Driving Sustainable Change: The Path Forward

As the business world becomes increasingly conscious of its environmental and social impact, investors, regulators, and stakeholders are demanding greater transparency and accountability from corporations. Along the way, environmental, social and governance (ESG) criteria have emerged as critical factors in evaluating a company’s overall performance and long-term viability. In response, many forward-thinking finance and accounting professionals are embracing a new opportunity to help integrate ESG considerations into financial reporting. 

So let’s examine the ESG landscape, including the current ESG reporting standards and the importance of ESG integration—and how finance and accounting professionals can navigate the challenges and opportunities as they brace for the future of ESG reporting.

Where are we now? Understanding ESG and its relevance in financial reporting

ESG provides a framework to assess a company’s impact on the environment, its relationships with stakeholders, and its governance structure. These interconnected components play a vital role in shaping a company’s reputation, brand image, and overall value proposition. According to a recent PwC survey, 79% of investors said how a company manages ESG opportunities and risk was an important factor in their investment decision making, while 49% said they were willing to divest from companies not taking significant ESG action. Yet the same report found that only 54% agree that board directors had sufficient knowledge about ESG issues. 

Integrating ESG into financial reporting entails incorporating relevant sustainability metrics alongside traditional financial performance indicators to provide a more comprehensive view of a company’s operations. ESG integration is already the law in the European Union—and could become mandatory in the United States in the near future. 

Of course, many U.S. companies are already reporting on ESG issues in their published sustainability reports. According to the Sustainable Business Survey Report 2023 by The Wall Street Journal, 63% of companies disclosed ESG information in 2023, up from 56% the year prior. Among the companies that are ahead of the ESG reporting curve is Apple. You can check out its latest Environmental Impact Report to see how the company has reduced direct and indirect greenhouse gas (GHG) emissions and explore which reporting metrics are involved.

Where are we going? Looking closer at ESG reporting standards – current and forthcoming

In response to the intricate nature of ESG reporting, it’s no surprise that regulatory bodies worldwide are working to establish standards and guidelines to help companies accurately disclose their ESG activities, allowing them to showcase their commitments and demonstrate progress toward meeting them. Numerous regulatory proposals have surfaced, focusing on the disclosure of GHG emissions from three primary sources: 

• Scope 1: Direct emissions of a business
• Scope 2: Indirect emissions resulting from third-party energy generation used by the company
• Scope 3: Emissions from the business’s value chain
  

At a global level, the International Sustainability Standards Board (ISSB) was established during the United Nations’ climate change conference in late 2021. The ISSB is developing a comprehensive set of disclosure standards, aiming to ensure stakeholders can access essential information about a business’s sustainability-related risks and opportunities. These standards, known as the International Financial Reporting Standards (IFRS) Sustainability Disclosure Standards, include two components: IFRS S1, which outlines general requirements for disclosing sustainability-related financial information, and IFRS S2, which focuses on climate-related disclosures. Both went into effect in 2024. 

Meanwhile, the U.S. Securities & Exchange Commission (SEC) has been providing guidance on climate change-related disclosures for more than a decade. The SEC is taking additional steps to enhance sustainability reporting, though its proposed rules are in limbo. One proposal targets public companies and the other focuses on ESG funds. While the status of the SEC’s rules could change at any time, the guidelines are expected to require many public companies to disclose their direct GHG emissions as well as indirect GHG emissions from purchased electricity. As Strategic Finance previously reported, many companies waiting for the final SEC rules to be ironed out are already making plans to incorporate the reporting guidelines—no matter what they include.

Of course, regulators in the European Union have been proactive in adopting the Corporate Sustainability Reporting Directive (CSRD), which took effect this year. This directive supports the European Green Deal climate change initiatives and expands on previous directives to encompass a broader range of European and non-European companies listed and operating in EU-regulated markets. According to the CSRD, companies must adhere to amended reporting requirements if they already fall within the scope of the EU’s Non-Financial Reporting Directive. These requirements are in line with mandatory EU sustainability reporting standards and necessitate external assurance of sustainability reporting. To facilitate compliance, the European Commission has provided background information on corporate sustainability reporting and the CSRD guidelines. 

Why ESG integration is imperative

The potential payoff for businesses that focus on ESG is huge. The main variables include:

1. Risk management: By assessing ESG factors, accounting and finance professionals can identify and mitigate risks related to environmental disasters, social controversies, or governance failures. This proactive approach can help businesses safeguard their reputations and avoid potential legal and financial repercussions. For instance, companies that have strong ESG practices are better prepared to handle climate-related risks, such as supply chain disruptions caused by extreme weather events or stricter environmental regulations. By incorporating ESG considerations into risk management processes, companies can enhance their resilience and adaptability to changing market conditions.
2. Enhanced investor confidence: Institutional and individual investors are increasingly seeking to align their investments with sustainable and ethical practices. Companies that prioritize ESG reporting attract more socially conscious investors, leading to increased access to capital and improved stock performance. Investors recognize that a company that is proactive in managing ESG risks and opportunities is likely to be better positioned for long-term success. Furthermore, the growing popularity of sustainable investing has led to the emergence of ESG-focused funds, which further emphasizes the importance of transparent and robust ESG reporting.
3. Improved decision making: Integrating ESG into financial reporting provides management with a holistic perspective, enabling better-informed strategic decisions that balance financial goals with societal and environmental responsibilities. By considering ESG metrics, companies can align their strategies with the broader interests of stakeholders and gain a competitive advantage by addressing evolving societal expectations. For example, a company that actively promotes diversity and inclusion may attract and retain top talent, leading to a more innovative and dynamic workforce.

