Editor's note:This article is part of the "2021 Industry Trends" series. You canvisit our trends topic pageto view all articles.

One of the many priorities CFOs face in 2021 is preparing their companies for increasingly rigorous scrutiny from investors, regulators, and the public regarding environmental, social, and governance (ESG) metrics.

For a long time, CFOs in many industries have recognized thebenefits and importance of standardized, audited ESG reporting. Last year's social activities further reinforced this understanding. But how will ESG requirements and expectations challenge the future work of CFOs?

Blaine Townsend, Director of Sustainable Investing at wealth management firm Bailard, believes 2021 is the year of ESG "surrender." "Much of the view stems from the fundamentals we've advocated for 50 years: companies that treat their employees and the environment well and are more transparent with stakeholders may become better long-term investments," he said.

Townsend has focused on ESG for 30 years. He recalls that early in his career, if you wanted to engage target investment companies on sustainability issues in the supply chain, they would often direct you to the public relations department. Now the situation is vastly different. "There has been a remarkable evolution in how senior management handles these issues," he said. "It has become a public relations issue. Senior management has realized that someone must be accountable for ESG."

In his view, CFOs should, in many respects, become the "chief cheerleaders" for sustainability issues. "Part of the reason ESG is accepted stems from the ability to internalize cost savings from improved energy performance," he said. "CFOs can benefit from better environmental practices. Long-term planning is a key part of business success and aligns well with sustainability issues."

Companies emerging from COVID-19 should move beyond survival mode and prepare for long-term success, which means proactively embracing ESG. "Regulatory issues are coming," he mentioned, referring to the possibility that the U.S. Securities and Exchange Commission (SEC) may formalize ESG reporting. "On that basis alone, getting ahead of the curve will pay off. Smart companies are always ahead of the curve, not passively catching up."

CFOs can demonstrate the benefits of prioritizing ESG in multiple ways. Townsend points out that companies with better ESG performance have lower capital costs, whether through retaining or attracting top talent or seeing benefits flow to the bottom line. "Avoid creating obstacles that don't actually exist," he said. "The market has spoken in 2020; investors are interested in good ESG performance, so if CFOs still see obstacles, they are likely self-imposed. The market's interest in good ESG performance is evident."

Best practices for CFOs

Michael Stanton, CFO of modern governance SaaS company Diligent, said: "CFOs have a tremendous opportunity to become ESG leaders. CFOs are not just financial leaders; in communicating and interpreting financial results or any other metrics/KPIs, CFOs have a natural leadership perspective and are accountable for investor reporting."

Regarding best practices, Stanton emphasized that the key is ensuring the company has the necessary infrastructure, appropriate frameworks, top-down understanding, and systematic reporting and accountability mechanisms to objectively and longitudinally measure starting points, direction, and gaps.

Bernard Borghei, co-founder and Executive Vice President of Operations at communications infrastructure company Vertical Bridge, agrees. He relies heavily on organized financial systems that allow him to access the various parameters and breakdowns needed to accurately calculate the company's carbon footprint. "The financial systems we use have played a huge role," Borghei said. "Every breakdown is clearly listed, which is helpful because the process itself is complex. I strongly recommend CFOs maintain a consistent system throughout the year to capture such expenditures."

Shailendra Gupta, CFO of Acuity Knowledge Partners, which provides research and analysis for financial services companies, said: "As ESG disclosure becomes mainstream, CFOs must address the growing number of questions from stakeholders regarding their organizations' ESG performance." Gupta added that companies should focus on building robust ESG data systems similar to financial data collection mechanisms.

Managing the process

At Diligent, Stanton regularly asks his team how they measure progress from a social governance perspective. "The governance aspect is the part of ESG most classically owned by the CFO," he added. "Other aspects can be shared among the executive team."

"We face many challenges; there are quite strong tailwinds behind ESG," Stanton said. "First, clarify what ESG success and compliance mean for the organization." He acknowledged that these things take time, especially for younger organizations. "Don't try to bite off more than you can chew. Define your requirements, know what success looks like, have tools that can track over time, and then build on that."

