How financial institutions can use reporting to effectively tell their ESG story
Given both the cost of getting environmental, social and governance (ESG) reporting wrong and the benefits of getting it right, many financial institutions will likely need to invest more in how they communicate their approach to ESG to their stakeholders. In the past, the winners may not have been the ones who were really the leaders at ESG but rather those who could tell a more convincing story to the market. Going forward, the winners will be those who have a credible ESG story and a credible approach to ESG reporting.
The stakes are high and getting higher. Many investors now actively allocate capital based on ESG information and ratings. Two-thirds of institutional investors believe that ESG will become “industry standard” within five years. Many consumers already gravitate toward brands that address ESG issues in ways that align with their own values. Perception is reality, and the perception of your ESG efforts will depend on your reporting. Does your ESG reporting resonate with your priority stakeholders? Is the information you’re disclosing accurate and complete? Even if the answer is yes today, you may be left behind by competitors in the not too distant future. As ESG reporting continues to evolve, firms that progress faster than others—for example, by conducting real-time ESG reporting and analytics and using those insights to inform strategic decisions—will likely race ahead.
With pressure from stakeholders continuing to build, ESG is getting more attention at the C-suite level. Our March 2021 Pulse Survey shows that CFO survey respondents in financial services (FS) are more focused on ESG reporting priorities than CFOs in other industries.
Most financial institutions understand the need to devote more attention to ESG—both to differentiate themselves in the eyes of customers and other stakeholders and in response to regulatory pressure. However, many struggle to apply a structured approach to the topic, and few have met the standards of investor-grade ESG reporting.
Investor-grade reporting represents a big step up from the current level of ESG disclosure at most firms, which is largely voluntary and ad hoc. We expect ownership of ESG reporting to eventually shift to the CFO, with the CEO retaining overall responsibility for the ESG agenda. We also expect ESG reporting to become integrated with standard financial disclosures, meaning that reporting will need to meet investor-grade standards and could become part of FS companies’ compliance and controls program.
That’s why we recommend that FS firms incorporate ESG reporting into the processes already in place for financial reporting, leveraging existing competencies, controls and reporting architectures to meet investor-grade standards. In the next sections we provide an overview of challenges we see FS firms encountering and make recommendations for how they can strengthen their ESG reporting.
What are your priorities related to environmental, social and governance (ESG) reporting?
FS CFOs
All CFOs
Source: PwC Pulse Survey, March 23, 2021: base of 46 FS CFO respondents, base of 182 CFO respondents.
A wide range of challenges
Firms face evolving global reporting expectations
FS firms are often all over the map when it comes to tying the elements of ESG into consolidated reporting and to their broader strategy. They face many different frameworks and standards for enhanced ESG disclosures, including Global Reporting Initiative (GRI) standards that have advanced sustainability reporting for years and the Sustainability Accounting Standards Board (SASB) standards that provide detailed industry-specific recommendations to the varying expectations from the rating agencies. The World Economic Forum has launched an effort to move toward common “stakeholder capitalism” metrics. For climate change, consensus is building around the Task Force on Climate-related Financial Disclosure (TCFD), currently supported by more than 1,500 firms and key regulatory agencies.
The European Union (EU) has established a very ambitious set of regulations affecting the definition of sustainable activities (taxonomy) and increasing the disclosures requirements for financial institutions providing investment advice (Sustainable Finance Disclosure Regulation), both of which are applicable in full or in part in 2021. The EU has also decided to update its Non-Financial Reporting Directive (NFRD, applicable since 2014) with a targeted adoption of the revised requirements as soon as 2022.
In the United States, SASB has momentum. Recently, the SEC also requested feedback on how the agency can better facilitate climate-related disclosures. The statement contains 15 questions on potential approaches to enhance climate disclosures, including:
- Whether new requirements should be incorporated into existing rules or advanced in a new regulation devoted entirely to climate.
- Whether they should be tailored to the size or risk of individual firms.
- The extent to which they should incorporate existing frameworks such as the TCFD.
There’s little clarity about how far to go beyond standards
In addition to knowing which standards to follow, financial firms often struggle with how far they should go beyond standards, either to meet higher stakeholder expectations or as a way to strategically differentiate themselves. ESG rating agencies such as MSCI, Sustainalytics and CDP Worldwide evaluate company performance in ways that often go beyond regulatory standards. Consider a bank’s B2B loan portfolio. Historically, all that mattered was good fundamentals: As long as a borrower could repay the loan and meet regulatory standards (such as KYC/AML), the bank would be happy. Now, an ESG rating agency might evaluate a strict ratio to dollar value threshold of loans given to firms that don’t meet ESG criteria. That criteria can be subjective, so a bank could find itself tagged as having 20% of its B2B loans out to firms that are considered not to be aligned with ESG causes.
