Background
Despite being a popular theme in the business world nowadays, sustainability is not a new concept. John Elkington in 1994 introduced the phrase Triple Bottom Line (TBL) to measure a corporate performance which relate to sustainability. This concept went beyond the traditional measures of profits, return on investment, and shareholder value and includes environmental and social dimensions. TBL focuses on corporate responsibility which emphasizes its priority to Stakeholders rather than Shareholders. Stakeholders refers to anyone who is influenced, either directly or indirectly, by the actions of the company. Stakeholders are employees, customers, suppliers, residents, government agencies, creditors, and so on. This is then known as 3P (People, Planet, Profit) framework.
The increasing awareness of society on how the corporations operate their business and the impact of their business operation to the people and environment, giving the business pressure to shift their focus from short-term benefits to maintain business continuity in the long term.
Environment, Social, Governance
Three words that are always discussed in relation to sustainability are Environment, Social and Governance or better known as ESG. ESG has become the language of capital markets, expanding the market value by maintaining the value for future generations. The term ESG (Environmental, Social, and Governance) was introduced around 2004 in a report "Who Cares Wins: Connecting Financial Markets to a Changing World", compiled by several Financial Institutions at the invitation of the United Nations Secretary-General Kofi Annan to develop guidelines and recommendations on how to better integrate environmental, social, and corporate governance issues in asset management, securities brokerage services and associated research functions. These financial institutions believed that in a more globalized, interconnected, and competitive world the way that environmental, social, and corporate governance issues are managed is part of companies’ overall management quality needed to compete successfully. Companies that perform better in these issues can increase their shareholder value. Over time, the ESG’s movement, which was originally limited to Corporate Social Responsibility, transformed into a global phenomenon. ESG is no longer seen as a compliance demand, but rather a "tool" for companies to achieve sustainability.
Some elements for each part of ESG are:
1. Environmental
includes amount of energy used, share of renewable energy sources, climate change and adaptation strategy, emission footprint and the use of raw materials and resources.
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2. Social
Includes respect for human rights, prohibition of child and forced labor, equal opportunities and diversity, social standards in the supply chain (e.g work safety and health protection), fair remuneration, training and development opportunities for employees and decent workplace conditions.
3. Governance
Includes existence of sustainable strategy, approach to strategy integration and implementation of sustainability management, ethical behavior, and existence of specific management systems.
The importance of ESG from Management Accountants’ Perspectives
1. How ESG Strategy may Supercharge the Business
From time-to-time unsustainable business practices continue to disrupt business. Here are some illustrations:
a. Around the 1990s a sports equipment company reportedly used child labor for more than 16 hours a day, 7 days a week. This immediately decreases sales and damages the brand image.
b. In 2010 a company stopped importing palm oil from Indonesia, after reports from Green Peace emerged that it was clearing forests to grow oil palm.
c. In 2021, the largest copper producer must suspend its operation due to a roadblock established by demonstrators from the rural community. This incident has lowered its stock price and traders pointed out that it was caused by the unrest.
ESG focuses on long-term sustainability and is used for creating environmental and societal impact and increasing brand image. Investors believe that it is an essential factor to assess companies’ performance related to sustainability. The good practice of ESG will open better access to capital and lower financing costs, increase investment efficiency and profit and in the end will give a better environment and wellbeing for employees.
There is a shifting of paradigm among companies to activities related to ESG. In the past, ESG was considered as costs and used only as a compliance to regulations, while with new paradigm, ESG is seen as an investment that can be monetized and gives companies opportunities and investment for better customer base and better access to capital. Management’s consistency and commitment in implementing ESG will open access to green financing, business incentive from Government and other investors.
2. Leveraging Data & Technology to Drive ESG Strategy
To do better in implementing ESG, there are ESG Principles that should be followed: a. Environment Measures
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Environment Measures are divided into 4 measurements:
• Climate change will measure companies’ exposure to physical climate change risk, exposure to Greenhouse Gas Emission, Product/Service Carbon Footprint, Financing Environmental Impact, Environmental Compliance.
• Use of Natural Resources will measure operational ecoefficiency, water stress, energy use, raw material sourcing, and circular economy.
• Pollution and Waste will measure environmental pollution, environmental taxes, packaging material and waste, and electronic waste
• Environment opportunities will look at cleantech, green buildings, green office, renewal energy and environmentally friendly innovation
b. Social Measure
Social Measures discussed on:
• Human Resources, include HRM, Occupational Health and Safety, Training and Development, Employee Engagement, Work life Balance, and Diversity, Inclusion, Equal Treatment
• Product/Services Liabilities, consists of Human rights, product services safety and quality, customer health and safety, Data security and Privacy, customer satisfaction and responsible investment.
• Stakeholder Engagement includes relations with public authorities, reputation questions, community relations, community engagement, philanthropy, and local economic and social impact.
• Social Opportunities include access to education, access to communication, access to health care, opportunities in nutrition and health.
c. Governance Measures
Governance measures consists of:
• Corporate governance, which includes leadership responsibility, risk management, remuneration, ownership, accounting and legal capabilities. • Corporate Culture consists of compliance, business ethics, anti-money laundering, anti-corruption and bribery, financial systems sustainability and Tax transparency and reporting.
