@ the IERP® Global Conference, August 2024
The views and opinions expressed in this article are solely those of the featured speakers and do not necessarily reflect the official view or stance of the IERP®. The content is provided for informational purposes only.
ESG reporting has been gaining traction in recent years, in financial institutions particularly, due to the central bank’s Climate Risk Scenario Analysis (CRSA) document, said Sarah Yeoh, Senior Manager with Ernst & Young’s Climate Change & Sustainability Services. For successful integration of ESG reporting, firms need to link it to long-term value creation, clarify its relevance to the organisation, measure it, and demonstrate what long-term value creation means to organisational sustainability. Her presentation covered the challenges and strategies that firms should consider when doing this.
“A lot of organisations today struggle with ESG reporting because of the numerous reporting disclosures demanded by the EU, globally and locally,” Yeoh said. “Boards have to take notice because it will impact how the organisation looks at climate change, and the financial impact on the organisation.” Geopolitical factors also figure prominently when it comes to ESG reporting, she added. “If you do not implement some ESG reporting requirements, your organisation could potentially face issues when exporting to the EU (for instance),” she said.
Investors, too, are increasingly expecting organisations to demonstrate sustainability. It was imperative to link four key values – people, customer, financial and societal value – to long-term value creation. But what does this mean for ESG reporting? “ESG reporting today is not just reporting metrics, or targets aligned to whatever Bursa or any reporting requirement is asking you for,” Yeoh said. “It is an important tool for you to narrate how your organisation is looking in terms of long-term value and what intangibles are built into your long-term value narrative.”
Yeoh then explained that when driving long-term value, organisations must look at sustainable profit growth, productivity optimisation, cost reduction, investments into asset optimisation and various types of compliances. ESG reporting was not just setting a matrix and communicating this through a sustainability report; there was more value to it, and this needed to be identified. “For example, when you look at human value, there are different focus areas like workforce transformation, diversity, equity and inclusion, organisation,” she said.
“What is important is how we find the specific metrics and value drivers, and link these to financial value, like cost of labour, that has tangible value which can then be linked to shareholder returns and returns on vested capital.” Boards and senior management are critical to identifying long-term value and providing oversight. Governance remains topmost because it ensures the organisation is measuring long-term value effectively and accurately based on an established framework. The board must ask the right questions, and have the right discourse during board meetings.
Members also need to scan the horizon and understand what drives ESG, and long-term organisational impacts. This can be achieved by periodic refreshing of board composition, board diversity, and by identifying ESG risks and opportunities. Yeoh said that when some boards today talk about ESG, they speak specifically about identifying a designated person who will focus on integrating ESG into operations, or hiring one person to look at sustainability – or even having one person who will wear both hats!
But what is important, she said, was that the board sets appropriate governance to drive organisational sustainability initiatives. Sustainability may be driven in terms of climate risk by the risk function, and in terms of reporting by the finance function, for instance. Challenges that organisations may face when trying to align ESG objectives with corporate strategies include commitment to ESG integration; measurement of non-financial metrics; and having the right talent. “It is pretty hard for organisations to inculcate and embed (ESG) in the whole organisation,” Yeoh said.
“A lot of climate-related metrics are difficult to measure and report because there are new matrices that have come up.” Additionally, measurement of non-financial metrics is sometimes still manually done, although firms may try automating this. Having the right talent to manage ESG integration and sustainability initiatives is a challenge; yet another is the inflexibility of organisational structures that resist change. How can board oversight of ESG reporting be strengthened? Very clear ESG objectives must be established, and roadmaps, pathways and scenarios must be identified.
“Sustainability must align with business strategy,” Yeoh said. “If it doesn’t, you will have a problem galvanising the whole organisation to move forward.” With the alignment of ESG objectives comes the touchy subject of executive remuneration, she noted. “When you start measuring and implementing, it affects remuneration,” she said. “When it starts affecting remuneration, that’s when you see a huge push to implement sustainability or some of the initiatives.” Some reporting requirements actually disclose how the remuneration of the company or senior management is linked to specific ESG objectives.
Another priority is supply chain due diligence; companies need to identify suppliers and vendors critical to the organisation and determine if they will be affected by any upcoming sustainability regulations in the future, especially if the firm has a global presence. Yeoh noted that companies doing supply chain due diligence often find a lot of smaller risks that have not been identified previously. When boards start to engage in ESG matters, they have to understand concepts; where ESG will impact particular sectors; and regulatory requirements.
“For instance, in terms of a carbon tax, if it does hit and is implemented in the next five years, what is the effect on the organisation? What is the financial impact and what can you start doing now to prevent a huge hit?” she explained, outlining key areas for boards to consider when integrating ESG into their risk management processes. “The easiest way is to come up with your materiality assessment,” she said. “Identify the key material matters in your organisation which are aligned with your stakeholders’ expectations.”
The materiality assessment covers important issues that significantly impact the organisation. “The second thing is to understand the ESG ecosystem and stakeholder expectations,” Yeoh said. “When you understand materiality matters, you will be able to identify what in the ESG ecosystem you have to consider and the stakeholder expectations as well.” Boards must understand how the materiality assessment guides and impacts the firm’s ESG strategy. If organisations want to mitigate climate risk, for instance, they should integrate ESG into their ERM practices.
They need to monitor and conduct scenario analysis to understand what types of risk could impact the organisation and its assets. “When we talk about climate risk specifically, there are two key risks that affect the organisation – physical risks like flood, and natural disasters etc, that affect assets, and transition risks that come from regulatory risks,” she said. “Those risk elements need to be properly identified and mitigated.” Also, the narrative of how ESG drives long-term benefits is what is important for reporting; not reporting for reporting’s sake.
How should boards and senior management incorporate sustainability into the organisation? Yeoh said the key thing was to ensure the board and management clearly identify what each function and level does, in terms of ESG. “For instance, who on the board does what? Who in which committee does what?” she said. “Some organisations don’t have a sustainability committee; they may have just incorporated some of their climate risks in terms of their role, into the risk committee…It’s not enough to say in the terms of reference for the board, that the board has oversight.”
It is equally important to identify who will be driving what, within a particular level. Finance plays an important role because it has a lot of data; risk is important because it does scenario analysis for different types of risk; sustainability aligns strategy, risk and opportunities with the overall sustainability strategy of the organisation. Other functions, like HR and business, all drive the ESG strategy. “It is important to identify who in the organisation is looking at sustainability as a whole,” Yeoh stressed. “ESG reporting is the by-product of what you are doing in your organisation today.”
Emphasising that boards have an in-depth role to play in the incorporation of ESG reporting into the organisation, she said, “You are able to help the company identify what objectives they should focus on, and how to clearly define and communicate sustainability goals. You can do this by making sure that there is transparent and effective communication of ESG strategy to your stakeholders, identifying what long-term value creation is, how it will impact the organisation, as well as the different stakeholders.”
