ESG: Environmental, Social, and Governance Issues

About the Panelists

The last panel of the morning was focused on environmental, social, and governance (ESG) issues as they affect accounting, auditing, and financial reporting. Jenny Lynch, audit and assurance partner in Sustainability and ESG Services, Deloitte, moderated the panel alongside Baruch Professor Norman Strauss. The panel comprised Todd Castagno, executive director, research, at Morgan Stanley, John Hodges, partner, EY, and Daniel Lim, ESG controller, Alphabet. The following is an edited and condensed report of the panel’s discussion. The comments made by the panelists represent their own thoughts and views, and are not necessarily representative of their employers, clients, or affiliated institutions.

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Jenny Lynch, audit and assurance partner in Sustainability and ESG Services, Deloitte, launched the panel by asking participants what they thought was the most exciting thing that’s happened in the ESG space in the past year.

“I think the most exciting thing is … there’s a lot of alternative data in the space that has really escalated over the past 12–24 months,” began Todd Castagno, executive director, research, at Morgan Stanley. “Investors approach the world differently even within ESG. People weight the information differently, and how they process that, and their investment-making decisions. But the momentum of this initiative—the variety of data, the variety of disclosures—I see it accelerating, not waning. … It’s really interesting to see institutional investors actually put some of this information to work to make investment decisions.”

“I think the most exciting thing is the fact that folks are recognizing that this is more than just a check-the-box-compliance exercise,” said Daniel Lim, ESG controller, Alphabet. “It’s about high-quality information that enables all the great things that companies are trying to do in this space. There’s a lot of purpose behind what we do as professionals in this space.”

John Hodges, partner, EY, said he was excited about technological advancements (such as electric vehicles and hydrogen technology) and movement in the regulatory space. “But there’s been some pushback on large asset management firms. And this is making front-page news,” he noted. “For decades, the people that work in ESG and sustainability in corporations—and the investor community as well—wanted to become mainstream. Well, this is what being mainstream is: you’re on the front page of the New York Times when you’re mainstream.”

The SEC Proposal

Lynch asked how companies are starting to think about the SEC’s proposed climate disclosure rule and its implications. “The world of corporate sustainability is entering a third era,” Hodges said. “The first era, decades ago, was corporations gave money to charity. … They were doing things in the community, and it would end up on a corporate social responsibility [CSR] report. Then about a decade ago, companies started thinking through sustainability and how it integrates and interacts with our business model.”

“’We’re in this third era now,” Hodges continued. “The second era had a tendency toward some greenwashing. … This third era is really about: Can we make this more accurate, more credible? Can we give the variety of stakeholders the information that they need to make better informed decisions? It’s moving into a more regulated world. And that’s where the SEC comes in.”

“The proposed rule is called the ‘enhancement and standardization of climate-related disclosures for investors’; the key word there is ‘disclosures.’” He continued, “Before we get asked what’s in it, we get asked, ‘Is it going to be real? Is this going to really happen? And, if so, when?’ And I think there’s a consensus belief that it is going to be real.”

Hodges went on to discuss some of the details of the SEC proposal, including the scoping framework for disclosures about climate risk and their potential impact on a company. He also noted that the proposal largely builds on the existing voluntary standards in the area; it doesn’t come entirely out of the blue.

Castagno described a spectrum of needs on which investors fall in terms of the information they are looking for from climate disclosures. But he thinks they agree on the need for comparability: “I think there’s a view that, having this in the financial statements, having it structured, having specific requirements, is appreciated by investors because they can get a level of comparability. And assurance is big as well.” He added that investors also wonder about how such items are measured and appreciate the internal control structures behind information currently reported in the 10-K.

In response to a question about what companies are doing right now, Hodges explained: “For years, the information that companies put out on sustainability was in a stand-alone corporate sustainability report. And a lot of times, it was developed by the marketing team or outsourced to a communications firm. There are, of course, standards and processes behind how you calculate that information, but it didn’t have that level of scrutiny that it has when it goes into a regulatory filing.” He said that a final SEC rule would lead companies to make sure that reported data is “consistent, comparable, and reliable.”

