The EU Commission recently adopted the proposed Corporate Sustainability Reporting Directive (CSRD). This signals that assurance of reported sustainability information will soon become widespread. The CSRD would mandate EU-wide audit under a “limited assurance” requirement, in line with the current capacity of the market to generate ESG information.24 As other jurisdictions adopt similar or parallel policies, the market for external assurance services providers specializing in ESG will develop at pace.
Initial progress towards robust sustainability assurance has been made based on the International Auditing and Assurance Standards Board’s (IAASB) Extended External Reporting Assurance guidance — intended to improve the reliability of assurance and help assurance practitioners respond to new reporting regimes. But further change is still on the horizon.25 In ESG, as in financial reporting, the audit profession must take responsibility for trustworthy conduct, but independent oversight will also be needed.
The ESG approach is itself a recent innovation in the world of corporate disclosures. It must continue to evolve. The combination of reporting convergence, fuller adoption and greater assurance to build trust would position ESG as a powerful strategic enabler for financial and nonfinancial parties alike to make more informed decisions.
Not only can future sustainability reporting converge and come closer to matching financial reporting for structure and stability, it can also more accurately reflect risk and thereby price a truer cost of business into decisions. It can integrate environmental and social data in a financially relevant way. The long-term value and impact of a business can be understood as part of a more coherent whole.
The concept of “FESG” recognizes that financial and non-financial information must be connected to shape strategy and allow interested parties to assess sustainability in the context of both financial performance and financial consequence. Traditional financial accounting has allowed interested parties to evaluate a business’s activities, but without always factoring in the impact of environmental, social and governance factors, the picture has always been incomplete.
Efforts to achieve greater alignment between financial and sustainability reporting have gained momentum in recent years. Looking ahead, more businesses will strive to express environmental and social impacts in the form of comparable financial data; about 15% are already doing so, according to the Climate Risk Disclosure Barometer 2021.26 However, new methodologies need to be developed to fully incorporate sustainability into strategy, capital allocation and operations, and to enhance ESG with greater financial relevance.
The Harvard Business School’s Impact-Weighted Accounts initiative is worth monitoring, as a growing number of companies are using it to address the challenge of aligning a firm’s “overall value to society” with its financial data.27 Similarly, the Value Balancing Alliance is seeking to “create a way of measuring and comparing the value of contribution made by business to society, the economy and the environment.”
An accepted method of monetizing sustainability will emerge from this innovative process to measure an organization’s net value contribution (positive or negative). Cross-sector accounting initiatives that can price the total impact of companies, therefore, are on the horizon. The realization of “FESG”, through the convergence of reporting standards and increased financial relevance, will allow companies to demonstrate environmental and social impacts in a way that is transparent, comparable and reliable.
ESG will become more dynamic and continue to develop. Businesses have the opportunity to harness this development. The G7 Finance Ministers and Central Bank Governors’ support for the newly launched Taskforce on Nature-related Financial Disclosure, as well as the upcoming UN Convention on Biological Diversity, suggests that biodiversity will soon be a main reporting topic.28
“Water, land use, biodiversity; all complex and multifaceted forces that will be critical in climate action, but difficult to capture in the current conception of ESG,” according to Deborah Byers, EY Americas Industry Leader. Standards-setters have been found to be relatively static and reactive until very recently. Business leaders can be more proactive in determining the factors that will make their organization stand out, embedding them into their strategy, operations, products and services, and communicating them through “FESG+”.