Seven insights from finance leaders on ESG reporting

Panelists in the December Think ESG webcast weigh in on the latest reporting developments in the ESG ecosystem.

In brief

• Ernst & Young LLP hosted a webcast with prominent finance leaders to discuss how expectations for ESG reporting are evolving and how they’re approaching them.
• Topics discussed included how boards are evolving to manage ESG matters, how the CFO’s role is growing to incorporate ESG, unique perspectives from an ESG controller, and how companies can best prepare for mandatory global regulations.

Watch the on-demand version of the Think ESG: insights from an audit committee chair, a CFO and an ESG controller webcast.

Environmental, social and governance (ESG) reporting is becoming increasingly complex as more jurisdictions establish mandatory reporting frameworks. According to the 2022 EY Global Corporate Reporting and Institutional Investor Survey, there’s currently a significant disconnect between companies and investors on sufficiency of ESG disclosures. While 73% of investors surveyed say companies must enhance their ESG reporting to provide the information they need for long-term investing decisions, 53% of finance leaders surveyed say they face short-term earnings pressure from investors, which inhibits them from doing so.

As ESG disclosure mandates evolve, companies should continue to improve reporting to better meet stakeholder needs. Here are some practical considerations for boards and finance teams to consider when thinking about developing, implementing and reporting on their ESG priorities and goals.

1. Most boards are increasing their level of engagement on ESG matters 

Given the increased attention to the ESG landscape over the last several years among boards, there’s been more discussions on shareholder resolutions, proxy firm reviews and guidance on how to vote on different matters. There has also been growing institutional investor interest in corporate governance, as well as higher demand from investors for more comparable, reliable and consistent ESG information to inform their investment decision-making.

Because of these factors, ESG issues have quickly become a major board and C-suite focus. The corporate responsibility reports of the past have not been reflective of what investors and debt rating agencies have been requesting more recently. Directors’ increased engagement on ESG reporting reflects the stakeholders’ need for enhanced corporate reporting.

Market participants want corporate reporting to: 

• Clearly outline the company’s business strategy.
• Communicate and define how ESG issues tie into the business strategy.
• Explain how these issues impact the company’s risk management.
• Clarify how these issues inform the company’s management structure, corporate reporting and board governance.

2. Boards can drive the ESG agenda forward by defining which ESG issues are most directly relevant to the company

One way board members can add the most value is by defining which ESG issues are most directly relevant to the company. This can be done by analyzing which issues matter most to key stakeholders.  In other words, identify which ESG issues are real business issues.

The factors that inform how a board addresses ESG issues include:

Size and complexity of the company

If a company is small enough, the entire board can address ESG issues. They can define which ESG issues the company will focus on, how that approach impacts corporate governance, then help build an ESG program and oversee all subsequent reporting. 

Alternatively, ESG oversight may be delegated to one committee, such as the nominating or corporate governance committee, or they may choose to create an ad hoc committee that solely focuses on sustainability. In large companies, we’re beginning to see governance architecture that defines what the board is responsible for, which includes strategy oversight, in addition to defining what the other committees will be focused on and how they’ll intersect with the sustainability committee. 

For example, the audit committee may focus on internal controls, data oversight and external reporting. The compensation committee would determine whether ESG targets and goals should be tied to compensation, and the nominating governance committee should source future board members that fit into the overall skills matrix that’s required. There’s also usually a separate climate risk committee, but if not, anything risk related is usually delegated to the audit committee. These roles are still evolving and need to fit facts and circumstances around the company, such as the size of the board and how many industries and sectors it operates in.

The industry and sectors the company works across as well as current market trends

ESG issues are largely driven by the industry and sectors the company works across as well as current market trends. For example, a utility company may target emissions reductions, whereas a company in the hospitality industry may focus on food security. Regarding market trends, after the financial crisis in 2008, boards enhanced their focus on enterprise risk management. For a period, companies prioritized recruiting board members with expertise in this area. However, since ESG matters are cross-functional and touch all departments, it’s difficult to recruit board members who have expertise in all the required areas. Instead, most companies look for board members who have diverse experience and can help get other board members and management teams up to speed.

3. The CFO’s role is evolving as ESG matters become a board and C-suite priority

At many large companies, the CFO’s roles and responsibilities are changing as ESG issues become more embedded into a company’s culture. CFOs are not only becoming more engaged on ESG issues to ensure initiatives are funded, but they are also engaging with more diverse stakeholder groups that are critical to a company’s long-term success — shareholders, employees and customers. 

The principles that underly ESG issues usually permeate several areas within finance to include accounting, investor relations and tax. Because of this expansion, the CFO role has evolved to require the efficient and effective communication and collaboration of ESG initiatives both within the finance function and beyond. Due to these changes, CFOs can be expected to:

Serve as advocates for stakeholder feedback

This includes advocating for shareholder feedback and responding to demands from investors. As seen in the EY Global Corporate Reporting and Institutional Investor Survey, investors are increasingly focused on ESG issues to inform their investment decisions. From the CFO perspective, the response to investor attention involves bringing together teams from investor relations, sustainability and government affairs so that there’s consistent engagement with stakeholders on corporate sustainability strategy and that all questions related to ESG risks and opportunities that are viewed as material to the company or sector are answered.

Prepare to disclose ESG information in regulatory filings

To prepare for ESG disclosure mandates, companies are setting up a designated role within the finance function to work closely with other teams, such as sustainability, human resources, communications, legal and government affairs, in order to address the new and emerging global reporting requirements.

