Environmental, social, and governance (ESG) reporting is no longer considered a soft investment. Market demand and regulatory guidance are coalescing quickly. Consistent and transparent financial reporting standards have helped investors measure business success for decades, and now that scope is expanding to include ESG strategy. Investors are funneling money into ESG investment vehicles and demanding information on company ESG practices. They are voting against directors of companies that underperform in “identifying material ESG issues and incorporating the implications into their long-term strategy,” as State Street Global Advisors wrote in a letter to CEOs (https://bit.ly/3z1su1J).

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From a regulatory standpoint, the European Union’s proposed Corporate Sustainability Reporting Directive extends the coverage and scope of ESG reporting requirements, including requiring limited assurance of ESG reporting. Meanwhile, the International Financial Reporting Standards (IFRS) Foundation, which is supported by the International Organization of Securities Commissions (IOSCO), is preparing to launch an international sustainability standards board at the 2021 U.N. Climate Change Conference (COP26).

This march toward a more global set of standards will continue. In 2020, the World Economic Forum’s International Business Council (IBC), comprising 140 CEOs and including the Big Four accounting firms, outlined an industry-agnostic ESG reporting framework, proposing 21 core metrics and 34 extended metrics that cover a range of issues, including greenhouse gas emissions, social factors (e.g., pay and gender ratios), and governance targets.

How do boards meet this moment? What is the role of audit committees? How can management teams incorporate ESG into their strategies? How do companies tell their ESG story to stake-holders?

These questions may seem daunting, but it is important to see ESG as a journey, requiring a new kind of engagement with stakeholders that properly frames business decisions and helps leaders craft sustainable strategies to create value today and tomorrow.

The ESG Moment: Seeing Opportunity Today and Tomorrow

ESG reporting is impacting the ability to attract new investors and affecting both the cost of and access to capital. ESG reporting can help companies build customer loyalty, compete for top talent, and understand risks that threaten their business models.

In that context, more and more companies are voluntarily preparing and presenting ESG information beyond industry and SEC requirements, according to “The Time Has Come: The KPMG Survey of Sustainability Reporting 2020” (https://bit.ly/3mhdxVR). In North and Latin America, 90% of the top 100 companies by revenue report on sustainability.

Much of the ESG discussion is focused on meeting stake-holders’ demands; the reality, though, is that ESG engagement is an opportunity to mitigate financial risk and realize new business potential. A data-driven ESG lens helps put conceptual tail risks in focus and inform corporate strategy. Alignment to ESG also creates more space to think and act boldly. More loyal customers, purpose-driven employees, investors with a long-term perspective, and coordinated management teams can make more effective decisions today while driving innovation that unlocks value tomorrow.

First Steps on the ESG Journey

ESG engagement should be embedded within a company’s strategy and purpose. When ESG initiatives are peripheral to core corporate activities, they will not contribute directly to a company’s competitive advantage. Over time, ESG initiatives may receive less investment and fail to create lasting change and value. Instead, the same methods companies use to drive financial results can be employed to bring focus and discipline to ESG.

For example, a KPMG survey, “The ESG Imperative for Technology Companies,” found a gap between what technology companies think about ESG and how they incorporate it into their strategies (https://bit.ly/3D3vAEX). Without a long-term cohesive strategy, many companies will not be able to set their own ESG agenda to drive value.

ESG issues vary by industry and by company. For example, a KPMG International survey, “Towards Net Zero: How the world’s largest companies report on climate risk and net zero transition” (https://bit.ly/3D1x6r3), found that 56% of the world’s 250 largest companies acknowledge in their corporate reporting that climate change is a financial risk to their business. In the oil and gas industry, 81% of the largest companies report climate-related financial risks, followed by retail (70%); technology, media, and telecommunications (60%); and financial services (57%). These differences are evident across industries and ESG issues, and a company’s ability to report on them will depend on the maturity of its systems and operations.

A Framework for Action

Though each ESG journey is unique, there are four steps all leaders can take to prove their ESG commitments are both effective and meaningful:

  • Develop a strategy. What does ESG mean for your company? How does ESG align with your company values? Determine what matters most and where should you spend your time and resources?
  • Operationalize plans. How do you realize this strategy in your work-force, supply chain, technology, infrastructure, and more? Embedding ESG into operations requires a team effort, including leading technologies.
  • Measure, report, and assure ESG plans. Which metrics will you use to tell your company’s story to investors and other stakeholders? Quantifying efforts can help you monitor your progress and shape your own ESG journey. How will you demonstrate credibility to stakeholders? Assurance over ESG reporting, especially when performed by an independent auditor, enhances the reliability of data.
  • Transform with ESG in mind. How do you grow with ESG in mind?

Developing the Strategy: The Role of Leadership

Level setting and strategy development are foundational to the ESG journey. The first step must be aligning the board with leaders and key stakeholders on what matters most, framed in business terms—particularly risk, opportunity, efficiency, and financial performance.

How entities frame their specific ESG priorities has a big impact on aligning strategy and resources to deliver impact.

Organizations should consider shifting from a model that siloes sustainability within one team or leader to one that engages meaningfully across departments and includes the chief financial officer.

