Alessia Falsarone, SASB FSA is a Managing Director in the Global Fixed Income team at PineBridge Investments in New York, a private, global asset manager focused on active, high-conviction investing. As Head of Sustainable Investing and Chair of the firm’s Corporate Responsibility Steering Committee, she brings an integrated portfolio management lens to the investigation of the Environmental, Social and Governance practices of global organizations that access developed credit markets. Previously, Ms. Falsarone served as Vice President of Global Investments in the office of the CIO at Citigroup, and as a quantitative strategist on Citigroup's institutional research desk in San Francisco. She started her career as an investment banker with Credit Suisse. Additionally, Ms. Falsarone is a Governance Fellow of the National Association of Corporate Directors and an active member of several technical expert groups including the Standards Advisory Group of the Sustainability Accounting Standards Board (SASB), the Advisory Council of the Green and Social Bonds Principles, and the UN PRI Advisory Committee on ESG in Credit Risk and Ratings. With all this experience, Alessia talks to us here at Count Me In about all things relating to ESG data and integrated reporting, with a focus on how technology has influenced stakeholder decisions in this area. Upon the completion of this episode, you will certainly understand why Alessia refers to 2020 as the year of ESG data!
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FULL EPISODE TRANSCRIPT:
You are now listening to episode 55 of Count Me In, IMA's podcast about all things affecting the accounting and finance world. I am your host, Adam Larson and I'll be bringing you right up to the conversation between my cohost Mitch and Alessia Falsarone. Alessia joined Count Me In to talk about how and why 2020 is the year of ESG data. She is the head of sustainable investing for portfolio management for PineBridge Investments and has a wealth of knowledge in the area of sustainability and integrated reporting. Let's head over to the main part of our episode now and hear Alessia share her valuable perspectives on ESG data.
What are some typical line items or key data points relating to ESG and sustainability that accountants should really be reporting on?
Well, first of all, thank you Mitch for inviting me to share the investor lens with your audience at the IMA today. 2020 is truly the year of data for ESG. The entire field, not only investors, I am referring to- but also corporate finance specialists, controllers, treasurers, CFOs and auditors are taking a much closer look at what is generated across their organization as relates to sustainability efforts of the enterprise and starting to take stock of any linkages between sustainability credentials that a company may list for customer outreach and end-market awareness in their reports and their website vs. the financially material sustainability factors that affect the profitability of their business. And that is an area where either accountants or treasurers or CFOs are spending in my opinion, as it is the case for the companies I engage with as an investor, a lot more time, since they're really looking at them not only as an engagement tool, but as an alignment with their financial commitments. So where sustainability is adding value in reporting is at the intersection of enterprise value, operating efficiency and top line growth. What's interesting about that is, when we think about corporate governance, and go back to corporate directors surveys for last year, for example, I think it was The PwC’s annual corporate directors survey that found more than half of directors say investors are giving too much time and focus to ESG – environmental and social governance considerations – which is nearly twice the percentage in 2018. What is it eye brow lifting for me as an investor when thinking about the accounting side of the business? Clearly there is the need for continued dialogue- if the board does not recognized the value, nor its audit committee, then investors can continue to debate the divestment saga or not but we will see little value in corporate reporting initiatives. So when you compare that survey to the engagement priorities for institutional investors during the 2020 proxy season remains environmental resilience and also the ability of the board to address resilience and capital planning considerations is clear. My lens remains bias as I am both a capital markets professional and a certified director with NACD – the National Association of Corporate Directors - in the US and a governance fellow for a number of years. I can assure you that at NACD there has been a strong push to elevate directors’ skills – certainly those sitting in audit committees – to see the relevant disruptions. This is something I would like to make clear to the audience at the IMA. ESG is certainly a tangible one on a clock – it carries reputational risk that no sustainability credentialing process could make up for if lost. Few enlightened board chairs or audit committee members see that and they are certainly keeping the accounting for ESG data up the priority list.
So that's really interesting. And you know, from this investor perspective here, you know, aside from the time and the priority that goes into it, I'm sure there are a number of other challenges as well that, you know, accountants particularly must be aware of. So from your perspective, what are some of these challenges that accountants face with this ESG data when it comes to giving investors the information that they're really looking for?