Challenges in integrating ESG into financial reporting

Despite the growing recognition of the importance of ESG, several challenges hinder the seamless integration of sustainability metrics into financial reporting:

1. Lack of standardization: The lack of a universally accepted framework for ESG reporting results in variations in reporting methodologies and data collection. Accounting and finance professionals face the challenge of ensuring consistency and comparability across diverse ESG data sources. Standardization efforts, such as the Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB), are making progress in this area, but more work is needed to establish a comprehensive and widely adopted framework. Collaborative efforts between accounting bodies, regulators, and industry stakeholders are crucial to develop a coherent set of reporting standards.
2. Data quality and availability: Reliable ESG data can be scarce, making it challenging for accounting and finance professionals to assess a company’s sustainability performance accurately. Collecting and verifying relevant data requires collaboration with various departments and external stakeholders. Accounting and finance professionals need to work closely with sustainability teams, human resources, supply chain managers, and other relevant departments to ensure reliable data is collected and analyzed effectively. Furthermore, advancements in technology and data analytics can play a significant role in improving data quality and accessibility for ESG reporting.
3. Complexity of ESG metrics: Measuring ESG performance involves numerous qualitative and quantitative indicators, making the process complex and time-consuming. Accounting and finance professionals need to develop expertise in interpreting ESG metrics and translating them into meaningful financial insights. This might require additional training and collaboration with sustainability experts to ensure a comprehensive understanding of the environmental and social impacts of the business. Additionally, companies need to disclose both positive and negative aspects of their ESG performance to provide a balanced and transparent view.

The ROI of integrating ESG into financial reporting

There are myriad benefits of sharpening the ESG focus for financial reporting: 

1. Strengthened corporate reputation: Companies that transparently disclose their ESG efforts build trust among stakeholders and enhance their brand reputation, leading to a competitive advantage in the marketplace. A positive ESG reputation can attract top talent, foster strong customer loyalty, and strengthen relationships with suppliers and partners. All of this also helps companies build lasting relationships with communities and governments, facilitating smoother operations and reducing regulatory risks.
2. Access to new markets and opportunities: Organizations that demonstrate a commitment to sustainability often gain access to new markets and business opportunities that prioritize environmentally friendly and socially responsible practices. For instance, some government contracts, institutional investors, and consumer markets are increasingly favoring companies with robust ESG practices. By integrating ESG into financial reporting, companies can tap into these emerging opportunities and create a distinct market position.
3. Long-term value creation: ESG integration encourages companies to adopt sustainable business practices, fostering long-term value creation for shareholders, communities, and the environment. By aligning business strategies with sustainable principles, companies can contribute to positive societal outcomes, such as reducing carbon emissions, promoting diversity and inclusion, and supporting local communities. Furthermore, companies that prioritize ESG are more likely to anticipate and address emerging trends and challenges, positioning themselves as leaders in their industries.

How companies can integrate ESG into financial reporting

ESG reporting is no longer a suggestion—it’s an imperative that helps companies accomplish essential goals that range from attracting and retaining investors to boosting efficiency. Managers must integrate ESG into financial decisions, enhance transparency, embrace efficient resource utilization, and drive innovation for a sustainable future.

What could go wrong if ESG isn’t a priority? Plenty. Consider a manufacturing manager overseeing a production facility. ESG reporting prompts them to assess and mitigate environmental risks, such as reducing energy consumption or implementing sustainable sourcing practices to minimize carbon footprint. Failure to address these concerns could lead to increased operational costs, regulatory fines, or diminished investor trust. 

Similarly, a human resources manager must prioritize social factors like diversity, equity, and inclusion (DE&I) within the workplace. By implementing policies that promote workforce diversity and equitable opportunities, they not only enhance employee satisfaction and retention, but also attract top talent and strengthen the company's brand. 

Moreover, a finance manager must incorporate governance principles into financial reporting and decision-making processes to ensure transparency and accountability. This might involve establishing robust internal controls to prevent fraud or corruption, thereby safeguarding shareholder value and maintaining investor confidence. In essence, ESG reporting guides managers in proactively addressing risks, seizing opportunities, and fostering sustainable business practices across the company, ultimately driving long-term value creation and resilience.

Integrating ESG into financial reporting marks a transformative shift in corporate accountability and transparency. As agents of change, finance and accounting professionals play a pivotal role in driving this transformation. They can help navigate the complexities of ESG metrics and facilitate comprehensive reporting. Embracing sustainable practices not only benefits businesses, but also contributes to a more equitable and sustainable world. 

As ESG continues to evolve, the expertise of finance and accounting professionals will be instrumental in steering organizations toward a brighter, more responsible future. By embracing ESG integration, companies can position themselves as leaders in sustainable business practices and contribute to a more resilient, prosperous, and inclusive global economy. As stakeholders increasingly demand transparent and meaningful ESG reporting, accounting and finance professionals have the opportunity to lead the way as the profession moves forward in shaping a more sustainable future for businesses and society at large.