ESG and the current regulatory landscape

Rebecca Archer

Welcome to Navigating the New Normal – Grant Thornton’s podcast exploring trends in business and the marketplace.

I’m Rebecca Archer and today I am joined by Partner and National Head of Financial Services Tax, Himashini Weeraratne, and Partner – CFO Advisory Services, John Askham.

Today we’re discussing the ESG landscape, the regulation and reporting requirements, and what that means for businesses. There is a growing demand for organisations to provide transparency on their commitment to sustainability and disclosure of the non-financial impacts of their business activities. While we often hear about the environmental side of ESG, the term is also used to describe a business’ social and governance frameworks.

So, what does this all mean, and who is responsible for making sure reporting requirements are met?

Welcome John and Himi!

Himashini Weeraratne

Thank you.

John Askham

Thank you.

Rebecca Archer

Okay, so, first of all, can you explain what ESG actually is and why these regulations are part of the accounting remit?

John Askham

Sure, thanks Rebecca.

So, I think it's fair to say ESG, which obviously stands for Environmental, Social, and Governance, is obviously a pretty hot topic at the moment. People may not see the link to accounting as immediately obvious, and as accountants, really, we see ESG as an umbrella term that covers a group of topics that people should consider when looking at the true value of a company. And so that means we need to take into account lots of non-financial information. So, what are the company's carbon emissions? What are its commitments to social issues, to gender diversity, to good governance? So, all things that have a real impact on its value but aren't typically captured on a normal financial balance sheet.

And so, as accountants, we need to find ways of measuring and reporting that non-financial information with the same level of rigor that we typically have done for financial information. The problem with that, though, is that there's never really been a standardised framework to do that under. There's no standard way or there hasn't been a standard way of measuring some of those factors. There are internationally recognised and accepted accounting standards, but only very recently have there been equivalent sustainability reporting standards that cover those non-financial factors that I mentioned.

And so, because of that, until now, ESG reporting has usually been voluntary, not subject to independent assurance like financial information, and not always comparable between companies. But companies are waking up to the fact that they have to now take this seriously to protect their brand, attract talent, and basically avoid reputational damage that might come from not taking it seriously.

And so, I guess lots of businesses are already doing lots of things that would typically fall under the ESG banner, but they just haven't always thought about it in that structured way.

Himashini Weeraratne

To add to that, ESG landscape with this range of definitions and regulations can mean many different things to companies as well. As John mentioned, as accountants, we are right in the midst of the information that is data, processes, and controls where we are able to easily gather the information or data and assess risk. But we also have the tools information to benchmark, and also have the understanding of the design of strong processes as well as controls to provide these types of assurance. So, it's really important to develop the core understanding of ESG as a concept and why it matters.

Rebecca Archer

So, we understand of course that ESG covers, as you mentioned, environment, social and governance aspects, but Himi, where exactly does tax fit in?

Himashini Weeraratne

ESG and tax are so closely aligned. Understanding how tax can really help you achieve your ESG goals, which will really benefit your organisation. On one hand, tax can be seen as a value-add bolt-on, meaning that the involvement of tax upfront in the overall ESG strategy can help to minimise the return on ESG investment, or to reduce the tax burden of the organisation's activities. On the other hand, tax can also be seen as a key driver of business change.

Governments often use tax to drive changes in their behaviours. Now for example, the recent uptick in environmental taxes, such as their Renewable Energy Credit Scheme, is a really good example of that. Now, transparency and good corporate governance, which John was talking about earlier, is obviously within the ethos of ESG. A really good example in Australia is the introduction of tax risk governance, which speaks to the 'g' of the ESG.

Being transparent about paying the right amount of tax is also critical element of the business's social contribution, which is part of the ‘s’ of the ESG. As you very well know, it is an important aspect of what we anyway do, that is compliance with tax law and filing of tax returns, paying the right amount of taxes. This is a critical importance of governance that firms of all sizes already do. So, it's important to get involved and add value to the ESG agenda through tax. Tax therefore should be seen as a value driver, not just a cost centre.

Rebecca Archer

And so, what are the specific regulations and frameworks, I suppose, that businesses should be across?

John Askham

The International Sustainability Standards Board is a new body that's recently released some climate related standards that, if adopted as currently proposed in Australia, will essentially mean that all companies that currently produce financial reports and lodge those financial reports with ASIC, the corporate regulator, will at some point in the next few years also have to prepare sustainability and climate related information in those reports.

So, it's really impossible to understate how significant that is going to be for some companies that haven't looked at this before. There's a whole range of information, both qualitative and quantitative about the sustainability related risks and opportunities that those businesses face. Some of those disclosures include measuring carbon emissions, which is something that accountants and a lot of companies just won't have done before and won't have any experience in. They're also going to have to predict how the business will be impacted financially by various climate change scenarios. So, if global temperatures increase 1.5 degrees, 2 degrees, or stay the same, what are the financial impacts on the business? Some of that scenario modeling is really hard and really new territory for accountants and for smaller companies in particular.