4. ESG reporting is becoming increasingly linked with financial reporting, and its success is largely tied to effective stakeholder engagement and clear communication

At many companies, the investor relations team is heavily focused on stakeholder engagement and outreach in partnership with the sustainability team, with a particular focus on large index fund holders. The goal is to enhance their understanding of ESG goals related to achieving net zero; their diversity, equity and inclusion (DEI) goals; and how they’re progressing toward these goals.

In addition to building and maintaining stakeholder relationships, many companies are also engaging with employees and customers through an independent materiality assessment to understand their ESG priorities. This process helps the company not only collect this information to inform the executive leadership team, but it’s also shared with the board so they can better embed sustainability principles into the culture and DNA of the company. 

Since climate change is often at the top of the materiality list, some companies are setting short-term and long-term net zero targets, coupled with strategies to achieve those goals through a publicly available decarbonization plan. 

Additionally, finance must work with business partners across the company to ensure ESG and sustainability become core parts of its corporate culture. Stakeholder engagement is continuously evolving to include public policy leaders as well, with the sustainability team now merging with the public policy team at some companies. As mandatory disclosures evolve and stakeholder demands expand, it’s important for teams to think about the long-term goals of the company to determine where these positions best fit organizationally.

5. Corporate compensation is now being tied to ESG performance

According to research published by Merel Spierings of The Conference Board, the majority of S&P 500 companies are starting to tie corporate compensation to ESG performance, with a strong focus on achieving goals related to DEI and emissions reductions. Other companies are integrating sustainability with other core business priorities. That could mean setting a goal to increase the number of ESG-related funds that hold their stock or tying the achievement of their ESG strategy to both executive and employee compensation to demonstrate accountability in delivering on their sustainability-related objectives. 

On a practical level, for companies that link ESG to executive compensation, progress toward ESG goals is measured and reported on a quarterly basis to the board and full employee base. At the board level, the governance and nominating committees may oversee the overall business-related sustainability matters, and the audit committee could oversee the financial risk, accounting and other filing disclosures related to sustainability. The compensation and human resources committee then might review the sustainability-related goals that they’re using for compensation to ensure targets were achieved and adjust pay accordingly. By doing this, employees are aligned with the company’s goals and empowered to prioritize and support sustainability.

6. Companies are hiring or designating someone in controllership to focus on ESG and corporate reporting

To assist with the ESG reporting evolution, companies are hiring ESG controllers to ease the transition. An ESG controller can contribute data collection skills, a focus on controls and a reporting infrastructure resident in finance.  

ESG controller positions are highly cross-functional, so being able to collaborate across the company is critical for success. They should be prepared to have consistent touch points with not only the sustainability team, legal and government affairs teams, but also engineering, marketing, investor relations and communications teams. Clear communication is critical to ensuring messaging around ESG initiatives is consistent internally and externally. 

Increasingly, sales teams are becoming interested in ESG information because it is starting to be required in proposals, as customers want more ESG information. Acquisition teams may also be interested to learn about the company’s ESG strategy to ensure any potential acquisitions are ESG-aligned.  

The responsibilities for an ESG controller can usually be broken up into two buckets:

Ensuring that the company is ready for global reporting standards 

This is achieved by making sure the company has all the processes in place to comply with the standards across international jurisdictions, if applicable. The level of detail required is significant.

Defining finance’s role and establishing what aspects of the corporate ESG strategy it’s responsible for achieving

This is a broader approach, as finance teams can offer significant value in several areas. Since ESG controller roles are brand new, at the beginning, a lot of time should be dedicated to figuring out how to best structure the position. The responsibilities of the role should also be nimble and adaptable, as the reporting requirements and needs of the company evolve with time.

7. ESG controllers should plan to assess the current state and desired future state, then get finance teams up to speed

Since ESG controller roles are still being defined, it’s helpful for those in this position to act as a consultant to determine where their time is best spent both initially and in the long term. 

One of the first things an ESG controller should do is start with a gap analysis to determine what metrics the company currently discloses and how that compares to what’s expected to be disclosed in the future. They should be thinking about the long term and questioning what kind of team is needed and what core skills are required. 

Secondly, ESG controllers should review their company structure and conduct a scoping exercise. This will help them determine what legal entities might be in and out of scope for certain ESG frameworks. The earlier companies can get ahead of this, the better chance they have for meeting requirements.  

Thirdly, when companies have large finance teams, there’s a need to create awareness. In most cases, ESG is becoming quickly embedded into the entire organization. As a result, ESG will become a day-to-day topic for finance teams, so consistent education and engagement is critical to success. As internal controls are established, much of the education will be around data management. Historically, sustainability reporting has had many communications channels, including surveys and annual reports. Ensuring the data is collected and controlled in a consistent manner will be important. Finance teams may choose to implement policies to ensure this takes place, as well as identify and close gaps in how the data is pulled together.  

What’s next for ESG reporting

As we enter 2023, we’re past the tipping point for ESG reporting. Now that sustainability is a board and C-suite priority, we’re witnessing a sea change in corporate reporting. Accounting and audit professionals need to get involved in ESG matters because they have become a focus for boards, management teams and external stakeholders alike. Audit committees are increasingly asking questions around how the controls will be implemented, what technologies will be used to track data and who will have the final signoff. When done well, companies should be reporting on the ESG issues most important to their business and determining how their ESG priorities and business objectives align. After all, ESG issues are business issues. Developing a strategy, achieving goals and reporting on progress toward those goals will become more and more critical to success.