The Future of Corporate Sustainability is Finance
To see the future of corporate sustainability, look to the present of corporate finance.
As an FYI, this piece is more wonky geared towards people who are interested in working in the corporate sustainability space than most of my recent articles.
To see the future of corporate sustainability, look to the present of corporate finance. Both functions: 1) cover four pillars of work (Strategy, Action, Measurement, and Reporting); 2) are overseen by a senior Executive (Chief Sustainability Officer or Chief Financial Officer); and 3) include an accounting team that’s often led by a controller (see this Greenbiz article on the rise of ESG controllers). In this article, I explain why sustainability is evolving to look like finance and explore what this means for corporate sustainability professionals.
Regulatory Convergence: A Floor, A Ceiling, and US
The big story of the last 15 years is the establishment of a global baseline for corporate sustainability disclosures. In 2009, the G20 Financial Stability Board identified climate change as systemic risk to the financial sector and established the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD developed climate-related disclosure recommendations across corporate governance, strategy, risk management, and metrics and targets that were voluntarily adopted by many companies.
Last summer, these recommendations evolved into the global baseline sustainability disclosure guidelines from the International Sustainability Standards Board (ISSB). ISSB is part of the IFRS Foundation, the friendly people behind the IFRS Accounting Standards used by more than 140 global jurisdictions. Over time, I expect the ISSB standards to achieve a similar level of global adoption as the Accounting Standards.
While ISSB will set the global floor, the ceiling is being set in Europe with the Corporate Sustainability Reporting Directive (CSRD), which applies to European companies and global companies doing significant business in Europe. The European sustainability reporting standards (ESRS), which include 10 topical sections (5 environmental, 4 social, and 1 governance) and two cross-cutting general requirements sections, cover the what and how of CSRD reporting.
For every CSRD topical section that is deemed material for a company, it must disclose a ton of information, including sections on its strategy to reduce the impact; impact, risk, and opportunity management processes; and metrics and targets to track progress over time. Going forward, CSRD disclosures will be part of the annual corporate reports that are heavy on financial performance today.
Lost, somewhere adjacent to the floor and ceiling in the US, which is forging its own path for climate disclosure–must like it’s done for distances, temperatures, and financial accounting, where it defaults to the GAAP accounting rules, though the SEC does allow foreign companies listed on US exchanges to use the IFRS Accounting Standards. Unlike other sustainability regulations such as the ISSB requirements and CSRD, the SEC will not require Scope 3 emissions, though the SEC climate rules draw from the same source materials. As the rules note, “while the final rules use concepts from both TCFD and the GHG Protocol where appropriate, the rules diverge from both of those frameworks in certain respects where necessary for our markets and registrants and to achieve our specific investor protection and capital formation goals.” Yet with the SEC rules already tied up in litigation, because everything in the US gets lawyered—often to the detriment of all.
Having given an overview of where the regulations are headed, let’s turn to the people who will be responsible for adhering to them—corporate sustainability professionals.
The Four Jobs for Corporate Sustainability
At the simplest level, CSRD and the ISSB define the what corporate sustainability teams need to do; the challenge is figuring out how teams can actually do the work. Because the number of sustainability topics is overwhelming, I think that it’s helpful to look at the four functions of corporate sustainability, which match up with those of finance. They are: strategy, action, measurement, and reporting.
Sustainability Strategy and Action: The What and the How
To make this real, let’s start with climate, where the headline goal is clear: meet the 2015 Paris Agreement, which established a legally binding goal to hold “the increase in the global average temperature to well below 2°C above pre-industrial levels'' and pursue efforts “to limit the temperature increase to 1.5°C above pre-industrial levels.” Voluntary corporate climate goal-setting is well established—more than 4,000 companies have validated GHG reduction targets under the Science-Based Targets initiative (SBTi)—but CSRD will require firms to actually meet the global 1.5°C decarbonization target.
It’s hard to move companies from goals to action. Goals make people feel good; action takes investment, time, work, and patience. (From a finance perspective, most teams love thinking about how they’ll expand and meet big goals in the coming year; it’s the finance team that brings teams back to reality, with an allocation of resources below their desired amount and an expectation that they’ll still do more).
