CFOs Hold The Key To Unlocking ESG Value – Securities

ESG (environmental, social, and governance) is now a priority of
many corporate leadership teams, playing an important part in a
company’s financial reporting, risk management and corporate
messaging.

New regulations surrounding ESG-related reporting and
disclosures are under consideration and review by the U.S.
Securities and Exchange Commission (SEC) and within the European
Union (EU). Adherence to high standards for ESG is critical for
demonstrating positive corporate citizenship, appropriate risk
management, resiliency and responsiveness to the investment
community. While mandated reporting on ESG issues will create a
baseline in terms of the quality and completeness of disclosures
provided, companies have an opportunity to differentiate themselves
versus peers and lower their actual and perceived cost of capital
by establishing robust processes for risk identification,
assessment, prioritization, the assignment of oversight, and
related internal and external reporting.

Increasingly, CFOs can play a particularly important role when
it comes to ESG, as finance functions have the necessary skills,
systems, and processes to track and report key ESG-related metrics,
and much of the information needed to track and measure ESG goals
can be found in financial systems. Given the centrality of
financial analysis and reporting to sound ESG programs, leadership
and direction from CFOs is becoming an increasingly important
factor in driving a company’s successful management of data and
thus target-setting and reporting. In practice, finance and
accounting teams skilled in managing large data sets and tying
financial metrics to non-financial measures are moving to center
stage as key business partners attempt to define how and where to
source necessary data for ESG strategy development and reporting.
For CFOs and their teams to successfully contribute to and empower
a company’s ESG strategy, they need to be well-versed in ESG
metrics and related international standards and reporting
frameworks. Among many other critical areas of focus,
knowledge-building within finance and accounting functions and the
development and continuous improvement of systematic ESG data
collection, tracking and reporting processes will likely be front
and center, given that:

• The SEC may soon mandate reporting of climate- related
  financial risks for public companies, which will be aligned with
  the recommendations posed by the Task Force on Climate-Related
  Financial Disclosures (TCFD) and guidance from the Greenhouse Gas
  (GHG) Protocol;




• Nine other international jurisdictions have announced adoption
  of TCFD-aligned reporting requirements: Brazil, EU, Hong Kong,
  Japan, New Zealand, Singapore, Switzerland, the UK and Canada;




• Many large asset managers such as Blackrock, Vanguard and State
  Street have requested that portfolio companies respond to the
  TCFD’s recommendations and, in some cases, have threatened to
  vote against directors in situations where such implementation and
  disclosures are lacking;




• The importance of ESG-related due diligence is increasing
  within the M&A process, including assessing a target’s ESG
  reporting, disclosures, transparency, commitments, and ultimately
  the value at risk and the cost to align the target’s ESG
  profile with that of the acquirer;




• Credit rating agencies (CRAs) like Fitch, Moody’s and
  S&P are beginning to roll out ESG evaluations and scores that
  have the potential to impact broader credit ratings and thus the
  borrowing terms that companies receive on their debt from banks and
  other lenders.

Understanding TCFD

The recommendations of the Task Force on Climate-Related
Financial Disclosures have quickly become one of the most utilized
and well-regarded frameworks for reporting the potential financial
impacts a company may face due to risks and opportunities
associated with climate change. The value in the TCFD’s
recommendations stems from its design, which replicates quarterly
disclosures already being discussed and provided by finance and
accounting functions internally: governance, strategy, risk
management, and related financial metrics and targets. These same
categories are the four substantiating pillars of TCFD, but through
a climate- focused lens. Regardless of organizational structure,
CFOs have key oversight, responsibility and partnership on each of
these corporate functions. They are also responsible for
communicating with investors, shareholders, creditors and supply
chain partners, making them an incredibly valuable part of the
process.

Figure 1 – TCFD Core Elements of Recommended Climate-Related
Financial Disclosures

The TCFD recommends 11 related yet distinct disclosures across
four pillars. Each disclosure from TCFD is thought- provoking in
its pursuit of properly identifying climate- related risks and
opportunities, establishing relevant oversight, quantifying the
resilience of an organization – along with the potential
financial impact of these risks and opportunities under certain
scenarios – and then disclosing metrics and targets that
enable stakeholders to evaluate a company’s current standing
and its path forward. A market shift is currently underway whereby
public companies are being pressured to pivot from pure disclosure
of discrete metrics to thoughtful analysis and reporting of climate
impacts on the company as a going concern. Privately held companies
should be mindful of the TCFD as well, as it helps frame
discussions around operational resiliency and responsiveness with
investors and creditors while also preparing them for ESG
discussions during due diligence. Additionally, given that many
companies subject to SEC reporting requirements may ultimately
report financially material indirect value chain GHG emissions
(Scope 3) and any related targets, supply chain participants
— even those privately held — may be pressured to begin
reducing their own GHG emissions (Scopes 1 and 2) and disclosing
efforts and progress accordingly. For all the reasons above and
many more, CFOs will likely play a central role in responding to
and implementing the TCFD’s recommendations.

What Is Happening with the SEC’s Climate Rule?