It’s quite interesting. When I think about financial innovation and the headlines surrounding the issuance of sustainability-linked financial instruments such as traditional green bonds, loans or even transition-linked capital raising instruments, they have certainly raised awareness as the treasury team at a company and the CFO is as involved as the auditors and the external verifiers in aligning capital raised with capex associated with a company’s green effort. That’s one part of it. Certainly, from an accounting perspective, the need for ESG data is to be aligned with the financial commitments of a firm as data is about long terms trends that will require as much opex as capex to build resilience or competitive advantage and top line growth. Either way, ESG data and the impact on $-Unit measures are the hardest to address as non-financial risks and non-traditional sources of risk don’t come in same unit measure. Clearly you have accounting and finance professionals testing themselves on kilowatt-hours when aggregating energy efficiency to metric tons of CO2 per home yearly when discussing home energy use, or even more esoteric such as “near misses” which is the count of events with the potential of loss or injury if the accountant is analyzing health and safety statistics within the workforce. Who’s domain is that? It is increasingly of financial professionals. While there is certainly room to define best practices, it is simply good business management to define E-S-G indicators at the company level that are associated with financial outcomes and address them and report them consistently – they could be in the form of trends or as statics, absolute levels if there are absolute (sustainability) targets in place.
I will give you an example- a new green cement laboratory finding in Colombia recently, which calls for the relevance of adopting green techniques in the production of cement. Yet production itself is clearly an energy intensive process. So while the green aspect of bringing to market a more sustainable product in terms of carbon released in the atmosphere during production may indeed be part of an environmental materiality approach and disclosure that can be externally verified – with clear financial consequences associated with potential carbon levies on that economic activity in the future – yet the financially relevant aspects to be accounted for are associated with another set of questions:
First, business materiality would call for near-term financing of that transition from legacy cement production to newer products, including timing of operating expenses and capex associated with it.
And then you have potential forecast of market share gains and therefore more stable pickup in free cash flows including the impact on credit metrics.
Unless we place the financial materiality of the innovation in the context of how sizeable is the opportunity, the financial benefit associated with greening products may not be fully captured in enterprise value and therefore there may be no additional incentives for a management team to carry out a full upgrade of their product offerings any time soon.
The accounting world has the remarkable opportunity to pick up on innovations like the one I have just mentioned and articulate that in terms of financial outcome, with a reporting time horizon in mind.
Moving from sustainability credentials, awards and recognition into a set of variables that are really part of an investor day -type of dialogue is key. Certainly, the underwriting of green bonds and loans and the advances in capital markets addressing the quality of project financing with green aspirations has made corporate commitments even more visible globally. Definitely in need for properly accounted metrics and corporate governance practices that are both internally and externally verifiable and assurable (if not assured yet). In a world where boilerplate language is still the norm, it will not be surprising then to our audience today to hear that in the face of boilerplate language and the lack of faster adoption of standards such as SASB’s, investors do in fact apply their own independent research and opinions to their investee companies – and they are already bridging the gap between sustainability accounting and financial decisions when looking at reporting package of a company.
So you just touched on a couple of things that I want to circle back to and make sure we address. I know you were talking about financial and outcomes and making sure that, you know, the traditional external financial reporting, for accountants we always rely on verification and, consistent units of measure. So how does this ESG data really translate and really what's the difference between integrated reporting with all these challenges compared to the traditional financial reporting that most accountants are familiar with?
Yeah, it's interesting, right? The value of integrated reporting is more tangible than ever when dealing with sustainability factors that affect a business in ways that are certainly not unidimensional. What I mean by that is, going back to the different unit measures and the continued need for comparability, the value of having a solid corporate reporting that incorporates the governance of environmental and social factors in management discussion and analysis as well as now entering the foundations of financial commentaries as well when material, that value is now more than ever at risk of miscommunication or lack of targeted communication surrounding financially relevant issues of strategic value to an organization. Yet, probably the largest study released that I know of zooms in on how 1000+ companies in Europe disclose information on their environmental and societal risks and impacts- The EU has been at the forefront of regulatory awareness and action surrounding standards and reporting initiatives. The study is fresh of the press – released yesterday, on President’s Day February 17th by the Alliance for Corporate Transparency. Briefly, results show that a majority of companies are focused on policies and procedures and commitments with respect to non-financial risks such as sustainability, but approx. 22% so less than 1-in-4 report on them and define performance indicators that are verifiable. And 13% or so define business exposures to polluting sectors. If we delve into issues related to the workforce, the statistics are even more alarming. 80-83%% describe their human rights policies, 25% disclose the actual risks related to Human Capital and less than 15% report actual impacts on the business.