Lim said that, while many companies are in a holding pattern until the SEC provides more clarity, “there are so many different ‘no regrets’ moves you can take as a company. … One of the things that companies are doing is an exercise to make sure they have a formal climate risk assessment.” He noted that the Task Force on Climate-Related Financial Disclosures (TCFD) framework, which is already investor-focused, as a place to start. “Some of these things you can do now don’t just put you in a good position to comply with these rules that are coming our way, it really sets you up to manage climate risks in a way that is useful for your organization.”

Lim noted that, notwithstanding the SEC, things are moving faster in Europe. “Putting compliance reporting aside, there’s this broader market need for this information. It’s a big driver to why companies like us have been reporting information voluntarily for many years.” He described greenhouse gas (GHG) emissions as a key metric and common denominator for companies to prioritize.

Lynch added that pressure is coming from the investor side as well. “The big private equity firms now are moving towards having their holdings disclose their [GHG] emissions to them, and then they are rolling it up and aggregating it. … It’s becoming more commonplace.”

“Whether there’s soft or official regulations, a lot of investors have an investment mandate, and they need that information,” Castagno added. “A lot of institutional investors want to access that data primarily so they can understand exposures in their holdings, because the data landscape, while it’s evolving, it’s still not very robust; there’s holes, particularly if you look at certain jurisdictions.” He noted that his group developed a tool to look at ESG factors across a portfolio and identify exposure and manage a portfolio on that basis.

Lynch circled back to the mention of the TCFD. Hodges said that the TCFD Framework, which includes governance, strategy, risk, and metrics, has been widely adopted, included being incorporated in the SEC’s proposal. When companies talk about risk, they ask: “Are there any processes existing in the company to analyze sustainability risk? Secondly, are they integrated with overall enterprise risk management in some fashion as well?” He described this as a long-term topic and noted that “there are a lot more companies using scenario planning and scenario analysis when thinking through climate and integrating that into their risk function. It’s becoming more of a norm.”

The International Perspective

Lynch turned the conversation to the work of the International Sustainability Standards Board (ISSB) in coalescing the different standards and frameworks out there. Castagno thinks that “a single set of standards where the disclosure is similar across jurisdictions, across companies, sectors, is a high objective for investors.” He continued, “I think there will be a push for more standardization, outside of climate as well. There’s other areas that the ISSB will be addressing.”

Hodges said that the ISSB is “a good attempt to try to bring everything under one roof, for what’s been developed in the voluntary markets. Many companies follow those voluntary standards and feel like they’re high-quality, but they’re relatively new.”

Lynch emphasized that on the global level, many think about ESG in a broad sense, whereas the SEC proposal is more climate-focused. She gave the example of the Corporate Sustainability Reporting Directive (CSRD) out of the European Union, which has been passed into law and will begin being implemented next year. Castagno noted that the CSRD has a very small threshold that includes subsidiaries of U.S. companies and major suppliers into the EU.

“Think of it as a really good corporate reporting on sustainability,” is how Hodges characterized the new requirement. “It’s more than just climate. It covers pollution, water, other environmental topics. It covers social matters, the whole ESG range. It covers ethics under governance.”

“But what it really looks at is not just the impacts of sustainability issues on the company and the company’s performance, which investors are really interested in,” Hodges continued. “If the weather gets really bad in certain regions, there’s lots of drought flooding, could that impact the footprint of this company, that physical risk? Is there transitional risk, legal requirements, technological advances that can impact this company? That’s interesting. … What’s the outward impact of the company on society as well? You’re looking at it from a multi-stakeholder viewpoint, and that’s required as part of this as well.”