Regulatory compliance is one of the most important areas where
CFOs have significant responsibility given their oversight of
financial statement reporting and disclosures. Globally,
jurisdictions are increasingly aligning reporting with the
TCFD’s recommendations, including the SEC proposal currently
under discussion, namely the “proposed rules to enhance and
standardize climate-related disclosures for investors”
released by the SEC in March. If finalized, these rules would
require registrants to provide narrative disclosure of
climate-related risks (and their governance), potential climate
impacts on the firm’s strategy and business model,
climate-related goals (if any) and GHG emission metrics, among
other disclosures. Additionally, in the notes to a registrant’s
financial statements, the company would be responsible for
providing detail on how climate change is impacting financials,
capital expenditures and forward forecasts. As mentioned above,
CFOs are responsible for helping to manage communications and flow
of information to the investment community, and this proposed rule
would add another layer to the financial metrics that must be
managed, reported and verified.

Within U.S. politics, the SEC’s proposed rule on climate
reporting is yet another contentious issue among many other topics
open for debate. Recently, the SEC was forced to reopen its public
comment window on the climate rule due to a technical glitch that
occurred earlier this year. This could push any formalized ruling
into 2023 (existing target is December 2022), at which point the
rule is almost certain to be challenged in court by conservative
lawmakers and others. As investors, lenders and other stakeholders
are increasingly asking for decision-useful climate-related
disclosures from both public and private companies alike, CFOs need
to be ready for TCFD-style reporting with or without a finalized
SEC rule, given the impact that effective reporting, or lack
thereof, can have on access to and cost of capital.

ESG Is the New “Must Have” for Due Diligence

Environmental, social, and governance issues have the potential
to impact acquisition value, as they can shed light on previously
unforeseen risks or opportunities, and thus may impact whether
deals go forward. Whether CFOs are on the sell-side or buy-side of
an M&A engagement, confirming that pertinent ESG information is
critical when evaluating potential legal and reputational risks
that may accompany the sale of an entity or acquisition of new
operations and facilities¹, not to mention any capital
expenditures required to maintain ongoing emissions-reduction
projects. CFOs can assist in three commonly occurring ESG due
diligence scenarios summarized here:

• Benchmarking the target against peers: Benchmarking is a
  critical exercise to perform to identify gaps between the
  target’s ESG risks, opportunities, strategy, reporting and
  commitments and those of its peers. As with financial due
  diligence, CFOs and supporting functions can leverage publicly
  available data and industry-specific resources to examine exposure
  to and management of relevant ESG risks and opportunities,
  including those related to climate change, anti-bribery and
  anti-corruption, among many others. Key questions to consider
  include: Is the target an ESG “laggard,”
  “leader,” or in the middle of the pack? Does the combined
  entity’s ESG risk and opportunity profile change materially? If
  so, what implications for ESG ratings, reporting and sustainability
  reporting frameworks may exist?




• Assessing value and risk when a target lacks an ESG program: If
  the potential target does not report ESG or climate-related metrics
  at all, this decisive lack of action requires diligence as well.
  Key questions to consider include: Do we need to adjust our
  purchase price multiple due to any unreported or unaddressed ESG
  issues? What investments need to be made to collect relevant ESG
  data and consolidate with the acquiring company’s existing
  analysis and visualization processes? Do accurately measured Scope
  1–3 GHG emissions and realistic and quantifiable reduction
  pathways exist?




• Aligning the target entity’s ESG initiatives with the
  acquiring company: When the target has reported ESG or
  sustainability metrics, financial due diligence can verify the
  sources for these metrics and calculations. Key questions to
  consider include: How comparable are the source data and
  calculations to the acquiring company’s metrics? What
  adjustments need to be made so they can be compared on a similar
  basis? How will the underlying data and processes be integrated
  post-acquisition?

CFOs can be a natural fit for guiding and defining a
company’s material ESG issues and setting corporate
sustainability goals where key issues and critical room for
improvement exist. With oversight of and insight into personnel,
systems and processes that are best able to accurately capture and
analyze the metrics needed to track progress and confidently set
and report on targets, CFOs ultimately have a large role to play in
the provision of decision-useful and transparent disclosure to the
investment community. Further, they also have influence over
corporate governance, financial reporting, regulatory compliance
and M&A activities, positioning them well to partner with the
executive team and board of directors to ensure that strategies
related to ESG issues are fully integrated into broader corporate
strategy and planning discussions and models.

How FTI Consulting Can Help

FTI Consulting has experts who can partner with executive and
functional teams to create a successful reporting strategy by
bringing our deep experience helping clients respond to and
implement the recommendations of the TCFD. Further, we know how to
work side-by-side as partners to identify the metrics, targets and
processes to enable effective sustainability reporting alongside a
company’s financial reporting. We create a tailored approach
that serves the needs of a company’s stakeholders, including
investors, employees, customers, suppliers and policymakers, and we
have numerous experts, including those with experience and advanced
certifications in ESG, finance and accounting, carbon accounting,
climate issues, climate scenario modeling, net-zero strategies,
financial and ESG reporting, and data transformation, among others.
Whether determining a company’s material ESG issues,
identifying relevant climate-related risks or opportunities,
evaluating the issuance of green bonds or the procurement of
renewable energy, or drafting TCFD disclosures and broader
sustainability reports, we provide clients with unbiased and
actionable advice that advances their ESG goals in the context of
their larger business objectives.

Footnote

1. https://www.sec.gov/news/press-release/2022-46

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