Robert Kugel's Analyst Perspectives

Environmental, social and governance issues have grown increasingly pressing over the past few years as investors and government entities urge organizations to measure and disclose ESG metrics. I’ve already covered the broader topic as it relates to external reporting and how financial planning and analysis groups are likely to own this mandate going forward. (It’s mainly been a marketing and public relations effort up to now.) FP&A departments are also likely to be charged with responsibility for internal ESG analysis and reporting, because to achieve environmental and social goals, organizations will need to assign specific objectives to individual business units and their responsible parties. I assert that by 2025 more than one-half of corporations required to comply with ESG reporting will centralize responsibility for preparing related reports and filings with FP&A to achieve accuracy, control and efficiency objectives. To do so, FP&A groups must immediately establish a data management strategy consistent with its targeted ESG analysis and reporting approach.

ESG has become a serious topic for senior executives and boards of directors as countries increasingly mandate reporting in some form, and institutional investors demand broader and deeper disclosures on ESG-related topics. In March, the U.S. Securities and Exchange Commission proposed a new set of rules for climate-related disclosures that, if enacted, will require a significant increase in the scope and detail of reporting by registrants. And the European Union is likely to mandate detailed, standardized and audited reporting requirements related to its Corporate Sustainability Reporting Directive.

The fundamental rationale for ESG reporting is rooted in the inability of purely financial measures to capture externalities (such as greenhouse gas emissions) or provide metrics that enable an objective assessment of management’s ability to properly determine trade-offs between short-term results and long-term sustainability. And, while in the United States the Sarbanes-Oxley Act mandates that auditors evaluate governance, the focus of this assessment is on preventing financial fraud as opposed to broader objectives that may be important to the functioning of the company as a sustainable entity.

Currently, corporations are grappling with how to meet ESG reporting requirements in the US and EU. If the SEC’s climate-related disclosures draft was enacted and the requirements were upheld in the courts (legal challenges are almost certain), the proposal would require a substantial effort to acquire the necessary data, prepare it for reporting and auditing, and incorporate the information in registrants’ filings. The EU’s CSRD requirements are likely to be somewhat less detailed but would apply to private and smaller companies compared to SEC regulations. While CSRD guidelines are within the EU’s authority, they also will apply to legal entities of US-domiciled corporations located in the EU.

While it’s understandable that the focus is now on high-level issues such as what data to gather, how to use it in reporting and perhaps how to manage the disclosure process properly, very little attention has been paid to how ESG issues are to be managed internally in the context of these external reporting mandates. That’s because once such measurements are in place at an organization-wide level, it will be necessary to devolve responsibility for meeting ESG-related targets, assigning measurable objectives and assessing performance in achieving them. This is another reason why the core responsibility for ESG analysis, planning and reporting will rest with the FP&A group in the finance department because it will be part of the planning process.

Devolving enterprise ESG objectives adds a further level of complexity to data acquisition, analysis and reporting: Management issues such as assigning targets, allocating indirect and companywide ESG metrics and measuring attainment will be challenging, especially where careers and compensation are at stake. How targets are set and measured internally must be transparent, those responsible for achieving targets must be able to control the forces that produce results, and the data used in the process must be credible. Moreover, ESG targets will only augment existing financial, customer and employee goals set by company executives, and therefore will involve explicit trade-offs to achieve a reasonably balanced set of objectives.

Because devolved ESG goal setting, analysis, planning, reporting and reviewing will be performed in parallel with existing budgeting and planning processes, I recommend that FP&A organizations use a dedicated planning application to manage the process of devolving responsibility to specific business units and individuals. I also recommend that FP&A groups use a planning application with a “data pantry” to facilitate the acquisition and management of ESG-related data. Rather than being a general-purpose data store, a data pantry is part of a business application designed for a specific set of users and use cases. A pantry is especially suited to supporting business processes that, like those related to ESG, must work with a broad set of data. A pantry uses application programming interfaces to automate data integration from multiple sources, since eliminating the need for manual integration of data is essential for accurate and efficient ESG management. Our Analytics and Data Benchmark Research reveals that with manual processes, individuals spend a considerable portion of their time preparing data for analysis and reviewing it for quality and consistency issues, activities that are no longer necessary when a data pantry is available.

ESG and ESG reporting are complex topics confronting senior executives, especially the degree of uncertainty around pending legal and regulatory requirements as well as related internal objectives, methods and frameworks for assessing these non-financial elements of a company’s performance. FP&A groups need a strategy to enable their company to meet ESG reporting needs, especially in managing the process of devolving objectives across the organization. Investing in and using a dedicated planning application is essential for this purpose and is justifiable from a business performance standpoint, even without the addition of ESG considerations. And a data pantry makes any kind of analysis, planning, reviewing and reporting faster, easier, more efficient and more useful than a manual approach to data integration.

Regards,

Robert Kugel