Just days into office, President Joe Biden and top officials defined environmental, social and corporate governance (ESG) issues as a key financial risk to U.S. corporations. As the executive branch elevates ESG matters to the top of the agenda, expectations for high-quality non-financial ESG disclosures from financial services firms are rising in tandem.
The sun had barely set on the inauguration ceremonies before a slew of executive orders strengthened workplace discrimination protections, returned the U.S. to the Paris climate agreement, and advanced a host of other ESG-related measures.1 Meanwhile, the Biden/Harris transition team began stacking the administration with officials who have made clear their ESG focus, including Treasury secretary Janet Yellen who has clearly stated her belief that climate and financial risk is inextricably linked.2
The new administration’s quick action accelerated efforts already underway to meet growing stakeholder demands for corporate ESG accountability, and financial services companies are preparing to meet expectations for more rigorous and transparent ESG reporting.
To help move ESG reporting in the right direction, financial services firms can start with four key considerations.
- Real action and accountability on ESG issues will replace lip service.
The COVID-19 pandemic and movement for social justice over the last year increased awareness of ESG issues. More than ever, consumers and investors expect U.S. companies including their financial firms to integrate ESG principles into their operations, supply chain, talent management, and other core business areas. At stake is company reputation, client retention, competitive advantage, revenue opportunities, and access to capital.
As ESG reports evolve, companies are expected to show tangible progress. Moving forward, these non-financial disclosures will need to be more than glossy brochures explaining last year’s carbon footprint reduction or listing diversity and inclusion as a corporate value.
Likewise, companies won’t be able to cherry pick the data that looks best for them. Rather, they will need to define specific, ESG-related metrics, follow through, and use robust and accurate data to measure their progress.
- ESG reports will start to look more like financial disclosure documents.
Given the current environment, non-financial reporting disclosures will begin to be held to the same criterion as financial reporting. We expect non-financial reporting to expand significantly, with more standard requirements similar to Sarbanes-Oxley (SOX) and the Comprehensive Analysis and Review (CCAR) process.
Within a few years, non-financial reporting may grow to hold the same weight and significance as financial reporting does today, which is what we already see in Europe. To date, the U.S has lagged Europe’s ESG measurement and reporting, both in voluntary adherence to ESG principles and in government regulation. Once U.S. ESG reporting requirements catch up, the next step will be global consensus.
- Integrating ESG reporting into financial reporting capabilities and functions requires new data analytics tools and methodologies.
With the expectation of greater ESG reporting accountability and a more standard ESG disclosure framework in place, chief financial and risk officers (CFOs and CROs) are being called on to institute additional controls on non-financial data and take more active roles in managing this new risk by gathering and analyzing non-financial information.
Today, most reporting is produced by the finance and risk groups uses methodologies and tools built to identify, control, and display financial information. However, these methods cannot simply be applied to non-financial information with the same accuracy and effectiveness.
As a result, financial services companies looking to improve the quality, control, and analysis of their non-financial data are turning to new methodologies, tools and technologies. For example, blockchain can help companies understand the link between environmental and financial performance. Blockchain and other innovations also can be tailored to track and analyze community investment, executive and board remuneration and demographics, and other ESG-specific measures.
- Financial services companies should act now; no need to wait for ESG reporting requirements shake out.
The basic expectations for non-financial reporting are known, so now is the time to develop methodologies and put the necessary tools into place. While the standards are being debated and finalized, there is an immediate need to ring-fence and control the relevant non-financial data—what data is needed, how to collect it, who owns it, and where it resides.
Importantly, the overall effort to integrate and improve ESG reporting requires modern data management and analytics solutions that can support massive amounts of structured and unstructured data gathering, quality assessment, organization, storage and metric reporting. That infrastructure can be put in place today.
The impact on the executive leadership team
The effort to address changing ESG reporting requirements will fall to multiple roles across financial services firms, from finance and risk to technology. In upcoming articles, we will explore the necessary response from CFOs and controllers, CROs, and chief sustainability and other enterprise leaders in the new era for ESG reporting.
In the meantime, for more detail on the impact of the new presidential administration on financial services, see our regulatory alert, Beyond day one: New administration impacts on financial services.