If we go back to the same EY report on investor engagement priorities for 2020, Human Capital retains top 2 positions along with environmental concerns as a key strategic success in the next 3-5 year time horizon including issues of workforce diversity and culture in the workplace. Yet traditionally investors have focused on workforce compensation in their analysis as in many cases that is clearly connected to pay equity and promotion rates across diversity categories.
Clearly, it is not a one-size fit all approach – if anything it is highly dependent on the end-markets in which a company operates and reporting should clearly be aligned with the need for more accurate statistics.
I encourage the audience to follow the research project on Human Capital that the Sustainability Accounting Standards Board (SASB) has launched in the 4th quarter of 2019. It clearly addresses the need for a deeper exploration of dimensions such as human well-being in the workplace, the impact of technology and innovation in upskilling as well as capturing the impact of D&I in terms of its financial materiality.
So if you ask me where do I see the value of integrated reporting going forward is as a communication toolkit that is very much lacking and much needed to define management discussion and analysis, financial reporting and management oversight of financially material sustainability risks. As an investor I see strong value in the work of SASB and clearly that is in my toolkit and certainly it is under the SASB guidance that increasingly investment analyses are performed - pre- and post- due diligence – for both public and private entities.
And I think that's all great and thank you for clarifying all that information. you did just recently mentioned something about technology and upskilling though. So I would like to get your opinion on what you have seen in the market as far as how technology has impacted this integrated reporting and what does that really mean for the accurate data that investors are really looking for when it comes to integrated reporting or financial reporting in general?
That's a really key point. Clearly we need to recognize that technology has affected the entire financial services and business management industries for the past 2 decades. Going forward I see technological innovation adding in 2 key ways: 1 through enhanced verification and assurance and the other directly in incorporating non-traditional source of sustainability oriented data feeds into financial analysis.
With respect to the 1st application, the enhanced verification and assurance, clearly the vast number of data points with consistent history and verifiable sources of information that are available today has created the best backdrop and a strong tailwind to harness use cases of alternative data and other non-traditionally collected nor accounted for data series that in aggregate enable decision-useful content in the reporting of outcomes.
An example that comes to mind is the emerging use of geospatial data or earth observation through remote sensing technology for the analysis, for example, of environmental risks in supply chains, it is clear to me that such applications will become core in financial reporting related for example to enterprise risk management and scenario planning under the TCFD reporting.
The 2nd leverage point of technology innovation in accounting and reporting applications, so to speak the translation of non-financial data into financial metrics, the real need is to ensure that whatever vendor is selected or in-house built platform is rolled out, it is conducted from a place that truly looks at the ultimate use of data as monetary liabilities associated with the mismanagement of the info collected, and how much that info has a verifiable process to derive financially material decisions for a business as it may also be subject to cyber and broader reputational risks even if it comes in non-financial unit measures and may look harmless. If we think of medical records and privacy it is easier to see the case for heightened vendor management practices surrounding the use of technology.
Anecdotal evidence: I have heard in between 700-800 data fields are available regarding ESG practices of an organization. Without accounting for the severity of impact, or the likelihood and other measures to address validation of the ultimate source of that data point, that may result in non-financially material information. The role of Big 4s in building not just reporting but also growing the existing advisory into sustainable services for management teams speaks to the need for well-rounded due diligence.
An area where technology will become increasingly relevant is the 3rd party verification of impact – which is yet to be addressed and likely a crucial aspect in a world where companies set bold climate-science aligned targets for carbon emissions and start discussing variables such as scope 3 emissions which are not measurable as part of operational framework but go outside of the company (the use phase) and follow the products or services once they leave the showroom or the shelf, so to speak.
I am a big proponent of blockchain solutions. I have heard the digital ledger defined for a long time as “the hammer looking for nails”. Sustainability as the perfect nail for blockchain and digital ledger technologies.
If there is one thing I would leave the IMA audience with today is the following question. Ask yourself whether XYZ (identify the most pressing ESG issue that your company is facing) and whether in house there exist a collection point where that data can be streamed, which processes it currently informed, who can verify its validity and take charge of its integrity and how many times that data point has been presented to the management team or to the audit committee of the board. If you start with that you will be already on your sustainability reporting journey.
This has been Count Me In,
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