Many FS firms also struggle with how quickly to start reporting and what to include in their initial transparency reports.The trigger for deciding when to make reporting disclosures has usually been financial statement materiality, a static percentage of revenue or assets under management. However, the identification of material ESG issues is often less prescriptive and involves more judgment by management based on input from stakeholders like directors, customers and employees.
Firms rarely have infrastructure to meet investor-grade reporting requirements
Once a firm works through the challenges of what ESG information to report, they often contend with the challenges of how to effectively collect, manage and produce the information in a manner in which they can have confidence. Both the breadth of ESG data types and the disparate internal and external users of ESG data drive significant reporting complexity. Those who perform ESG reporting pull data from a combination of financial and nonfinancial systems, in some cases going back to data from external vendors. The process of extracting, cleaning and aggregating data for disclosure is still largely manual—often on multiple spreadsheets—which means that poor-quality data can make its way into reports. We also see those responsible for reporting having trouble tying the information that ends up in the public domain back to trusted sources. The lack of controls and independent confirmations often result in metrics that are not verified. While beginning to focus on ESG reporting, traditional IT vendors have not yet developed enterprise solutions that support ESG data gathering and reporting. Adding to the difficulties, self-service analytics tools can be limited.
Recommendations: Managing the complexity
ESG frameworks, issues and metrics are evolving quickly, and they encompass many aspects of a firm’s operations. This makes it challenging to determine the leading way to report ESG performance with investor-grade standards. It will likely take time to get this right, so starting-and-refining will be far more useful than waiting-and-seeing. We suggest FS firms stick to a narrow set of priorities:
- Decide on the broad framework and key metrics you’ll use.
- Define process and governance steps to have confidence in your reporting.
- Carefully design your reporting architecture and tools to effectively enable your ESG reporting.
- Develop a way to tell an authentic and coherent story.
Decide on your ESG framework and metrics, and define your audience(s)
The first step is strategic: to set an overarching approach to ESG. This should be supported by a clear tone from the top, with the CEO and leadership team committed to an ESG strategy that can work across the entire organization in a cohesive way.
- Look for common ground when responding to regulators. Regulators are likely to build on existing standards and frameworks. In the US, for example, federal regulators will potentially follow precedents set by regulators in the UK, EU and certain US states to further raise the bar for US financial institutions. Align your efforts around the story you want to tell consistently to regulatory agencies. When it comes to climate disclosures, the TCFD provides a common framework for responding to multiple regulators. A financial institution with operations in the US and UK, for instance, could use the TCFD framework for not only its own assessment and reporting of climate-related risks and opportunities but to comply with regulations in both countries. The UK’s Prudential Regulatory Authority (PRA) and the New York Department of Financial Services (NYDFS) have both referred to the TCFD framework in developing their approach to climate-related financial disclosures.
- Decide exactly which stakeholders you’re addressing. Listen to your stakeholders regarding the environmental and social issues they care about and develop your response accordingly. Employees, customers, investors and regulators may have varying priorities based on the pillar of ESG—and those priorities may change. For financial institutions, there’s been a longstanding focus on cybersecurity and data protection. Today, diversity and inclusion (D&I) issues and climate change are getting greater attention. Make sure you know the baseline expectations of each group with regard to different ESG issues, which almost always exceed regulatory standards.
- Prioritize which ESG issues you’ll focus on after analyzing ESG impact and expected return on investment. Focus first on opportunities that deliver both.
- Determine which ESG issues you consider material. It can be difficult to evaluate whether an ESG-related issue is material in the non-financial sense. At what point should D&I be included? What’s your plan for explaining to the world the extent to which getting D&I right leads to better decision-making, while not doing so may damage your business? Will you develop qualitative statements or quantitative analyses? And given that you plan to disclose this information for all to see, what commitment are you making going forward? All of these questions are still being discussed at many organizations.
Example: ESG vs financial materiality
Materiality for ESG issues can’t be determined in the same way as traditional financial materiality. You’ll need to decide based on whatever you think is a top priority for your stakeholders. Let’s say your bank puts a heavy focus on getting its ESG reporting correct. Your executives spend time calculating the impact individual branches are having on the environment and finding ways to reduce it. They think through how they address labor standards and minority representation in the institution, and they redo their tax structures to be more beneficial to the communities they operate in. However, without realizing it, the bank takes on a customer that has a large, public-facing environmental disaster. Now, the public won’t think about all of that ESG work when they think about your bank’s ESG impact. They’ll think about that one customer—and your connection.
- Define a set of relevant ESG metrics that encompasses both internal and external reporting. Identify what information to report, how to source it and who the key stakeholders are. Then get buy-in across key stakeholders. Finally, evaluate—and ideally quantify—the impact of your business on the environment or society. You may want to start tracking some metrics before you’re ready to release them publicly. Be deliberate in your planning.
