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Unlocking the value of extra-financials for the CFO

December, 2017

Sustainability & social responsibility are issues which have traditionally fallen outside the influence of the Chief Financial Officer (CFO). CFOs crunched numbers and focused on bottom lines, while others handled aspects such as CSR. However, such job silos are crumbing today. This shift is a result of increasing interest of companies’ stakeholders to viewing ESG factors as complementary to financial valuation and performance. While credit-rating agencies have focussed on companies’ financial performance, they now want to information about companies’ sustainability practices, as well as more there is an emergence of specialized of sustainability ratings providers and indices, such as Dow Jones Sustainability Index (DJSI), MSCI Global Sustainability Index and FTSE4Good. ESG and low-carbon indexes are in the sweet spot between two major trends – the rise in passive investing and the rise of responsible investing. A recent study by MSCI found that its ACWI ESG Universal index, which excludes a small number of “red-flag” stocks and tilts the remaining constituents towards companies with strong sustainability performance, has outperformed its benchmark by 39 basis points annually since 2012.

Speaking from an investment perspective ESG refers to the integration of ESG factors in the investment decision-making. Banks, insurance companies, private equity funds and other institutional investors are now considering the sustainability rankings of the companies in which they invest. While ESG parameters may vary by company, industry, geography and type of investment, it is imperative for an investor to match the investment with the set of ESG values that they seem fit. Some common ESG factors which play a role in determining the risk and return of an investment, include factors such as

Table 1 ESG Factors considered in determination of risk and return of an investment

Environmental

Social

Governance

  • GHG Emissions
  • Climate change
  • Deforestation
  • Air & Water Pollution
  • Water Scarcity
  • Waste management
  • Biodiversity

 

  • Worker health and safety
  • Impact on local communities
  • Child labour
  • Human rights

 

 

  • Board Composition and Independence
  • Shareholder rights
  • Gender diversity
  • Bribery and Corruption

 

 

 

Inclusion of such extra-financial or ESG criteria into investment decision-making has gained ground, as a means to determine financially robust and resilient investment opportunities. Institutional investors are looking at ESG issues such as climate change and sustainability, as often bearing direct impact on companies’ risk profiles, their reputations and their financial performance. Investor groups, such as Ceres’ Investor Network on Climate Risk, are dedicated to addressing the financial risks and investment opportunities posed by climate change. Notably, in a February 2016 memo to leadership of the world’s largest companies, Larry Fink  (Chairman and CEO of BlackRock), urged CEOs to remain cognizant of the pivotal role of ESG performance on financial impacts and that handling ESG issues well, was a sign of operational excellence at a company. Investors such as BlackRock, the Rockefeller Brothers, The Wallace Fund and Ben and Jerry’s Foundation, have taken actions towards divesting their holdings in fossil fuels in an effort to combat climate change.

There is an emergence of a unique opportunity for companies to engage in value creation beyond economic imperatives to improve their company’s overall performance. To unlock the value of ESG, CFOs could adopt a six-point action plan:

  • Ratings matter: Understand the ESG ratings landscape and focus on ratings most vital to your company

  • Align goals: Align business goals and incentives with national and global agenda, such as Sustainable Development Goals (SDGs)

  • Eye for detail: Analyze any data that contributes to your company's environmental & social impact

  • Prevention is better than cure: Take precautionary actions on sustainability issues now, rather than being forced to react or to manage crisis later

  • Build strong Investor Relations: Good Investor Relations (IR) is a key of the company’s share price, and the cost of capital, so CFOs must stay up to date on their companies’ sustainability policies & performance. IR department should be fully aware of ESG performance metrics and ratings

  • Stay informed: Keep updated information on environmental, social and governance regulations (besides financial and economic) which may impact the supply and distribution chain

Given the central role CFOs play in steering the course of businesses, incorporating ESG impacts in business strategies would enable CFOs to future-proof their businesses, as well as be better prepared to spot the relevant risks and opportunities.

 

 

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