Prioritising Environmental, Social, and Governance (ESG) factors in decision-making processes are not solely driven by the introduction of mandatory sustainability reporting. It’s also influenced by the growing recognition that ESG performance is intrinsically linked to financial performance—and can help organisations gain a competitive edge.
Though we’ve still got a way to go when compared to the EU, expectations around carbon accounting and emissions data within Australian organisations have shifted. For CFOs of Australian financial institutions, this shift underscores the need to quantify the financial implications of ESG factors.
However, tasked with reconciling traditional financial objectives with the somewhat intangible dimensions of ESG, there are a number of challenges that come up for CFOs.
Understanding the challenges that CFOs of Australian financial institutions face
The challenges confronting CFOs in quantifying the financial impact of ESG risks and opportunities are multifaceted.
ESG factors have long lacked standardised metrics and frameworks in Australia, making it difficult to measure and compare across industries and regions. The introduction of mandatory reporting frameworks in Australia has only been a recent development, with the Australian Accounting Standards Board developing its own Sustainability Standards (ASRS 1, ASRS 2 and ASRS 101) based on the International Sustainability Standards Board’s Sustainability Standards (IFRS S1 and IFRS S2), with implementation due to begin in early-2025.
The long-term nature of ESG impacts also complicates financial valuation and ROI calculation. Many ESG initiatives, such as investments in renewable energy, may yield returns over extended periods. (While to some, it may feel challenging to assess their immediate financial impact, it’s actually fairly easy to calculate a buyback period on investments in renewables.)
Finally, the interconnectedness of ESG factors with traditional financial metrics adds another layer of complexity. For instance, a company's environmental performance can affect its operational efficiency, regulatory compliance costs, and brand reputation, all of which impact its financial bottom line. According to Deloitte, a lack of ability to monetise non-financial sustainability data has left many CFOs struggling to meet investor, management, and customer expectations.
The benefits of quantifying ESG impacts for CFOs
Despite the challenges, there are compelling reasons for CFOs to invest in quantifying ESG impacts.
Enhanced risk management
Integrating ESG metrics into risk management frameworks empowers CFOs to navigate risks more effectively. Understanding the financial implications of climate change-related risks, for example, enables institutions to evaluate their exposure to both physical and transition risks. Armed with this knowledge, CFOs can devise tailored risk mitigation strategies, ensuring resilience in the face of evolving environmental challenges. By quantifying ESG impacts, CFOs not only bolster financial stability but also build a culture of proactive risk management.
Improved decision-making
Quantifying ESG impacts equips CFOs with actionable insights to inform their decision-making processes. By incorporating ESG considerations into investment analysis and capital allocation frameworks, CFOs can identify opportunities for value creation while mitigating potential risks. As an example, assessing the financial impact of ESG factors enables companies to prioritise investments in sustainable technologies, aligning institutional objectives with broader environmental and social imperatives.
Strengthened investor relations
In an era marked by increased investor scrutiny of ESG performance, quantifying ESG impacts has become instrumental in building positive investor relations. By demonstrating a commitment to sustainability and long-term value creation, CFOs can communicate a compelling narrative to investors, enhancing transparency and trust. This not only bolsters investor confidence but also attracts socially responsible capital, positioning the institution for sustainable growth. By quantifying ESG impacts, CFOs can effectively engage with stakeholders, improving access to financing opportunities and reinforcing the institution's reputation as a responsible organisation.
Methods and tools that can help
The good news for companies? A variety of methods and tools exist to aid in quantifying ESG risks and opportunities.
Integrated financial modelling
One approach is the use of integrated financial modelling, which combines traditional financial analysis with ESG data to assess the financial implications of ESG factors systematically. This approach enables companies to assess how environmental, social, and governance considerations impact key financial metrics such as revenue, costs, and profitability, ultimately assisting with ROI calculations. By quantifying the financial impact of ESG risks and opportunities within financial models, CFOs gain actionable insights to inform strategic decision-making and resource allocation.
