By Bridge Taylor and Roy Snell
The short answer is that it’s not. To me, with a background in financial accounting, ESG reporting is a logical extension of financial accounting, regulatory disclosure, and management’s discussion & analysis. Over the next couple of months, I’ll share my thoughts on ESG, non-financial reporting, and how to execute a successful ESG program.
In Accounting 101, lesson one is about the assumptions that we agree to make so that we can tell the story of an organization through financial statements. However, investors and managers are beginning to understand that there is material information lost in those assumptions. Reporting on ESG metrics alongside financial accounting gets us one step closer to the reality of your organization.
Additionally, you can’t manage what you don’t measure. ESG factors exist in every company regardless of disclosure or understanding. It makes sense that managers have largely ignored these factors because they did not have the vocabulary or incentive structure to work on them. Thankfully, SASB (Sustainability Accounting Standards Board) is a non-profit that has built a framework with industry specific vocabulary, topics, and disclosures for ESG reporting. SASB’s disclosures serve the same purpose as traditional accounting information in that they give a truer picture of an organization’s enterprise value.
Both ESG and financial reporting need assurance, comparability, and relevance to be useful to providers of capital and other stakeholders. Traditional financial accounting has taught us that assurance will never be perfect, but with the benefit of 100 years of development in the US the audit system is very robust and is coming to the sustainability space.
Audits, financial ratios, & materiality in financial accounting are a blueprint for where ESG reporting will take us. Conversations around non-financial materiality have been a great jumping off point for my clients as we work to communicate between financial, compliance, and sustainability people. A conversation that nearly always brings us back to the core of why we are passionate about expanding traditional disclosure to ESG. It reveals the risk and opportunity that is missed with traditional accounting and compliance. And yes, ESG reporting is more than just risk avoidance…anyone telling you differently is just trying to scare you.
I’ve asked my friend and colleague, Roy Snell, a pioneer in compliance, about his take on the similarities between compliance and ESG:
ESG has a large regulatory compliance element to it. There are many environmental and social laws to monitor for compliance, and even more on the way. California has recently added diversity laws for company boards and the UN and European Union are jointly working on climate legislation.
However, ESG has an element to it that is unlike anything we have seen in regulatory compliance. There is a huge component of what one might call “voluntary regulatory compliance.” Organizations are voluntarily adding ESG requirements/policies that go beyond the rule of law. ESG Officers will help ensure compliance with existing ESG laws; however they will also spend as much time, if not more, on issues that are important to the organization but not mandated by existing regulations. Carbon emission, new diversity goals, human capital metrics, and many other ESG issues will require policy development by company leadership and require subsequent employee education. But there is more, much more.
Much like the regulatory compliance activities of the past, we will have what one might call the “ESG assurance process.” All of the tools of a compliance program will be utilized to assure that the organization’s new voluntary ESG policies are followed. There will be policy development, employee education, auditing, monitoring, risk assessments, anonymous reporting mechanisms and investigations of potential wrong doing. There is an unbelievable amount of discussion about the need for ESG programs. There is also an enormous focus on reporting ESG information to stakeholders. What is remarkable to me is the lack of discussion about how to actually improve your organization’s environment, social and governance metrics. The main thing compliance programs brought to regulatory compliance will bring to the ESG community is going beyond talking to action.
We will monitor ESG metrics and implement changes in company processes that will assure improvement in our ESG metrics. Furthermore, few things discourage employees more than their company making bold ESG proclamations and then seeing no effort to ensure those proclamations are enforced. This is where the tools of regulatory compliance will come into play. It is really quite simple, if you want to go beyond talking and reporting to the actual improvement of your organization’s ESG metrics, then you have to implement an effective ESG Compliance Program. And this sort of effectiveness will also minimize an ESG misstep that could result in government fines, death by social media or both.
Great insight Roy, good to have the compliance perspective!
With the benefit of many mature tangential professions like auditing, accounting, and compliance it is our responsibility to take advantage of the work that has already been done. Personally, my background is in accounting so I can’t help but see ESG through the eyes of an accountant. As SASB and IFRS converge their standards and the SEC begins to pass rules expanding climate disclosure in 10-K’s ESG programs will become a more mainstream component of organizational reporting.
Assurance and compliance knowledge is already out there and there is an excellent opportunity to take work already done in those fields and apply it to ESG. Big 4 auditing firms have already started building out non-financial auditing teams and are reviewing Green Bonds. As capital markets come to terms with the true effects of global warming, racial and socioeconomic divides, and the next hot issue arises, providers of capital will be demanding a narrative, backed by assurance that fills in the gaps left by financial accounting assumptions.
Though I’ve titled this why is ESG different, I think it’s clear the more interesting conversation is why ESG is not too different. Hopefully, this blog will calm the nerves of all the professionals out there worried about why they are expected to know everything about ESG when the concept didn’t even exist 15 years ago! Environment, social, and governance disclosures are inevitable, but approaching this challenge as an extension of one’s compliance and accounting practice might make us all a little less nervous.