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CFOs should rethink how to draw on financial and nonfinancial information to meaningfully communicate the creation of long-term value.
In brief
- Finance leaders should play a leading role in setting the strategic direction for sustainability and ESG reporting.
- Finance leaders should drive financial reporting excellence while meeting growing demand for nonfinancial insight.
- Finance leaders should address important roadblocks to measuring long-term value, drawing on frameworks and approaches from stakeholders and standard setters.
Businesses are increasingly looking to drive broad-based prosperity by creating long-term value for multiple stakeholders: not just shareholders, but customers, employees and the communities in which they operate. Turning this ambition into reality demands rethinking corporate reporting and may present hard questions for finance leaders. This can be difficult, given finance teams are already balancing disruption from the COVID-19 pandemic, adjusting to remote working, and meeting the evolving demands on their function.
Many CFOs and financial controllers understand the shift toward long-term value and have embraced it. The 2020 EY Global Financial Accounting Advisory Services (FAAS) corporate reporting survey found 69% of respondents think, “CFOs and senior finance leaders are increasingly seen by key stakeholders as the stewards of long-term value,” while 72% said, “finance teams are increasingly expected to measure and communicate how the company creates long-term value for investors and other stakeholders.”
The question is: how? The aim is to create disclosures that are clear and transparent, founded on high-quality data and produced using robust and reliable processes and systems. And, in addition to driving excellence in financial reporting, a focus on long-term value means demand is growing for nonfinancial information, including environment, social and governance (ESG), and sustainability reporting. Stakeholders are also looking to see how ESG performance and reporting link to business strategy and financial outcomes, which means finance leaders should think about how to respond to these increasing expectations and new levels of reporting transparency. Such changes are examined in our CFO Imperative series, which identifies critical answers and actions to help leaders reframe the future of their organizations.
Challenges to nonfinancial reporting
While nonfinancial reporting has been around for many years, dating back to the Global Reporting Initiative, it has arguably become much more important today, driven by investors as well as other stakeholders. This has led to a number of initiatives in this space, including the Sustainability Accounting Standards Board (SASB), the Financial Stability Board’s Task Force on Climate-related Disclosures (TCFD) and the World Economic Forum International Business Council (WEF-IBC) with its consultation paper Toward Common Metrics and Consistent Reporting of Sustainable Value Creation.1
In addition, the IFRS Foundation has released a consultation paper on a possible global approach to sustainability reporting and a possible role for the Foundation.2 For Leo van der Tas, EY Global IFRS Services Leader, this sort of initiative is important to ensuring that financial and nonfinancial reporting come closer together, rather than drifting further apart, and thereby give stakeholders greater transparency and insight. “What people would like to avoid is a situation where financial reporting goes one way and nonfinancial reporting goes the other,” he says. “What you actually need is a coherent view of the performance of the company. For example, why is the business model relevant and what performance did you achieve? How did you remunerate management? What was your impact on the environment? In this way, it would be possible for investors not just to understand today's financial performance, but also to understand the long-term value of the company.”
Delivering finance excellence in the COVID-19 pandemic: the regional view
While many finance leaders feel largely positive about their teams’ response to the COVID-19 pandemic, there’s significant variance at a regional level. In particular, fewer finance leaders in Asia-Pacific feel positive about the shift compared with other regions. For example, while 80% of respondents to the survey in the Americas were satisfied with the shift to remote working, only 65% of respondents were satisfied in Asia-Pacific.
Lawrence Lau, EY Greater China FAAS Leader, points out that, in China, organizations had essentially no time to plan, given that they were in the forefront of the COVID-19 pandemic’s emergence. “No one had the chance to prepare for anything like this, and no one had any experience of what to do,” he says. “There were significant challenges. Companies had to move to remote closing, but work-from-home is a new way of working in China. Organizations have multiple operations around the world, and with their American or European operations not going into lockdown until March or April, it created a really challenging situation. Office infrastructure was able to cope with the volume of data processing in finance, but then we were suddenly moving to a virtual environment. And then, of course, there’s the human aspect. People were concerned about their personal health, the need to deal with family matters, and the damage that was potentially being done to businesses and daily life.”
Looking forward, Lawrence Lau believes that organizations in China and the Asia-Pacific area will need to consider what the future of work looks like. “In certain industries in China, I can see where we could accommodate more flexible work approaches, between work-from-home and office,” he says.