CFOs can use integrated financial modelling to assess the real world and financial impact of transitioning to renewable energy sources. By incorporating renewable energy investments, carbon emissions reductions, and potential regulatory incentives into their financial models, CFOs can quantify the cost savings and revenue opportunities associated with sustainability initiatives. This allows companies to make informed decisions regarding capital allocation and investment strategies, aligning financial objectives with broader ESG goals.
Scenario analysis
Another valuable tool is scenario analysis, a technique that involves modelling different future scenarios to assess potential financial outcomes under varying conditions. By incorporating ESG factors into scenario analysis, CFOs can evaluate the resilience of their business models to ESG-related shocks and disruptions.
This approach enables CFOs to stress-test their strategies and operations against a range of plausible scenarios, from climate-related events to shifts in consumer preferences and regulations. By identifying vulnerabilities and strategic priorities through scenario analysis, companies can proactively adapt their business strategies to mitigate risks and capitalise on opportunities.
As an example, a CFO may explore the financial implications of a carbon tax or a shift in consumer preferences towards sustainable products. By quantifying the potential costs and opportunities associated with different scenarios, they can identify strategic priorities for resilience building, such as investing in climate-resilient infrastructure or diversifying revenue streams. This enables the financial institution to adapt proactively to changing ESG dynamics, minimising risks and maximising opportunities for long-term financial sustainability.
Carbon accounting platforms
The emergence of specialised carbon accounting data providers and analytics platforms has also greatly facilitated the quantification of ESG impacts. These platforms offer a wide range of tools and metrics for assessing and benchmarking ESG performance, allowing CFOs to track progress, identify areas for improvement, and make data-driven decisions.
Sustain.Life is one platform that assists in quantifying the financial impact of ESG factors. By streamlining accounting and disclosure processes, the platform ensures transparent and accountable reporting practices. It can also help accurately measure emissions, including scope 1, scope 2, and harder-to-measure scope 3 emissions. Sustain.Life centralises all ESG data and simplifies report generation, offering comprehensive insights for audit-ready ESG disclosures.
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Sources
1. Thomson Reuters Regulatory Intelligence, “ESG: Fast-emerging challenges for financial institutions,” https://www.thomsonreuters.com/en-us/posts/wp-content/uploads/sites/20/2021/09/ESG-2021_A4_Final_web.pdf Accessed on May 28, 2024
2. McKinsey, “Five ways that ESG creates value,” https://www.mckinsey.com/~/media/McKinsey/Business%20Functions/Strategy%20and%20Corporate%20Finance/Our%20Insights/Five%20ways%20that%20ESG%20creates%20value/Five-ways-that-ESG-creates-value.ashx Accessed on May 28, 2024
3. UTS, “Unlocking Australia’s Sustainable Finance Potential,” https://www.uts.edu.au/sites/default/files/2019-06/Unlocking%20Sustainable%20Finance.pdf Accessed on May 28, 2024
4. Australian Accounting Standards Board, “Exposure Draft ED SR1 Australian Sustainability Reporting Standards – Disclosure of Climate-related Financial Information,” https://aasb.gov.au/news/exposure-draft-ed-sr1-australian-sustainability-reporting-standards-disclosure-of-climate-related-financial-information/ Accessed on May 28, 2024
5. Deloitte, “The CFO as the Driver of Sustainability,” https://www2.deloitte.com/content/dam/Deloitte/de/Documents/finance-transformation/CFO-as-the-Driver-of-Sustainability.pdf Accessed on May 28, 2024
6. Deloitte, “How CFOs can manage sustainability risks and create long-term value,” https://www2.deloitte.com/us/en/pages/risk/articles/cfo-esg-sustainability-reporting.html Accessed on May 28, 2024
7. PwC, “ESG trends in 2023,” https://www.pwc.com.au/important-problems/esg/2023-esg-trends.pdf Accessed on May 28, 2024
8. University of Oxford, “ESG Modelling Framework: Quantification and Measurement of ESG Factors in the Profit and Loss Statement,” https://www.sbs.ox.ac.uk/sites/default/files/2023-01/ESG_Modelling_Framework_Working_Paper.pdf Accessed on May 28, 2024
