The CFO’s role in balancing ESG risks with financial reporting

ESG or Environmental, Social, and Governance factors are fast gaining importance in the C-suite. Many choices made there must pass through an ESG lens in addition to the economic lens that used to be the yardstick for many decisions. Where’s the CFO in all this? Busy doing financial reporting or at the center of the engine room crafting the company’s sustainability strategy?

Let’s first look at why ESG is gaining importance, how it impacts company performance, and finally what role the CFO should play in all this. There are multiple reasons such as stakeholder expectations, risk management, regulatory pressures, access to capital, talent attraction and retention, and reputation and brand enhancement.

It’s clear that these mostly outside pressures forces management into action as they can no longer be ignored. One such example is the large-scale green energy transition that’s going on where former oil and gas majors have started to invest heavily into sustainable energy sources.

 

ESG – a double-edged sword

Dealing with ESG factors can be challenging as each of them presents both opportunities and risks. For each factor you can easily highlight both and the only thing that’s certain is that ignoring them will be a risky decision. Looking at it from a CFO’s perspective we could highlight the following.

It’s hard to deny that ESG factors have a significant impact on most companies’ performance today. Therefore, it’s imperative that CFOs add new performance measures to their performance management efforts. We have suggested factors like stakeholders e.g., impact on the market and wider society, wellbeing of staff, net-zero ambitions, etc. If the CFO fails to update the performance management framework with ESG factors the company will surely miss out on many performance improvement opportunities. It’s simply impossible to do proper risk and opportunity management if continue to look at performance through an outdated lens.

 

ESG risk management

We have highlighted many of the most critical ESG factors above and to each of them there are significant associated risks. What should the CFO’s role be in assessing and managing these risks? One might say it’s no different from managing any other risks as highlighted in the points below.

• Quantifying financial impact: The CFO should work to quantify the potential financial impact of ESG risks on the company's bottom line, considering factors such as revenue, costs, asset valuation, and shareholder value.
• Scenario analysis: Engage in scenario analysis to model the potential financial implications of different ESG risk scenarios, helping the company understand the range of outcomes and develop appropriate strategies.
• Investment decision support: Provide financial analysis and insights to support ESG-related investment decisions, such as investments in renewable energy, sustainability initiatives, and supply chain improvements.
• Reporting and disclosure: Collaborate with the sustainability and reporting teams to ensure accurate and transparent ESG reporting, addressing the concerns of investors and other stakeholders.
• Integration into strategy: Work with the executive team to integrate ESG considerations into the company's overall strategic planning, aligning financial goals with ESG objectives.
• Engagement with investors: Communicate the company's approach to managing ESG risks and opportunities to investors, addressing their concerns and showcasing the company's commitment to long-term value creation.

 

We also highly recommend working with an updated risk assessment matrix for all the identified company specific ESG risks and having mitigation plans at hand should they be needed.

 

From reporting to strategizing

As we have discussed, one of the important aspects of the CFO’s role in ESG is the integration of ESG factors/actions into the company’s strategy. We would highlight three important actions for CFOs to take.

These actions cannot stand alone as CFOs should also push to align incentive structures to the ESG targets and ensure that initiatives significantly pushing the company’s ESG agenda in the right direction get priority in the resource allocation.

Naturally the CFO is also the primary owner on following up on the progress with the company’s ESG initiatives. Are they successful and of course, are they improving the overall company performance. While there’s no two ways around the necessity for companies to take action on the ESG agenda it doesn’t mean they’ll have to forego completely their financial return targets. This might just be the biggest challenge yet for CFOs!

And let’s not forget that they’ll still need to manage all the reporting requirements. However, we envision that if ESG is embedded into the company’s strategy and a performance management framework is set up around measuring its success then it’ll also be much easier to satisfy the reporting requirements. The finance team and non-finance leaders are simply more motivated to get it done when they can see business results being delivered.

 

CFOs cannot do this alone

As much as the CFO can try to take the lead on the ESG agenda within a company s/he cannot do it alone. It will require a close collaboration with all C-suite members and their departments. Finance cannot execute on (m)any of the ESG initiatives, so they’ll need to take a strong partnering approach to make it happen.

CFOs will also be the primary focal point towards many external stakeholders and not least the investor community. Make sure to craft a compelling story around the company’s ESG initiatives and highlight the real progress that’s being made. Getting the reporting done is not enough. The storyline needs to be communicated in a clear and concise way too!

Without a doubt there’s a lot to get done on the ESG agenda for all companies. CFOs need to play a strong role if companies are to succeed. Not just because there are regulatory requirements for reporting but just as much because the CFO’s leadership is needed to create real progress while still making satisfactory financial returns. What role is your finance function playing in ESG in your company? Are you only trying to report the numbers or are you taking ESG into the strategy room?