Define process and governance steps to have confidence in your reporting
Standardized policies, procedures, controls and governance are crucial if you’re going to efficiently manage ESG reporting. Automated workflow and data transformation tools can help make sure that your data meets required standards and that your metrics are clearly defined. Through this kind of structured approach to reporting processes and governance, your ESG story will be grounded in objective, reliable and holistic data.
- Establish a clear, controlled ESG reporting process. Building a sophisticated ESG reporting process requires the same level of diligence as standard SOX controls in the United States. Start by constructing a workflow of your ESG reporting process and then install controls and checkpoints along the way. This way you can have a clear, digitized audit trail of everything.
- Prepare for change. As the ESG landscape continues to evolve, you’ll need to stay agile, building new capabilities to collect, integrate and report new types of information from new sources. Don’t build processes that will be difficult to change.
Carefully design your reporting architecture and tools
- Define your ESG reporting architecture. Treat ESG reporting like the holistic and integrated effort that it is. Create an architecture that includes data sourcing, aggregation, calculation, validation, reporting and analytics. Leverage existing financial reporting architectures to the greatest degree possible. Map each ESG reporting element to the architecture.
Click here for detail of an illustrative example.
- Recognize that data is the foundation of your ESG reporting. By applying a standardized approach to sourcing your ESG data and aligning your approach to existing frameworks, you can improve the quality of your ESG reporting. Identify standardized data sources and attributes to satisfy the ESG framework. Find the sources to which you will need easy access in order to create the metrics you identified earlier. This can include sources from across business units, geographic markets, portfolio companies and some third-party sources.
- Use existing processes and tools to streamline both internal and external reporting. Don’t build separate ESG reporting tools when you already have established tools in place for other processes. You can save time and improve quality by adding ESG components to existing reporting rather than bringing reporting to ESG.
- Supplement your process with reporting automation and visualization as needed. Many vendors have emerged in the ESG reporting space. We believe the larger enterprise IT providers will soon enhance their capabilities to leverage much of their existing reporting functionality. This will enable you to leverage much of the same technology available for financial and regulatory reporting for your ESG reporting.
Tell an authentic and coherent story
When telling your firm’s ESG story, it’s critical to present more than a snapshot of where you are now. Rather, talk about where you want to go next and how you plan to get there.
- Consider your audience(s). Customize the information for various audiences, jurisdictions and stakeholders. Link all reports to the same underlying source of integrated, centralized, digitized information so that ESG data is consistent across all formats and channels—financial statements, ESG reports, websites and social media feeds.
- Tailor your reporting based on your ambition. Take time to analyze, internally align on your objectives and come up with a thoughtful reporting plan based on your level of ambition. Are you aiming to simply keep pace with regulatory standards? Proactively address climate risks? Position yourself as an ESG leader to win in the markets? As part of this assessment, consider what your peers may be doing. What will happen if you lag behind? If a particular segment is going to be ranked in quartiles according to ESG performance, for instance, understand the ramifications of being in the top, or bottom, quartile.
- Provide the context. Without context and a story, ESG data is just that—data. Instead, help give meaning to the ESG information you disclose by incorporating it as part of a narrative that reveals your firm’s purpose and mission.
Tax structure as a way to tell your ESG story
Firms increasingly collaborate with regulators to generate more sustainable tax positions that go above baseline requirements and stand up to public scrutiny. The key message for stakeholders should not be that your firm will simply pay more in taxes—rather, it’s that the company is striking the right balance between its own organizational benefit and broader societal benefits. This can help support the proposition that your firm’s brand is a force for positive change.
Conclusion
Whether driven by investor demand, regulation or the desire to enhance societal value, there’s now an expectation that financial institutions integrate ESG issues and sustainability into their corporate strategy, philosophy and reporting. With that expectation comes clear opportunities for firms that take a proactive approach and clear risks for those that don’t. Firms that tell a clear and credible story can not only establish themselves as leaders in the market, they stand to benefit from increased access to capital and the returns associated with that access.
Take advantage of tech-enabled solutions that can help you assess maturity, reduce potential risks, recalibrate your efforts using deeper insights and benchmark against your peers. This can help you develop required disclosures and transparency reports more quickly, gain a better understanding of your firm’s current ESG situation and more easily identify what actions you should take next.
In the longer term, as data and reporting get more regulated and standardized, objective comparisons will become easier. But by stepping into the spotlight now with a compelling ESG story, you can take strategic action in a measured way and start to build momentum over time to truly differentiate your firm.
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Jeffrey Spector
Sustainability Partner, Financial Services Consulting Solutions Leader, PwC US
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