“It’s a really interesting accountability mechanism,” Hodges continued, “more than just putting your sustainable report in the public domain, it has a regulatory component to it. It’s also forcing companies to really think through, ‘What harm are we causing to the environment and society in our operations?’”

“My single piece of advice is get started,” Lim added. “A lot of companies are just figuring out which entities are in scope and how the rules will apply to you. It is really important to get started on that, including some of the different exemptions that are out there, especially for U.S. parent companies.”

“Touching on those different reporting exemptions and approaches, for some companies you might be able to report at the group level, so it may not be at the entity-specific level. … Maybe it’s at the EU consolidation level,” Lim continued. “It’s important to evaluate the different trade-offs between these different approaches, whether it’s based on what information you might already be disclosing today relative to the gaps that you might need to fill. What new processes do you need to review, gather data, that might need to be put in place if you decide that you want to take a different approach than what you normally prepare information on today?” He stressed the importance aligning an initial strategy with the reporting entity and building a roadmap from there.

“It’s important to start doing something to figure out your material topics, or your priority topics, or the other topics that are important to you as an organization, beyond climate and beyond your own workforce,” Lim added. “Because that is really going to drive what your compliance obligation is and what disclosures you have to make against those standards.”

Lynch followed up with a question about how companies are collaborating to move from what historically has been a global reporting voluntary mechanism to thinking about a localized regulatory perspective. “We have to recognize that we’re shifting from this primarily voluntary reporting space to one that’s kind of a hybrid. It’s a dual reality of voluntary and regulatory,” Lim replied. “One of the most important things from a governance standpoint is beginning to clarify and codify what the roles and responsibilities are between these different teams. For a lot of global companies like Alphabet, we have controllership and we’ve got our existing sustainability teams that are led by our chief sustainability officer. We’ve got international controllers. We’ve got folks in finance. So it’s important to codify who’s doing what today … It’s really aligning the right skill sets, recognizing that the work is expanding.”

“It’s an opportunity in some ways for, say, your sustainability teams to free up time and capacity to do what they enjoy doing and what we need them to do. … It allows people to do the things that they’re skilled to do and overall have a more effective program,” Lim observed. “It’s really important to clarify those roles and responsibilities—and then be willing to change that.” Lim continued, “This space is evolving. One of the biggest things that we can do as professionals is keeping an open mind, and being able to evolve your roles and responsibilities as this space continues to change.”

Lynch asked the panelists how they see the role of voluntary ESG reporting evolving over time. Castagno and Hodges talked about how regulatory requirements might differ from historical voluntary practice, creating inconsistencies over time and challenges for reconciliation.

Evolving Roles and Strategies

The mentality around ESG is shifting and moving away from a compliance mindset, said Lynch. Lim replied that this is because of broader stakeholder needs. “Disclosure and data is really the natural evolution or progression in terms of where this space is going in this third era,” he said. “Companies need consistent, comparable, reliable information. Forget your external stake-holders for now. Companies need this information to better manage risks, as well as manage their performance in progress against their goals.”

“The role has evolved beyond, ‘How do we get ready for rules?’ It’s more alignment of different teams, building these different cross-functional environments,” Lim continued. “’It’s about bringing the overall financial reporting expertise and diligence, creating this center of expertise, and saying, ‘How can we bring all these best practices from the world into this space of nonfinancial information—and combine that with sustainability knowledge to enable the reporting ’that’s already happening?’”

“If you think about companies that have a net zero strategy, there’s all these different levers that probably need to get pulled to make things happen,” Lim said. “And all that needs data, professionalization, and discipline, and rigor and accountability. As accounting professionals, we have an opportunity to bring that value to that space. If you just think about it from a compliance perspective, I always think you’re missing the opportunity to find a lot of purpose and value to your organization.”

In response to a question from Norman Strauss about the role of auditors, Lim said: “We get limited assurance over certain metrics that are provided in our environmental sustainability report. We do lead those efforts—primarily because my team is accustomed to working with auditors. We all come from a Big Four background, so we understand the questions that will be asked and the type of documentation that’s expected.”