The growing importance of nonfinancial disclosures is highlighted by the significance that investors are placing on ESG performance. In the 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey, which looked at the perspectives of investors on ESG performance, 72% of respondents said they conduct a structured, methodical evaluation of corporates’ ESG disclosures, more than double the 32% of respondents who said they used a structured approach in 2018.
An increasing focus by investors on high-quality nonfinancial information is reinforced by this survey, where 65% of respondents said there “is significant value for our organization that is not measured or communicated using traditional financial KPIs, such as brand value and human capital.” However, as shown below, only 48% say their organization has made “significant progress” in measuring and communicating human capital.
Driving progress will likely involve overcoming a range of challenges. The top three roadblocks identified by finance leaders as standing in the way of measuring and communicating long-term value are:
- The challenge of establishing materiality (identifying what ESG factors are material to creating value over the longer term and most relevant to stakeholders (30% of respondents))
- The need to instill greater discipline into nonfinancial reporting processes and controls to build confidence and trust in the numbers (23% of respondents)
- The absence of formal reporting frameworks showing how the connection between tangible and intangible assets contributes to long-term value creation (17% of respondents)
Measuring sustainable value creation: the Embankment Project and WEF-IBC
The Embankment Project for Inclusive Capitalism (EPIC) brought together the Coalition for Inclusive Capitalism, EY teams and 31 companies, asset managers and asset owners with approximately US$30 trillion of assets under management, in pursuit of a single goal: to identify and create new ways to measure and demonstrate long-term value to financial markets.
EPIC developed 63 indicators and a framework that helps organizations to measure and communicate long-term value creation for a broad set of stakeholders, not just shareholders. The approach provides a set of indicators in four categories: financial value, consumer value, human value and social value.
The next phase in the project is to leverage the EPIC findings and framework to identify, manage and measure the intangible assets that are often the greatest contributors to an organization’s success. EY teams are committed to supporting a comparable and scalable framework aiming to support organizations in building out the connection between the tangible and intangible assets contributing to long-term value creation.
Long-term value approaches also informed the EY contribution to the Sustainable Value Creation initiative led by the World Economic Forum’s International Business Council (WEF-IBC). EY teams contributed to this initiative, which aims to develop a common core set of metrics and recommended disclosures that corporates can use to report the shared and sustainable value they create. The WEF-IBC 2020 consultation paper Toward Common Metrics and Consistent Reporting of Sustainable Value Creation outlined consistent metrics under four ESG pillars: principles of governance, planet, people and prosperity.2 In 2021, 61 business leaders committed to the core metrics, including reflecting them in their reporting to investors and other stakeholders.3
For more information on EPIC, visit epic-value.com and www.ey.com/ltv.
The way forward: putting finance at the heart of sustainability and ESG reporting
As sustainability and ESG reporting become ever more important to how organizations measure and communicate long-term value creation, the effectiveness of nonfinancial reporting is likely to depend on how trusted and credible it is, and how relevant the link is between the disclosures and the organization’s long-term strategy for success in its sector. Stakeholders – such as investors – will likely require ESG disclosures that are clear and transparent, founded on high-quality data and produced using robust and reliable processes and systems.
Finance teams should look to play a leading role in setting the strategic direction for nonfinancial reporting. However, there is some concern that finance teams are lagging behind in this area. The survey found significant variation and ambiguity about the precise role of finance in this domain, with 24% of respondents identifying sustainability reporting as a “very significant” part of their current role and responsibilities. And only 30% of respondents said their finance functions had end-to-end, significant involvement in the collection, analysis, assurance and reporting of ESG information.
Finance should look to get ahead and show leadership in this space by using its experience to proactively shape the organization’s approach in a range of nonfinancial reporting areas, from assessing materiality to developing joined-up reporting frameworks.
One area finance leaders could focus on is helping instill discipline into nonfinancial reporting processes and controls, to build confidence and trust in the numbers. This means creating systems, controls and standards as disciplined as those that typically characterize financial reporting. With their extensive experience in establishing processes, controls and assurance of financial information, CFOs and their finance teams can help lead the way by establishing effective governance practices and assurance of nonfinancial processes, controls and data outputs.
These are likely to be important steps as finance leaders look to play a leading role in putting long-term value at the heart of the organization’s strategy and corporate reporting approach.
Summary
As the importance of long-term value creation grows, CFOs should take the lead on what is reported and communicated to demonstrate the strategic progress of their organizations.
How EY can help
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