For better decision making many companies are gradually improving the quality of ESG data management. There are 5 stages on data quality and maturity which can support ESG data management:
a. Foundational (stage 1)
At this stage, companies use existing data (emails, production units, etc.), spreadsheets, manual data management and high-level partner input (e.g report).
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b. Advanced (stage 2,3)
Company at advanced stage using standard ESG reporting tools, BI/Analytics dashboards, details supply chain reporting, sourced of third party data and investing in “for purpose” solutions.
c. Leading (stage 4,5)
This is a stage where companies use boardroom using ESG data-driven insights, advanced ESG forecasting and predictions for strategic decision making, exploration and investment in solution-building and data acquisition, ESG data of sufficient quality to be tied to compensation and bonus scheme, and ecosystem collaboration around the technologies, business models and partnerships.
The stages show us that ESG data is evolving from static and backward-looking to dynamic and forward-looking and harnessing digital revolution. To support ESG implementation and reporting, companies have to build the source of data collection. This is where technology plays important roles. The variety of data needed is very wide, which requires a more complete and complicated data source.
3. Implementing Sustainable Leadership
The decision to implement ESG is at a strategic level. The company should take strategic actions to cope with fundamental changes in the environment. The change to implementing ESG lies at the board and will change almost everything in the companies. ESG principles discussed above showed the level of change that should be made.
According to Etton Bridge, ESG decision lies 58% in the Boardroom, 30% in the executive team and 12% in the senior leadership team. There is a certain characteristic to be able to lead a changing company to an ESG company because it will need to change the company’s culture, structures and policies.
4. ESG Reporting
ESG reporting is used for:
a. Disclosing the implementation of ESG covering business operations related to the environmental, social and governance aspects of a business.
b. Benchmarking of company’s progress on ESG implementation compared to other companies.
c. Providing full transparency over an organization’s ESG impact across multitude of stakeholders, including investors, employees, and customers.
d. Attracting investors and financing
e. Meeting stakeholder demands.
f. Responding to regulation change
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g. Devising an Effective ESG strategy and
h. Improving all company performance
Standardized reporting could make one company’s report comparable with another’s and help analyze its risks and values. Using standard means using specific quality requirements in reporting, which will detail the criteria and metrics used for ESG focusing on the public interest, independence, due process, and public consultation.
ESG framework gives a broader contextual frame for presenting information. ESG Framework setters consists of many organizations, which can be divided into 3 frameworks:
a. Voluntary disclosure frameworks
The framework setters are:
• Carbon Disclosure Project (CDP)
• Global Real Estate Industry Benchmark (GRESB)
• Dow Jones Sustainability Indices (DJS)
b. Guidance Framework
The framework setters are:
• Global Reporting Initiative (GRI)
• Sustainability Accounting Standard Board (SASB)
• International Integrated Reporting Council (IIRC)
• Value Reporting Foundation (VRF)
• Task Force on Climate-Related Financial Disclosure (TCFD)
• Carbon Disclosure Standards Board (CDSB)
• IFRS Foundation
c. Third-Party Aggregators
• Bloomberg Terminal ESG Analysis
• Institutional Shareholder Services Quality Score
• Sustainalytics
There are certifications for professionals which will be able to acknowledge their competencies on preparing sustainability reporting and give added value and quality assurance on the report and in return will increase the value of the certification holders.
The Future of ESG and the Role of Management Accountant
In the future, the movement will grow bigger and bigger in line with the increasing interest of society- especially the younger generation- to a greener industry. More companies will invest in this industry with many new opportunities emerging. Although the industry will always seek more profit, the green industry shows that in the long run it is profitable despite the current large investment that should be made. It is believed that in the future the green industry such as geothermal and battery industry have economic benefits. Awareness of the industries on
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their impact to the environment and excessive use of natural resources lead them to strive for a more sustainable pathway of growth, which will benefit the company in term of: Economic Benefits (e.g more innovation and growth, and increased resilience), Social Benefits (e.g more employment, rising incomes and empowerment), and Environmental Benefits (e.g more efficient resource use, and less waste and pollution)
The discussion above showed us that although the pressure to implement ESG comes from external of the companies, the implementation needs an internal effort and changing the mindset of the preparer (Board, Executives and Operational of a company). A management Accountant, not only as the report preparer, but also as an operational and decision maker, has to lead this changing business. Their understanding of the company business process will benefit companies to have a smooth transition and less costs.
References:
1. December 2004 Financial Sector Initiatives, “ Who Cares Wins - Connecting Financial Markets to a Changing World” - United Nations
2. 2011, Timothy. F. Slaper & Tanya J. Hall, The Triple Bottom Line: What Is It and How Does It Work? Indiana Business Review
3. 2023, Ethics and Compliance Initiatives, The State of ESG in the Workplace: A Fad or The Future A Global Business Ethics Survey Report
4. United Nations Industrial Development Organization on Green Industry 5. 2021, Deloitte Climate & Sustainability
6. 2023 ,PWC, Investor’s interest in ESG Metrics
7. 2021, Verdantix/Cority ESG and Sustainability Survey