“One thing that’s important to note is that even though we do engage with the auditors, we don’t necessarily own the data. It varies depending on the company,” Lim added. “If I’m facilitating the assurance, if I’m making certain assertions to the auditor, I have to be comfortable with the information. Building the right process, controls, and certifications is important.”

Strauss asked the panel if audit committees are spending more time on ESG disclosures, and Hodges replied yes: “Now it’s starting to land in the places it should be. The controllers and CFOs are getting more involved, and the audit committees are getting more involved and asking good questions about how this will all work.” Castagno added that the increased pressure from quasi-activist investors has provided another avenue for ESG to get into the C-suite and the boardroom.

“We are enhancing our disclosure and reporting systems to ensure that we create this collaborative environment and break down organizational barriers in terms of teams that are involved in creating and executing against a reporting strategy, but also gathering, preparing, reviewing, and publishing sustainability disclosures,” Lim added. “That includes controllership, finance, sustainability, investor relations, communications, public policy, legal, and even marketing, depending on what tools your company uses to put out ESG-type information. Groups like these are really important, not just because they break down those organizational barriers. They ensure that you are looking at disclosures through different lenses, integrating different priorities, different skill sets, knowledge, expertise—and that’s super important.” He described a dual reality where “you have voluntary reporting and regulatory reporting of that same information across different communication channels and different tools.”

“Groups that are cross-functional really allow you to have diverse perspectives and richer conversations,” Lim continued, “to really ensure that you have a better understanding of what we’re saying in public—not just through that financial reporting lens, but how we communicate to other stakeholders and how people are using this information. In that way, we enable potentially earlier identification and management of risks across the organization.”

In response to a question from Lynch, Castagno said that there is a tradeoff between having information that has been assured, versus information that has been voluntarily reported. “With some of the core disclosures, there seems to be a strong consensus that there should be, concurrent with the financial statements, some level of assurance,” he said. “There is also a desire for more forward-looking information which perhaps ’doesn’t belong in the financial statements. But ultimately, you’re trying to understand where a company is going, what the targets are, how they’re going to choose those targets, and what those targets are going to cost.”

The discussion turned to how companies should approach ESG. Hodges pointed out that the SEC proposal “is not prescriptive necessarily in telling companies exactly what to do. The CSRD doesn’t regulate how companies address ESG risks.” He suggested companies start by taking an assessment or inventory or what they’re doing, get it organized and catalogued, and then “understand who has rules and responsibilities and what that means from a business operational standpoint and a financial standpoint as well.” He noted that the SEC proposal would require attestation from the CEO, and he doesn’t think many CEOs understand the GHG protocol. “So there is an education component internally with your senior leadership to understand what the requirements are—but also what’s the bigger picture? And what’s the key knowledge that they need to be able to manage the company correctly for the long term?”

Lim added that many companies are looking into software tools, which vary widely in terms of capabilities and costs. He referred to data ingestion as “the first mile, probably one of the most challenging parts of the process, as opposed to say the reporting side, which I think sometimes you hear about. There’s all these tools that can do all this stuff, but they really just focus on that reporting last mile. The first mile is what’s really challenging.”

“I think we tend to overweight climate,” Castagno added. “I mean, it’s obviously a big deal. But looking at E, S, and G, I’ve seen a rate of change or focus: governance is becoming more and more explicitly incorporated. You’ve seen some proxies saying pay votes like exec compensation, as you mentioned, the whole dual-class share structure is getting a lot of pushback … Climate is important, but this whole movement, there’s other verticals and channels that are important as well.”

Making Decisions and Forecasts

“How do investors use these ESG metrics when they’re making investment decisions and valuation?” Castagno asked rhetorically. “It depends. There’s certain exposures that are more material than others. One example we’re seeing now is portfolio analytics. What am I exposed to? I’m exposed to water, shortages, climate—that’s one way of actively managing exposures, there’s real institutional capital being deployed. … We analysts don’t necessarily have the historical data, so it’s hard to forecast something that you don’t have the data for.”

