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Strategy DFIN

ESG Integration into the Investment Analysis Presents ERM Opportunities and Challenges


Sponsored by DFIN

CFO and finance professionals are well-positioned to support boards and management to fully understand risk and opportunities that are material to your company’s long-term sustainability and value creation.

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Today’s boards, c-suite and management are challenged to identify Environmental, Social and Governance (ESG) risks and opportunities across all forms of capital including financial, human, social and relationship, environmental, manufactured and intellectual – as defined by the International Integrated Reporting Council’s, Integrated Reporting Framework. CFO and finance professionals are well-positioned to support boards and management to fully understand risk and opportunities that are material to your company’s long-term sustainability and value creation. 

CFOs, with clear risk management responsibilities, are in a better position to make a greater contribution to strategic and operational risk management. The foundation of informed risk taking and decision-making requires high-quality information about opportunities and risks and their implications. Fundamentally, high-quality information is crucial to good decision making, as well as for transparency to investors, as it reduces uncertainty – and can support a higher risk appetite.

ESG analysis is becoming a fundamental part of investment analysis, requiring a disciplined approach to be fully integrated into the investment process. In a 2018 study by the CFA institute, the drivers of ESG integration were identified to include global demand from institutional investors as a method of evaluating risk, as well as an approach to uncover investment opportunities. Investors who can spot companies looking to improve their E, S and G profiles in advance of the broader markets may be rewarded. 

Corporate leaders from public and private companies, both large and small cap, should begin by evaluating material ESG issues for specific business, industry and segments. With CFO leadership, there is opportunity to focus on the delivery of high quality, decision-useful ESG data for their boards, investors’ and all stakeholders’ consideration. 

CFOs looking to be proactive should familiarize themselves with the evolving standards and frameworks, building on existing ERM process and common understanding of financial materiality assessments, including the COSO ERM Integrated strategy and performance framework, recently updated to incorporate ESG Risk; and, the Sustainability Account Standards Board ESG standards for financial materiality on ESG issues for U.S. companies in 79 industry categories. 

COSO published its Enterprise Risk Management—Integrated Framework in 2004. The purpose of that publication was to help entities better protect and enhance stakeholder value. Its underlying philosophy: “Value is maximized when management sets strategy and objectives to strike an optimal balance between growth and return goals and related risks, and efficiently and effectively deploys resources in pursuit of the entity’s objectives.”

COSO has updated these frameworks to keep pace with fast-changing global dynamics and risk. The World Economic Forum commented on the “increasing volatility, complexity and ambiguity of the world.”  Organizations today encounter challenges that impact reliability, relevancy, and trust. Stakeholders are more engaged today, seeking greater transparency and accountability for managing the impact of risk while also critically evaluating leadership’s ability to mitigate risks and capitalize on the opportunities. 

In October 2018, the COSO ERM Framework was updated to include ESG risk-related controls and analysis.  Boards are expected to provide oversight of ERM, and the COSO Framework supplies important considerations for boards in defining and addressing risk oversight responsibilities. The COSO ERM – ESG Framework is built on the five pillars of existing ERM reporting;

  1. GOVERNANCE & CULTURE FOR ESG-RELATED RISKS 
  2. STRATEGY & OBJECTIVE-SETTING FOR ESG-RELATED RISKS
  3. PERFORMANCE FOR ESG-RELATED RISK
    1. IDENTIFIES RISK 
    2. ASSESSES & PRIORITIZES RISKS 
    3. IMPLEMENTS RISK RESPONSES
  4. REVIEW & REVISION FOR ESG-RELATED RISKS 
  5. INFORMATION, COMMUNICATION & REPORTING FOR ESG-RELATED RISKS 

Many entities have ERM structures and processes in place to identify, assess, manage, monitor and communicate risks. The new COSO ERM ESG Framework is not intended to be used in isolation, but in partnership with other established ERM and Sustainability frameworks. 

Wherever possible, the COSO document leverages existing frameworks, guidance, practices and tools from both the risk management and sustainability fields including: Global Reporting Initiative Standards; Greenhouse Gas Protocol; International Integrated Reporting Council’s Integrated Reporting Framework; Sustainability Accounting Standards Board Standards; and Recommendations of the Task Force on Climate-related Financial Disclosures.  

SASB standards focus on financially-material issues to help global businesses report on the sustainability topics that matter most to their investors. Although there is considerable ESG and sustainability information disclosed publicly, often it can be difficult to identify and assess the information most useful for making financially-related investment decisions. SASB identifies a limited number of financially-material issues, which are likely to impact the financial condition or operating performance of a company, and be of most importance to investors.

For more detailed information on the emerging ESG standards and frameworks visit DFIN Solutions “Insights - ESG” where we cover the data, trends and reports that are shaping global markets.