Why Financial Reporting Cannot Exist without ESG
First published on Finance Derivative, July 3, 2021 by Andromeda Wood, Senior Director of Global XBRL Strategy at Workiva.
There are many factors involved in effective financial reporting, which can make it a complex and time-consuming task without the right technology or infrastructure to accelerate it. But it is critical that companies invest this time and resource to deliver an accurate representation of finances, including revenues, expenses, profits, capital, and cash flow, as demanded by stakeholders.
However, business performance reporting is changing. The new proposals for the Corporate Sustainability Reporting Directive (CSRD) will have an impact on internal processes, building on the existing Non-Financial Reporting Directive (NFRD) and will apply to all large companies and all listed companies in the EU. This means an increase from 11,000 businesses who were subject to existing requirements, to nearly 50,000 that will need to follow detailed EU sustainability reporting standards.
Sustainability comes to the fore
Regulation is directing fund and asset managers to ensure that the information and funds are assessed against a common set of criteria (for example, EU sustainable finance, in particular the EU Taxonomy and associated Sustainable Finance Disclosure Regulation). These changes echo the mood of investors both big and small, who are starting to scrutinise where their money is going, as ethics and moral values move up priority lists.
As a result, the decision of whether a business can secure funding is increasingly dependent on how a company performs against environmental, social and corporate governance (ESG) factors. Companies who fail to demonstrate the right metrics (or progress towards them), may face challenges accessing capital.
CRSD comes to the forefront
Conversations around social movements and increasing concerns around climate change, inequality, and diversity have left the investor community questioning the impact of their decisions. Investors want to be sure that their investment is aligned with their vision for the future. Indeed, in a recent survey conducted by Workiva, 66% of all respondents in Germany wanted to know whether a company lived up to their social and moral beliefs before investing.
As a result, it’s clear that the existing NFRD no longer met the changing needs of modern investors. The CRSD was proposed to enhance and strengthen the measures already in place, following three years of consultations, market pressure and political discussion. The greatest shift this new directive brings is an emphasis that the term ‘non-financial’ is technically incorrect. It’s now apparent that sustainability factors have a financial impact on the business and should be considered alongside finances as part of the organisation’s Annual Report.
Financial reporting no longer just in the office of the CFO
The increasing focus on ESG data brings operational change, encompassing a wide range of factors which may reside across different departments outside of finance, such as human resources, supply chain, and business development. Information from across the company will be required, both to align operations with a sustainability strategy and to fulfil disclosure requirements in areas such as carbon footprint and employee demographics.
To address this, a clear end-to-end reporting process that is well-managed, produced in the right format and remains compliant is necessary.
Companies will be required to digitally tag reported information (powered by Inline XBRL) to ensure that it is machine-readable, standardised and comparable against other organisations. Importantly, such improvements must not compromise the ability; indeed, XBRL will speed up the aggregation of data for users. Finally, an assurance obligation with respect to the sustainability disclosures, ensuring audit professionals will be required to confirm the validity and accuracy of reviewed information.
Internal siloes are barriers to success
Responding to the new CSRD first requires a frank assessment of the processes currently in place and the areas in need of attention to bring the whole function up to optimal performance. As financial reporting tends to be a complex, yet well-oiled machine, companies can leverage the experience they already have to help bring the ESG data and controls in alignment.
In doing so, the company will have oversight of all operations; and joint reporting will break down the walls between finance and sustainability. This will ultimately help streamline processes.
The right technology will augment existing models. Automation, for example, will accurately and efficiently collect and integrate data from different departments across the business. From this, the data is analysed to determine the materiality, before being collated into the right, easily audited, format.
Processes fit for a brighter future
Emphasis on ESG issues will only continue to intensify and investors want to be sure that the companies they invest in are genuinely committed to sustainable practices, and unlikely to have a detrimental impact on the planet and society. Large investors already see the importance of valuing a company based on a broader set of standards, as these are linked to current and future performance.
Compromising integrity, breaking regulations, or having heavy fines implemented as a result of issues ESG aims to address will fundamentally devalue a company. The new regulations – and investor demands – will force organisations to be more transparent with their reporting. This would allow potential investors to have a clear understanding of their practices and intentions, enabling them to make more confident, informed decisions on where to invest money. It’s critical for organisations to get their houses in order, by streamlining processes now to prevent losing out on future investments.