“We actually kind of force our analysts to make to make assumptions where we think it matters in particular industries,” Castagno continued. “How do you manage your business through these issues? What are the timelines? What are the targets?” He stressed there is no one-size fit-all model, even for a particular industry, because companies have different business models. “I frankly don’t see a lot of institutional investors buying or selling stocks based on the [ESG] score, and if you look at the very recent past, you have some companies that had very good ESG scores that are no longer here.”

Strauss asked the panel if all of the attention given to ESG really reflects the value investors place on the information. “If you’re looking at ESG through the lens of evaluating different risks and opportunities to business,” Lynch replied, “that is important information that different stakeholders will make decisions on.”

“If you look at the big macro issues of what’s really trying to be addressed, it’s, ‘Are we going to have a just and sustainable society in the long term?’ And corporations have a disproportionate impact on those outcomes,” added Hodges. “I’m not trying to appeal to the right thing to do, because I do think there is a business decision to be made, and we always take the position that sustainability is good for business.”

Although Castagno admitted that there’s been some “greenwashing,” he suggested it might be a healthy phase for the market to go through. He noted that even investors who don’t care about ESG in particular would not ignore SEC climate disclosures once they come out: “’You’re going to use the information you have to make better investment decisions.”

“The question more commonly is not, “Are these issues important?” but “Are we going to invent our way out of it? Is technology going to surpass the problems?” Hodges posed in response. “’That’s a healthy debate. Do you need regulations, or is there a free market solution? Because people value clean air. They value clean water.”

“When we go back to your very first question, what are you excited about?” Hodges continued, “Technological advancement is super interesting and coming along the line in a profound way that is really helpful. The sustainability products and services are making money and doing well.’ There’s a lot of other technological benefits to come with sustainability benefits.”

Questions from the Audience

An attendee asked how ESG standards will be enforced. “I think that is actually up to local jurisdictions globally,” Lynch answered. “’We’ve seen some countries indicate that once the standards are final, they will sweep them up under their local jurisdictions.” She noted that some countries have indicated that they will focus on ISSB, whereas others, including the EU nations, have gone in a direction that is not totally divergent from the ISSB but is slightly different. Companies will need to plan accordingly.

A follow-up question asked about the assurance of proposed ESG disclosures. “There is certainly a level of education that needs to happen from both companies as well as auditors, and we’re in on that journey, and I’m sure the rest of our audit companions are doing the same,” Lynch said. “A lot needs to happen both from the company side, as well as auditors communicating what these changes mean to companies. … There’s still a lot of questions and clarity that’s needed [on the SEC proposal]. I know some are preparing in different ways. That’s one that they may be taking a little bit of a pause on, to see what the ultimate impact of that rule might look like.”

With respect to who will provide assurance, Lynch explained that “what lands in the financial statements themselves, within S-X, will be subject to the audit; your financial auditor; outside of the financial statements, the S-K portion, the greenhouse gas emissions assurance, does not have to be your financial auditor. Historically, with this voluntary reporting world, we’ve seen engineering companies, different boutique consultancies, as well as Big Four and other accounting firms providing assurance. I’ve seen a couple of instances where some of the boutiques are actually stepping away from this, given where the information is now landing in regulated filings.”

As to whether companies should use their auditor to provide assurance on ESG information, Lynch said, “I think there’s a lot of benefit … Anytime you have someone that knows how your company works from an operational perspective, a systems perspective, and the different individuals that might be playing a role, it adds efficiency and provides better quality at the end of the day.”

“My personal view is that it probably should be the same firm that does both,” Lim agreed. “It goes back to my personal north star, that these things link up together, the nonfinancial metrics and the financial metrics.”