Sustainability is similar, only the inverse; we need to tell Executives the goals that they need to track towards and estimate the investment needed to meet them. Transitioning your executive team from feeling good about the goals they just set to investing in action is priority number one. While there are tons of sectoral decarbonization frameworks and collection action coalitions that can help get you started, but making the business case and securing the resources needed to drive decarbonization is the responsibility of sustainability teams.
If you don’t like the idea of the internal negotiations and politicking required to turn goals into action, corporate sustainability may not be for you.
For impact areas where the goals are less well-defined (e.g. biodiversity or the circular economy) sustainability teams also need to figure out how to set smart goals. While defining the goal needs to come from the sustainability team, a goal without business team support and buy-in isn’t going to accomplish much. In financial terms, think of this like the work teams need to do with finance to develop a pro forma and make the case the invest in a new product or offering. Only with sustainability, the goal is impact reduction—which can, but often doesn’t, correlate with increased revenue or improved financial performance.
Sustainability Measurement and Reporting: Calculating the So What
Accounting is where sustainability and finance will see the most convergence in the years to come. That’s because carbon accounting is evolving to look more like financial accounting. The GHG Protocol was an amazing starting point, but it was written in 2004 with the Scope 3 guidance coming out in 2013—the world has changed a lot since then. Today, companies can be in compliance with the GHG Protocol without providing primary value chain data. This is an untenable situation.
According to CDP, Scope 3 (“value chain” or upstream operations and downstream activities) account for 11.4 times more emissions than operational emissions (Scopes 1 & 2). Under the GHG Protocol, companies can use four approaches for calculating Scope 3, including the spend-based methodology. This methodology relies on data from an environmentally-extended input output life cycle assessment model (EEIO-LCA) and has massive limitations.
First, some background. EIO-LCA breaks the economy into a few hundred sectors and calculates the carbon impact per dollar spent in that category of goods. In practice, this means that the model cannot differentiate the impact of two vastly different products that are part of the same EIO-LCA model category. For example, using the spend-based methodology, a dollar spent by a company on any product in the apparel, leather, and allied product manufacturing sector— a hoodie, winter hat, wedding dress, handbag, etc.—will have the same carbon impact per dollar, which is ridiculous. As the Scope 3 guidance more charitably notes, “broad sector averages may not represent nuances of unique processes and products, especially for non-homogenous sectors.” Ya think?!?
The second limitation is temporal. Consider an apparel company that integrates a new material that will reduce the carbon footprint per shirt 15% but increase costs by 2%. Under a spend-based methodology, its corporate carbon footprint will see a 2% increase in carbon emissions per product even though it should show a 15% reduction (try explaining that difference to your Executive team).
Thankfully, the GHG Protocol is in the process of being updated, with draft updates coming out later this year and being finalized in 2025. When these new guidelines come out, I hope that they’ll phase out of the use of spend-based Scope 3 calculations.
As the carbon accounting rules tighten up, I expect to see more professional standardization, accreditations, and certifications for carbon accountants that will mirror what we have in place for financial accountants (the IFRS has already introduced Fundamentals of Sustainability Accounting exams and credentials). As the accounting methodologies for additional impacts mature (water usage, circularity and resource use, etc.) a similar process of accounting standardization will likely occur. In the future, sustainability accounts will be like CPAs, with an ever increasing number of impacts, allocation rules, and external disclosures under their purview.
While financial reports and sustainability disclosures provide information to external stakeholders, managerial accounting provides information that helps managers make better and more informed decisions. Sustainability professionals need to own their responsibility as the management accountants of impact.
One concept from managerial accounting that I’ve seen used repeatedly in sustainability conversations is that of a relevant cost. In financial terms, the relevant cost is the cost differential between two alternatives; from a sustainability perspective, the differential is often based on environmental impacts. Developing tools to help decision-makers under the financial and environmental impacts of their decisions is the next frontier for sustainability and managerial accounting.
Conclusion
Finance is at the center of everything companies do. It’s just the way it is. Soon enough, corporate sustainability will be at the center as well–just the way it should be. If you want to be part of that sea change, master one or more of the four pillars of corporate sustainability: strategy, action, measurement, and reporting.