Stanton also encourages collaboration with the CEO, Chief Human Resources Officer (CHRO), and Chief Information Officer (CIO) to deploy solutions. "There is no better time than now to improve ESG," he said. "This is the time for CFOs to step up, seize the opportunity, and lead. There is a view that CFOs are just scorekeepers, but this is the best way to keep score—CFOs have the opportunity to demonstrate leadership not only on purely financial metrics but also to all stakeholders and employees."

A broader perspective

Rene Ho, CFO of supply chain management and financing software company Taulia, said: "Philosophically, I tend to focus on perfecting the processes derived from ESG reporting rather than the outcomes themselves. This not only produces the results the organization wants and needs but also changes the culture from within, creating positive, lasting change." Taulia has about 300 employees and a smaller physical goods and services footprint. "The biggest focus of our ESG reporting is talent analytics," Ho said. "When developing analytics and data management capabilities, we focus on eliminating bias in people processes such as hiring or compensation, rather than setting specific quotas or targets." Ho's biggest challenge in implementing ESG analytics was generating actionable insights after applying the anonymity required by law to the data.

Vincent Manier, CFO of sustainable business consulting company ENGIE Impact, points out that companies often fail in their ESG goals because they do not establish the necessary capital allocation models and governance structures during implementation. Manier believes that finance teams must be involved early in ESG planning to ensure projects are designed to be financially sound and can be effectively presented to corporate decision-makers and stakeholders. They must also update existing standards to reflect the benefits of sustainability strategies. "This will guide financial leaders to invest in meaningful short- and long-term financially sustainable strategies, thereby enhancing industry reputation and reducing climate risk." He added: "Without shared, quantifiable success metrics, teams lack the motivation to innovate and collaborate across departments."

Key Performance Indicators (KPIs)

Furthermore, current industry reporting systems cannot accurately capture the data needed to measure the financial benefits of environmental sustainability projects. This gap limits financial leaders' ability to report on metrics such as energy price volatility, water scarcity risk, water and waste regulations, and supply chain carbon footprints. "Companies must improve long-term visibility into these metrics to drive ESG initiatives and make informed decisions," Manier said.

Since measuring ESG-related performance can be overwhelming, breaking down financial communication and reporting into four distinct categories of KPIs can be helpful:

  1. Investment in sustainability projects (including total expenditure and proportion of total corporate investment)
  2. Financing metrics, such as the use of sustainable corporate financing instruments like green/sustainable/social bonds and loans
  3. Governance metrics, such as board composition
  4. Operational metrics, such as reduction in climate-related financial risk exposure

Manier added: "Financial leaders should not obsess over the absolute values of ESG-related KPIs; they do not necessarily represent success." Instead, CFOs should focus on evolution and momentum throughout the year, as most ESG and sustainability goals are long-term and difficult to quantify against specific benchmarks.

Focusing on compliance

In terms of compliance, Borghei said Vertical Bridge reviews and regularly publishes key ESG KPIs, including the percentage of minority employees, the number of employees by gender, and executive representation. "We focus on this very much, so we report quarterly," he said. "When you look around the industry, there are no public KPIs or guidelines," he explained. "So, if I tell you we are a company of 225 people, can you tell me what the appropriate percentage of minorities should be? There really are no guidelines; this is where the industry still has room to grow."

Depending on the industry, each new presidential administration can bring new ESG rules and regulations. "As a CFO, you've already budgeted for 2021, but you don't know when the rules will change," he said. "For companies like ours where ESG focus is truly voluntary, we have leeway and can adjust flexibly."

Borghei said everything Vertical Bridge has done under the ESG banner since its founding is less about money and more about social responsibility. "I know CFOs face performance pressure and should always focus on the numbers, but truly successful ESG programs must become part of the company culture," he said. "It means more when everyone buys into it. Don't view it as an obligation; recognize and understand that its benefits will affect everyone in the company. Once you see it that way, developing sustainable programs becomes much easier."