Many CFOs are moving the finance function away from being solely a cost centre to a function that generates value, and they are using ESG as a tool to get there. In particular, CFOs, along with other executives like CEOs and chief sustainability officers, are creating value by using an ESG lens to better manage growth, capital, risk, and talent.
To explore how, I chatted with Simon Hutton, director of strategy, ESG, and transformation at BDO Canada and John Asher, CPA, CA, a partner in BDO's Vancouver office and leader of BDO's risk advisory services practice in Western Canada.
Listen to the full discussion on the Coffee Chats with CPABC podcast. Here are some highlights from our conversation.
Lori: How are CFOs moving the finance function from being a cost centre to a function that creates value, and using ESG to get there?
Simon: In the past several years, there's been a shift from seeing ESG residing in a risk pillar to residing in a value creation pillar. Today, we often think about how to use ESG to create value by building on and creating momentum behind our core competitive drivers – growth, talent, risk, and capital – which are top of mind for C-suite individuals. ESG has also, in the past, been associated with acronyms and practices of risk and compliance and regulations, which has taken away from people viewing it as a factor that can drive value. While ESG is related to risks and regulations, today, it is also very much related to driving value within a firm.
John: ESG is a central component of business strategy. When CFOs integrate ESG principles into the operations, it can increase value in many ways. for example, sustainability practices can lead to greater efficiencies like reducing energy consumption, which results in cost savings. ESG is also a factor in investor attraction since many investors now look at ESG practices in their decision making. Customer and employee engagement is another area, as we see these groups making decisions about who they want to purchase from or work for based on ESG practices.
Lori: Could you speak further to the competitive advantage of integrating ESG into a business?
Simon: Talent management is a prime example. In this context, we generally think about keeping the good people that we have and recruiting the good people that we want. So, is ESG critical to this? There is data to suggest that the majority of adults believe climate change is the most important issue facing society today and consequently, many want to work for an organization that aligns with their beliefs around the climate crisis.
In particular, we need to remember how important this issue is to younger professionals because it will affect them profoundly. They want to see that their organization has at the very least, articulated some commitment to climate change.
Consequently, we're seeing more organizations being very careful about trying to align organizational values with those of their employees. This is one way organizations can achieve a competitive advantage – if you can get better talent because your current and future employees are aligned with the values of the organization, they are more likely to stay. Arguably, they're more likely to be productive and more likely to go home and share the story with their family and their network, which subsequently builds brand.
Lori: What key risks might a business face if they don't integrate ESG?
John: There’s no shortage of risks. One that comes to mind is reputation – customers may boycott a brand for not following particular ESG practices or for not sticking to their ESG commitments. Another is regulatory. It’s still early days for what Canada’s ESG framework will look like, but I think there will be increased focus on ESG from governments and regulatory bodies as time passes.
There are also evolving regulations and failure to adhere to them could mean risking sanctions, fines, and legal actions. There’s also a risk of divestment as investors move capital to ESG-friendly organizations or industries. In terms of financing, we've seen some finance institutions factor their client’s ESG practices into their risk profile to determine who they want to lend to and, based on ESG risks, what rates to charge their clients. Supply chain vulnerabilities are another risk that CFOs should consider. Typically, poor working conditions, environmental degradation, and lack of transparency can result in supply chain instability and reputational risk.
Lori: Are there any government incentives that could support an organization to take on ESG?
Simon: First, we are seeing market forces that are creating incentives. Increasingly, many organizations are getting detailed surveys from their biggest buyers asking them to disclose what they are and are not doing across a spectrum of ESG issues.
The buyers are using this information to better qualify their supply chain because they do not want to be guilty by association and they want to know who is doing what as it relates to ESG and sustainability. Does the client, for example, have GHG targets? Do they have policies that speak to EDI? Some organizations might not be able to answer these questions in a favourable light and as a result, they may be deprioritized as a preferred supplier. As large and influential buyers send these questionnaires, there is an inferred incentive to suppliers.
Second, in terms of governmental incentives, there are many, but one that is garnering attention is the proposed Clean Technology Investment Tax Credit program , which gives an up to a 30% tax break on capital expenditures that are clean technology oriented.
Lori: Do you think there’s a need for government incentives?
Simon: Considering the federal government’s goals around climate change and the targets it has created for greenhouse gas emissions reductions for 2030 and 2050, I think there’s a need for government incentives. Let’s look at the government’s goals around electric vehicles (EVs). Considering how many EVs need to be sold and supported by appropriate infrastructure like charging stations in the coming decades to meet GHG targets, it’s clear that those goals cannot be met unless the government create incentives for people to make it easier for them to change their behaviours to purchase and drive EVs.