This type of engagement is bolstered through materiality and gap assessments, providing leaders with insights into risks and opportunities through the lens of different stakeholders—employees, clients, regulators, and competitors.

How entities frame their specific ESG priorities has a big impact on aligning strategy and resources to deliver impact. After prioritizing the critical issues, management identifies the efforts and changes to policies and operations that must be undertaken to result in measurable change.

Operationalizing the Strategy: Technology is Key

Companies that recognize the strategic importance of ESG embed these issues into their long-term performance goals. This is especially true with technology. Although technology is always advancing, organizations should take stock of existing systems to understand how they can be leveraged to collect relevant information for analysis. Likewise, if a company is already undergoing digital transformation, ESG should be part of that conversation to ensure that new technology systems are ready to incorporate ESG. A lasting ESG approach should draw the same levels of investment as other core business workflows, including automation, blockchain, AI, and data analytics.

Measurement, Reporting, and Assurance

As discussed above, market demands are not only driving ESG strategy and action; they also drive ESG reporting. Currently, 96% of the top 250 global companies (based on the Fortune Global 500) report on sustainability, up from 64% in 2005 (https://bit.ly/3mhdxVR).

ESG reporting has been an alphabet soup of standards and frameworks, making comparability and consistency a challenge. The Global Reporting Initiative (GRI) is currently the most commonly referenced standard, but the Sustainability Accounting Standards Board (SASB) standards are quickly being adopted by many companies. For climate disclosures, one in five companies reports using recommendations from the Task Force on Climate-related Financial Disclosures (TCFD), including 32% of the top 100 companies in North America (https://bit.ly/3mhdx-VR). Of the top 250 global companies reporting on sustainability, only 22% have integrated reports, up 8 points since 2017. In addition, third-party assurance of sustainability reports passed 50% for the first time since KPMG began tracking it in 1993.

Regulatory guidance has yet to coalesce. Different reporting methods, driven by stakeholders’ expectations or regional requirements, dictate different levels of control over the information. Are companies reporting ESG data in consumer-oriented infographics or 10-Ks for investors? Reporting strategy should align with a company’s overall ESG strategy and fit within the evolving regulatory landscape as well as investor expectations. ESG information tailored to this audience should be monitored as rigorously as traditional financial reporting.

Boards, Management, Audit Committees, and the Role of the Auditor

The ESG journey requires engagement across the business. Directors must understand the company’s ESG approach and how it is integrated into strategy and the reporting of key metrics in order to best perform their oversight duties. Management across the C-suite—including the CEO, CFO, CRO, and COO—should be aligned on operations to drive business model transformation to meet their ESG objectives. Audit committee members are responsible for overseeing the responsible reporting of material information to investors. Committee members may not set ESG strategy, but they must understand priorities and material ESG topics.

Audit committees should be asking: What are we measuring, and why? What are the processes and controls over the data we report? How are we reporting? Committee members should be engaging auditors on these questions in the context of assurance.

Auditors are well-positioned to support ESG reporting. They gauge whether metrics have been prepared consistently and transparently, ensuring that the collection and preparation of data follow clear policies and procedures and verifying that the numbers reflect what a company says it does.

Because auditors are independent and skeptical, the assurance of ESG data is in many ways an extension of the work auditors already conduct. A company’s financial auditor brings valuable knowledge of a business and a preexisting working relationship.

Historically, many companies have jumped to the measurement and reporting steps of the ESG framework without taking a holistic view of how ESG is integrated into the larger

Own the Journey, but Stay Aware of Context

Historically, many companies have jumped to the measurement and reporting steps of the ESG framework without taking a holistic view of how ESG is integrated into the larger corporate strategy. There are also many companies that have already implemented strategies, but do not yet call them ESG or rigorously report their impact.

No matter where a company is on its ESG journey, the more tied to long-term strategic initiatives, investments, and reporting it is, the better leaders can communicate ESG’s returns to stakeholders.

Uniqueness is no substitute for contextual awareness, however, and leaders who are informed on ESG are tracking recent trends. ESG issues are evolving quickly. For example, COVID-19 amplified ESG awareness and expectations among investors, public policy makers, and consumers; accordingly, social factors, such as workplace safety and customer engagement, have grown in importance.

This awareness extends to regulatory developments. There is considerable movement toward a global set of standards. Understanding the potential scenarios, players, and issues is essential. How is materiality handled? What companies are excluded from certain requirements? What is the transition schedule? Are there safe harbors for forward-looking statements? These are important technical questions that have implications for the feasibility and effectiveness of any standard.

Even with global standards, companies that are thinking creatively about solving societal problems may want to develop internal or industry-specific metrics and reporting strategies.

Taking the First Step

Although ESG topics and considerations have been around for more than a decade, best practices aligned with the four steps outlined above are emerging at a critical moment.

ESG propositions create value today and tomorrow—providing growth, reducing costs, and increasing productivity for organizations. The pressure is on, and leaders should begin their ESG journey as soon as possible in order to build strategies on their own terms. Although the journey will take time, with market and regulatory demands rising, conversations can no longer wait.

Maura Hodge, CPA, is an audit partner and ESG audit leader at KPMG Impact.