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Strategy and innovation

ESG criteria in the finance function: Measure and lead.

Companies have a new mission: saving the world. Environmental, social and governance (ESG) criteria are transforming business models and the way organisations are managed. It is a cross-cutting change that has a full impact on the finance function, which in Spain is currently facing the challenge of adapting to the new EU taxonomy in the coming years.
Las distintas entidades de certificación y de regulación avanzan este año 2022
Strategy and innovation
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Editorial Dept
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10 minutes
05 Sep 2022
ESG criteria (Environmental, Social and Governance) emerged twenty years ago as a way of measuring corporate social responsibility, but have ended up becoming the lever of change in the economic system in dealing with the greatest threat hanging over us: climate change.
"Sustainability is in the DNA of the company ". This is one of the most frequently heard lines in recent times. But stakeholders, particularly investors, no longer believe the lofty words: they demand data and verifiable facts. And it is CFOs who must ensure the reliability of financial and non-financial reporting.

CFOs, according to the major consultancies, are the main driver for this change. A CFO's ability to adapt, the cross-cutting nature of their role and their credibility as the head of reporting make them a key figure. The CFO of the future will transcend the position's traditional roles and act as a cross-cutting leader to manage this process of sustainable transformation, as pointed out by CFO Frontline Report 2022 elaborated by Bankinter.

La sostenibilidad está en el ADN de la compañía

Environmental, social and governance criteria are clearly becoming increasingly important in the finance function. Although the social and governance aspects have advanced internally, triggered by new regulatory frameworks and public pressure, it is environmental criteria that dominate the agenda:

  • The new EU taxonomy and the growing legislative output to boost the ecological transition.
  • The relevance of non-financial information, which has been refined to be increasingly reliable, transparent, traceable and auditable.
  • Climate change risk management and its impact on annual accounts. Both those caused by natural phenomena, such as the heat waves we have experienced this year, as well as those related to regulation and the road maps of the ecological transition.
  • New investment and financing modalities linked to sustainability, with improved terms and conditions and linked to a new accountability model.
  • The use of funds such as Next Generation funds for projects that drive sustainability and energy transition will mark a turning point in virtually all business sectors.

The philosophy behind ESG criteria is clear. Companies have already drawn up their road maps. But the challenge and difficulty lie in measuring. A methodology and indicators that are universal, comparable and traceable have not yet been found yet. This is the great challenge awaiting CFOs.

No puedes abarcar todo: céntrate en la E y reduce tus emisiones

However, it is already years ago that companies started measuring a reliable and universal indicator that is now embedded in our imagination: the carbon footprint. As we recently saw in a Bankinter workshop on How to calculate the carbon footprint in SMEs, the advantages of reducing emissions and accounting for it in companies' reporting can be summarised in 8 points.

  • Reducing CO2 emissions is the most discernible way of adapting processes to the regulations derived from the Paris Agreement and in particular Goal 13 of the 2030 Agenda.
  • Cost optimisation associated with reduced environmental impact.
  • Business transformation to sustainable models that make us more competitive.
  • Access to certain subsidies and more favourable green bank loans.
  • Becoming a sustainable supplier to other companies.
  • Gaining customers that are more loyal and opening new markets.
  • Greater involvement of the team in the company.
  • Improving the image of our company.

You cannot cover everything: Focus on the E and reduce your emissions

¿Who can really change their business model and do a 180o U-turn to meet the E, the S and the G? This is what The Economist asked weeks ago, in a shocking cover story. "The three letters that won't save the planet" was the headline of the magazine, for whose editors the ESG criteria, like the commandments, should be summed up in one: reduce emissions.

According to their calculations, one in three assets managed by the major investment groups already meets ESG criteria, but a decline has been observed in recent times, due to the concatenation of crises. The paradigm shift, warns the British magazine, is ushering in a new capitalism, where societies are turning to companies to solve the world's problems. According to the magazine, it is not possible to deal with all three letters at the same time. The solution is to unbundle them and focus objectives. This will be better understood by all stakeholders.

Another leading financial publication, Bloomberg, recently discussed a possible “bubble” in relation to products associated with green or blue (linked to the reduction in water use). And Sarah Murray, of the Financial Times, talks about an “alphabet soup” of indices measuring ESG criteria.

The very contradictions we see in the market today are a sign that trying to square the circle is an impossible mission and it is better to focus on what is important, have a goal and go for it. Contradictions, notes The Economist, such as that seen in companies like Elon Musk's Tesla: it is not a benchmark in corporate governance, but instead is revolutionising mobility and making the planet more breathable. Or that seen in wind farms that produce clean energy, but have an impact on the natural areas where they are installed.

Because the E of sustainability encompasses too many things - water, biodiversity, commodities, CO2, let's focus on what is really accelerating climate change: emissions. Let's standardise that indicator and focus on it, argues the magazine founded in 1843. It is what actually makes the difference, and regulators, investors, suppliers, customers and society at large will understand it.

Estandarizar un intangible: la sostenibilidad

Standardising an intangible: sustainability

It sounds like an oxymoron: finding ways to measure a reality that we have hitherto believed to be intangible. The reputation (related to governance), sustainability and social impact of companies need an international standard, but the solution has not yet reached the ESG criteria.

This standardisation, as we have seen, progressed firmly with the measurement of the carbon footprint, which is already possible today with protocols such as GHG, which measures the emissions of six greenhouse gases, or the ISO 14064.

These protocols allow us to certify the so-called Scope 1 reductions (direct emissions of fossil fuels and greenhouse gases in machinery, buildings, cooling systems, means of transport, etc.), those of Scope 2 (direct emissions in the consumption of electricity) and the increasingly relevant Scope 3 (those produced by third parties, by our suppliers or employees, for example, in their commuting to work).

In Spain we have the Calculate, Reduce and Compensate seals awarded by the Spanish Climate Change Office. All of these certificates and protocols set the way for the measurement of ESG criteria and the dismantling of so-called "greenwashing". As do international indices and rankings that rate the environmental commitment of companies, such as the Dow Jones Sustainability Index.

In a recent study, the great CFO Forum of the United States warned: “The problem today is in the implementation. The complexity of ESG is, frankly, mind-boggling. So are the difficulties around standardised reporting". This is evidenced by the problems faced by some companies under investigation by the judiciary and competition authorities for alleged greenwashing.

The various certification and regulatory bodies are moving forward in 2022 to achieve these first, more robust standards that will not give rise to doubts. The Massachusetts Institute of Technology (MIT) published a study comparing the different measurement standards of consulting firms and organisations and found significant differences in the results obtained for the same companies. This is a shortfall that the new standards seek to address.

The SEC in the US has just presented its strategy on ESG compliance and the World Economic Forum in Davos has been looking for a universal metric for three years, to which many companies and consulting firms have adhered, in the light of its initiative "Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation”.

Inspired by the principle that only what is measurable can be managed, the new metrics represent a paradigm shift in management linked to environmental, social and quality in corporate governance. The new EU Taxonomy and the processes initiated by the European Financial Reporting Advisory Group (EFRAG) and the International Sustainability Standards Board (ISBB), which will publish their conclusions in the coming months, are working along the same lines. A challenge for the finance function.

Las distintas entidades de certificación y de regulación avanzan este año 2022