Lori: How can CFOs better manage growth to ultimately bring value through ESG?
Simon: I'll offer two examples that are quite different. First there’s the potential to differentiate your service or product by making it clear to customers that this product was created under a circumstance of highly reduced carbon emissions, made from products that are renewable in nature, and made from a labor force that is globally sourced with attention to fair trade. By showcasing your commitment to ESG, consumers are more likely to choose your product over the competition who don’t follow ESG practices.
Second, let’s look at better managing growth through values – for example, by selling a product that reflects the values that you align with. For instance, I’ve been a fan of Patagonia clothing since I was 12 years old. They've also got a great marketing team and they've instilled in me the sense that Patagonia is committed to doing better as it relates to the preservation of our natural world. By way of investing in sustainability and creating differentiation, they've done two things. They've increased their quantity of cash flows because I'm going to buy more of their products. They've also increased the quality of their cash flows, which will be recurring, because they have won my loyalty as a customer over my lifetime.
Lori: What's your perspective on how CFOs can better manage capital using ESG strategies?
John: In terms of identifying risk, CFOs need to improve their risk assessment not only on ESG itself, but on long-term financial impacts of not adopting best practices with respect to ESG. CFOs need to look at the potential of allocating capital more efficiently by understanding what the potential environmental liabilities are for the organization, potential social risks, and potential governance issues along with that. That analysis may help them avoid making investments in areas that may not result in an optimal rate of return.
Let’s also look at access to capital – companies with strong ESG credentials are more attractive to investors and creditors. CFOs can leverage this advantage by showcasing their company's ESG performance and do so to a broader pool of capital too. Along with large financial institutions, you might access different lending markets, such as green bonds and sustainability linked loans. Lastly, there are innovation and growth opportunities with ESG. Companies are developing new products and services that meet emerging market demands and there's an opportunity for CFOs to direct capital towards research and development into sustainable technologies to potentially open up new revenue streams.
Lori: Are there any other key ESG-related issues that CFOs should focus on to manage risk?
Simon: Recently, Bill S-211 came into effect and has changed the game for transparency in the supply chain as it relates to forced and child labor. This is also an interesting example of an ESG regulation that is changing how thousands of companies think about their supply chains. Companies are being asked to disclose what they did in their last financial year across eight different disclosure topics. This creates compliance risks. If companies fail to comply with Bill S-211, they’re subject to fines of up to a quarter of a million dollars. There are also potential reputational risks. The reports that are required as part of S-211 compliance will be in the public domain, so everyone can see the organization’s position on forced and child labour.
Additionally, there are business risks. You may find your imported goods are stopped by the Canada Border Services Agency because they have an association with forced child labour. The additional risk of supply chain disruption will impact distribution, customer experience, and may affect your bottom line. Last year, we saw a little less than a billion dollars in goods stopped at the American border because of ties to forced labour, so there’s no reason why this couldn’t happen in Canada.
John: Establishing an enterprise risk management framework is step one, after which CFOs will need to identify ESG risks specifically. What I've seen in the past is that if an organization has an enterprise risk register of perhaps 20 risks, they ensure one of them is ESG. However, the ESG risk tends to be very high-level and generic and might only cover the “E”, the “S”, or the “G” individually, but not each element. It's important to consider the “E”, “S”, and “G” risks separately and integrate those into your risk management framework. Risks change on a daily basis, so continue to assess related risks in these categories.
Next, engage your internal and external stakeholders, and use that feedback to refine your risk management strategy. Risk management is an evolution, so make sure ESG is part it. Develop clear policies and procedures; develop comprehensive ESG policies to integrate them into the company's overall strategic and operational plans, and make sure that's clearly communicated. We don't want this to sit on the shelf and collect dust. After that, monitor and measure performance. Make sure that you have ESG performance indicators so that you can see how the risk is evolving over time and integrate them within your financial performance system.
Lori: Do you have any final recommendations or resources to suggest?
Simon: As people contemplate ESG and the options at their disposal, I encourage them to find focus, narrow the funnel of choices to the items that are going to have the greatest impact first, make those things work, create some winning momentum, then move on to the next item. There are many organizations that have tried to do too many things too soon. This doesn't work and it causes organizations to lose momentum, so be very thoughtful about the choices you make.
John: Professional services firms within and outside of Canada have great resources on their website. As well, talk to your peers and share resources – see what's been working for them and what they have produced. If you are thinking about producing your first ESG report, talk to someone who already has. We’re all in this together.
Lori Mathison, FCPA, FCGA, LLB, is the president & CEO of CPABC.
