as well as former member of IMA’s Global Board of Directors and the former chair of the Formats Working Group of the European Financial Reporting Advisory Group’s (EFRAG) Project Task Force on Corporate Standards Reporting Directive (PTF-CSRD).

“Sustainability and ESG reporting and disclosure best practices are still in an emerging stage because the standards themselves aren’t officially adopted yet,” Watson says. “So [executives across] industries have come together to look at best practices, but we all know today quite clearly that the data underlying these nonfinancial disclosures aren’t going through rigorous processes, so the number-one pitfall is if you only look at ESG as a disclosure process, then you aren’t going to change the behavior of integrated thinking and decision making that drives a sustainable long-term company, because it’s really a paradigm shift in business development.”

Watson urges management accountants to step up to the plate and start looking at how your company’s business will actually operate once sustainability guidelines and ESG standards are integrated into the strategic-planning process and execution of those plans. She warns against not integrating ESG into the management accounting body of knowledge.

“Management accountants have a huge opportunity because we sit within the business that has to capture sustainability and ESG data and help senior management and decision makers to make good decisions,” Watson says. “If we don’t understand the data quality and communicate with a broader stakeholder group, then we have huge pitfalls in our strategy.”

DECIDING WHICH ESG METRICS TO MEASURE

A recent Deloitte survey asked CFOs, “Which proposed rules or regulations are of most interest to your organization due to their impact on your ability to comply or other factors?” Nearly two-thirds (63%) of CFOs who responded said that ESG accounting and disclosure requirements are of the most interest to their organization due to the impact on their ability to comply with them, among other factors, according to Deloitte’s second-quarter CFO Signals report.

Sustainability and ESG reporting and disclosure best practices are being developed, including by the International Financial Reporting Standards (IFRS) Foundation’s International Sustainability Standards Board (ISSB). Watson suggests that management accountants read IMA’s Statement of Position on Sustainable Business Information and Management, which defines nine fundamental principles for building successful, sustainable accounting practices within an ever-changing regulatory and standards-setting playing field.

“It’s a good first step to try and understand what the management accountant’s role in sustainability is, as this is part of a due-diligence process that we as management accountants do today,” Watson says.

When a regulated regime is in place, all the data goes through a materiality framework that doesn’t necessarily capture the business factors that drive sustainable business, so it’s important that finance professional follow materiality in their assessments for disclosure, Watson notes. That being said, global best practices include analysis of the business metrics that really drive strategic decisions internally, but that’s still in the infancy stage at many organizations. In addition to profitability, liquidity, risk management, and sustainability, investment is also considered to be part of ESG criteria and is useful for gauging each organization’s impact on the whole ecosystem.

“Industry groups and associations like IMA have come up with sustainability and ESG best practices, but there are some key metrics that we all have to collaborate, especially those related to climate issues, as we also see that the first new ISSB standards coming out are focused on climate and carbon,” Watson says. “So climate risk, your carbon footprint, your own organization’s and your supply chain’s greenhouse gas emissions, energy consumption, water usage, waste, and pollution are some key metrics that are getting the most attention from a disclosure standpoint.”

CARBON ACCOUNTING PRACTICES

Right now, carbon accounting faces fundamental challenges, such as double counting. This occurs when the same emissions are counted multiple times at the aggregated level due to the issuance and simultaneous claiming of carbon credits by different entities. Conversely, while individual companies’ carbon emissions may remain below the materiality threshold and therefore unreported, Watson says that cumulative supply-chain emissions are likely to be material but will have fallen off the radar because of the individually assessed materiality.

Robust accounting mechanisms and governance frameworks are necessary to prevent double counting. Clear rules, standardized methodologies, and transparent verification processes can ensure the accuracy and integrity of carbon accounting practices.

“So how do I explain that the industry comes together and says, ‘If you have tea bags from this part of the world and send them across the ocean, they all have just a metric estimate, but it’s not connected to the financial systems, and it hasn’t necessarily gone through internal controls,” Watson says. “So even if there are industry metrics out there, we still need to fix the accounting, and the industry is really starting to understand that today we do need to look at the externality, the cost, the dependency, and the impact for internal controls, so this is a journey we’re all going to go on, and it’s still evolving.”

DECISION-USEFUL ESG METRICS

It’s become a fiduciary duty of the board to ask questions about the organization’s approach to ESG data management, as well as strategic planning and efforts to achieve sustainability objectives, as there have been companies and individual board members being sued for not living up to the goals that they committed to. When examining how leadership can make better strategic decisions related to sustainability, Watson suggests looking at where your organization’s major expenses and dependencies are.

“Are you dependent on the water supply or certain raw materials? Dependencies have to be an earlier phase in the discussion,” Watson says. “Before we were able to just look at data points, but now we have to look at more complex dependencies. We also can’t just look at the data we have internally for coming up with metrics to impact business; we have to look at climate risk.”

According to Watson, potential questions that management accountants and finance leaders should ask themselves related to climate risk include: Are your own or your suppliers’ physical locations going to flood in the future? Are you in a place where there’s been drought and water is running out? Are you living in a place where the raw materials can’t supply your business’s needs anymore? To what extent can ecosystems and natural resources sustain the economic development and profitability that you’re expecting on your balance sheet? Are there political issues or geopolitical conflicts that could disrupt your long-term strategic plans or operations?

“The confluence of metrics for decision making have become a lot more complex, as we see that many more dependencies and externalities are impacting business decisions,” Watson says. “So my key message is that we have to broaden our accounting profession’s scope and understanding of these dependencies’ impact on the general ecosystem and not just depend on internal data for balanced scorecards and [nonfinancial or integrated reporting.”

Management accountants and finance leaders are now facing challenges related to setting and working to achieve ESG objectives, evaluating risks, and having to deal with a lot more influence from external stakeholders, according to Watson. It takes concerted cross-departmental efforts to execute effective stakeholder engagement with on-point messaging that communicates the organization’s sustainability and ESG strategic plans and objectives.

“We can start seeing the influence of external stakeholders in that if you don’t set and clearly define sustainable objectives, then it’s going to impact your cost of capital—investment is going to flow to businesses that can sustain the climate impact that we’re going to have,” Watson says. “That’s happening with or without ESG legislation or sustainability/ESG disclosure requirements.”

Assessing your organization’s business model in light of these factors and dependencies is key, Watson asserts. Nonfinancial metrics and benchmarks have a real impact on organizations’ enterprise performance and relationship with various stakeholders, even though many still don’t clearly understand that link, whose importance is difficult to quantify in numbers.

“It doesn’t have a price, and you can see now that the United States is even going to start regulating carbon offset trading—once we have a price, then the whole dynamic changes,” Watson says. “It’s the only way to start mitigating it and [ensure that] it’s on the agenda. Will it be successful globally? It depends, but Europe is going to price it, so if you do business in Europe, then you better start pricing it too.”

SUSTAINABLE BUSINESS PRACTICES TRAINING

It would behoove companies to tailor their employee training, upskilling, learning, and development initiatives to increase their personnel’s knowledge of sustainability and ESG. IMA^® (Institute of Management Accountants) offers a six-course IMA Sustainability Business Practices Certificate self-study program to help management accountants and finance professionals drive ESG initiatives and effective sustainable business practices within their organizations.