Strategic perspectives and insights on emerging risks and business issues

How finance executives and board directors can understand and respond to the rapidly evolving business and regulatory landscape.

In brief

• Anticipate a bumpy ride for the economy in the coming months.
• Reframe your thinking on sustainability and environmental, social and governance (ESG).
• Prepare for increased transparency as the Securities and Exchange Commission introduces new rules.

Today, business leaders face an economic environment like no other in modern history, in which the lingering impacts of the pandemic, surging inflation, the war in Ukraine, and evolving regulatory actions are high on C-suite agendas — as a global recession likely looms on the horizon.

During a recent virtual session with 600+ senior finance executives and board members, business leaders reflected on how their organizations are preparing for what lies ahead. A poll showed that just 22.5% of participants were cutting spending and headcount, while 41% had put contingency plans in place with hiring and spending freezes, and 27% had not made any changes yet. A further 9.5% were actually ramping up.

To offer clarity into this unique moment and what to do about the challenges, EY leaders who participated in “Strategic perspectives and insights on emerging risks and business issues” discussed today’s macroeconomic outlook, the latest on sustainability, and updates into rulemaking from the US Securities and Exchange Commission (SEC). Here’s what they had to say — and what steps executives can take to build resiliency and capture strategic upsides in a time of profound uncertainty.

Today’s economy requires resiliency

“Navigating this world of uncertainty will require more attention to things that weren’t so central to the decision-making process before,” says Gregory Daco, the Chief Economist with EY-Parthenon. While the US economy is the “cleanest shirt in the laundry basket,” he says that economic activity globally is slowing faster than anticipated: an estimated 3% in 2022, and perhaps just 1.5% in 2023.

In a new paradigm that has punctured old assumptions, Daco cites five areas to monitor:

• Inflation. It’s present everywhere, and not just related to energy: it is present in different forms, and risks over the medium term are tilted to the upside.
• Labor. The value of talent has increased dramatically. Businesses are much more attentive to building a resilient labor force, but that goal comes at a cost.
• Supply chain. We’ve experienced a massive disruption to supply in the wake of COVID-19 — and now there’s increased geopolitical fragmentation. Resiliency is crucial, yet elusive.
• Environmental, social and governance (ESG). The importance of ESG is no longer theoretical: record droughts and flooding are happening across the world, with major consequences.
• Cost of capital. Debt and equity have both increased tremendously, along with deep shifts in foreign exchange. The euro, pound and yen are at record lows, which is a new risk.

Central banks are now executing a historically rapid and globally synchronized (but uncoordinated) tightening of monetary policy, carrying risks of a hard landing. In a poll of participants, 43% said their businesses had deferred or cancelled low-priority investment, and about 30% said they can fund only their priorities for now, while 22% were not changing their plans. The remaining 5% said they had paused all long-term projects or implemented a freeze on investments.

Action items:

• Build resilience through developing robust and reliable supply chains and addressing scenario planning to sharpen your corporate strategy oriented around a growth slowdown.
• Balance those efforts with ways to be nimble, and proactively seek out alternative scenarios, because the characteristics of this recession will be unique.

We’re at an inflection point in the climate crisis

The 2022 United Nations Climate Change Conference, also known as COP27, brought together nearly 200 governments to build on previous successes and pave the way for future ambitions, with key pillars around accountability, solidarity, and innovation. Against this backdrop, companies are embracing science-based targets developed through a collaboration among nongovernmental organizations in line with the latest climate guidance.

“The current energy crisis resulting from the war in Ukraine shows that we should be moving to a low-carbon economy even faster,” says Veli Ivanova, EY Americas Chief Sustainability Officer. Businesses have shown strong leadership in their climate related commitments as demonstrated at COP26 in Glasgow last year and COP27 in Egypt this year. It’s time now for businesses to make significant progress on these commitments through collaboration and innovation across their value chains.

Research findings from the EY 2022 Climate Risk Barometer report shows that companies are making strides in their disclosures, yet they are struggling to provide meaningful information on climate challenges and quantifying them. This highlights the need for awareness and training, so that finance departments are positioned to work better with other stakeholders across the business.

Action items

• Look at emissions across the entire value chain, and consider different scenarios. Science-based targets have been designed as a useful pathway for industries to set goals. 
• Note that the climate challenge poses risks but also brings opportunities in products and services to take to market. Reframe your thinking.
• Explore new opportunities to collaborate, whether through industry initiatives, public-private partnerships or company-to-company efforts.
• Track your performance in real time through data solutions, so that you can measure what’s happening and ultimately where there is need to improve.

Plenty of activity on the regulatory front

ESG is also a prime topic of discussion within the latest SEC proposals and final rules. In a poll, 43% of respondents said they expected that climate-related disclosures would have the most impact on their organizations, the top response in a field that also included cybersecurity (30.5%), pay versus performance (8.5%) and clawbacks of incentive-based compensation (4.5%). The rest selected “other,” highlighting the jump in activity since Gary Gensler took over the chairmanship of the SEC.

Steven Jacobs, EY Americas Director of SEC Regulatory Matters, notes that the SEC has other tools that it also relies on to advance its initiatives leading up to the issuance of and beyond rulemaking. “For the first time in 10 years, the number of comment letters issued by the SEC staff has gone up, reversing prior trends,” he says. “The SEC can also pursue its priorities through staff guidance, speeches, staff accounting bulletins, and enforcement actions (all of which have increased recently).”

His updates included:

• Final pay versus performance. This “new old rule” requires companies to demonstrate, in an illustrative format, how compensation compares to performance over time. And they must regularly remeasure the value of their equity awards as part of calculating “compensation actually paid” for purposes of the table. Be mindful of the story you need to tell, with added context in light of what the table may present.
• Final clawbacks of incentive-based compensation. These requirements in this “new old rule” are much more expansive, broad and inflexible than what companies may already have in place. They encompass how clawback policies will need to change including covering large and small restatement, and cover a broader population of executive officers.
• ESG. These proposed rules are more extensive, aiming to gain consistency and comparability on the nature of information, as well as the timing and method of disclosure. Companies need to think about the controls to develop climate change disclosures (including in the financial statements) at a level that may require greater disaggregation than is typically the case. “We are expecting some change in the final rulemaking, but it’s good to think about controls now,” Jacobs said, expecting some potential delays into 2023.
• Proposed cybersecurity incident and risk governance disclosures. These rules would largely codify guidance issued in 2018 — for instance, requiring companies to reveal a cyber breach when they’ve concluded that it is material, with ongoing reporting regarding the remediation. Other aspects go toward how companies are managing cyber risk, their policies, and governance at the board level.

Action items

• Have the resources and people in place to respond to those changes, with policies and processes. You may be getting comment letters from the SEC staff for the first time in a while, and you must digest and respond to them.
• Understand that you likely need to put new clawback policies in place, even in the event of those small restatements that happen from time to time.
• Don’t lose sight of the “G” in ESG. Governance also includes cybersecurity and board diversity, which are hot topics. Companies have to tell their story appropriately.