Himashini Weeraratne

To add to that, there is a lot out there, but I will only talk to a few. Frameworks for ESG reporting also continue to be developed by standard regulators as well. The EU's Green Taxonomy, for example, is a classification system designed to provide clarity for investors seeking to gauge the environmental sustainability of various economic activities.

In addition to that, there's the EU CSRD Reporting, which is the Corporate Sustainability Reporting Directive requiring companies to report on the impact of corporate activities on the environment and society, which requires the audit and assurance of reported information.

Now from a tax overlay on it and an ‘s’ and ‘g’ point of view, they that focus on transparency and paying the right amount of tax. For example, the OECD BEPS program focusing on multinationals to pay the right amount of tax in each jurisdiction. There are now 130 countries which have signed up to implement these rules – Australia have been obviously one of them.

As we know, tax governance is not necessarily a new concept. It's been there for a long time and it's continuing to evolve with cha It's been there for a long time and it's continuing to evolve with changes in legislation having a focus on the importance of data, process and controls. To add to that, there is a justified trust system, which is happening right now in Australia, which is an OECD concept, which makes this assessment even more important. This is just a cream at the top and the ESG reporting landscape, you have to remember, is ever evolving and it's important to be across it.

Rebecca Archer

So how does a business go about building an ESG report? Where would they start?

John Askham

It's a great question because the critical starting point that a lot of companies miss is actually identifying what the top five or six material topics are. So, do stakeholders care more about climate change reporting, or commitment to local communities and commitment to gender diversity? They may all be material topics, but the first step in reporting is to identify that list of topics, rank them, and then identify a reporting framework that has prescriptive disclosures under each of those topics to allow some measurement and some real data to be gathered and structured in an appropriate way.

And so, I think starting at that point really makes sure that the report covers the right topics, is underpinned by data that's verifiable and avoids the company being exposed to the risk of greenwashing and other concerns that I'll talk about in a second. The responsibility for that typically falls with a finance team because they're generally seen as having the experience and skills in managing lots of data, putting robust internal control frameworks around that data, and really telling stories about that data.

So, it's all about building repeatable robust processes to get that data and have it audited in the same way as financial information.

Rebecca Archer

And what should companies and businesses be aware of when it comes to ESG reporting? What are the things that they should really have on their radar?

John Askham

One of the key things that should be on everyone's radar is the risk of being accused of greenwashing, which is a real focus of ASIC and other regulators at the moment. ASIC, in particular, have been looking very closely at companies' disclosures around climate change and not just in financial reports, but also in advertising and in some cases Facebook posts and social media language around vague and unsubstantiated claims like we're green or we produce less waste than our competitors.

Those are quite vague statements and if they're not backed up by sort of verifiable data, ASIC have been finding and publicly naming companies that don't have that. So, I think company directors in particular need to be aware of that risk, but can manage that risk by only making claims that are supported by robust process and have the data behind them.

Rebecca Archer

I wonder about your opinion on who should really care the most about ESG reporting. I mean, do Boards play a pivotal role in ensuring that their company is meeting ESG standards?

Himashini Weeraratne

Boards actually do and should. ESG fundamentally means being a responsible corporate citizen, and I would like to focus on the ‘g’ at this point, which is governance, of course, and governance always, and the tone of the governance begins at the top, which forms significant part of overall tax risk management and compliance strategy.

Tax governance plays a vital role in helping transparency and good corporate governance. The aim was to uplift business strategies from back office to become a key responsibility of the Directors and the management. So together the management and the Board must show that the organisation has an effective taxes management and governance framework in place.

A transparent tax policy can be a strong tool for companies to demonstrate their wider ESG contribution, and also build on public and stakeholder trust. Put it simply, having a poor relationship with the tax authorities, especially one which gives a negative result, can significantly affect achieving your overall ESG goal or impact on the reputation as well as the Board.

Now, I would like to add on what John was talking about earlier – why should companies and businesses be aware of when it comes to ESG reporting? Now, Boards of many companies are now starting to think through what disclosures might be beneficial to users of financial statements to increase transparency around the company's tax footprint, as well as contribution to the global tax base. For example, this might include total tax paid by the significant jurisdictions, effective tax rates paid by each jurisdiction, or cash tax paid by each jurisdiction.

So, there is an ever-increasing governance rules and reporting requirements that the Boards of businesses need to be aware of.

John Askham

And I think just to add to that, I agree that Boards certainly do play a pivotal role, but really, anyone who cares about a company, or its values, should also care about their ESG reporting. Companies, employees, customers, regulators – they're all considered stakeholders when it comes to ESG, and engaging with that stakeholder group is a really critical first step as we discussed before.

Rebecca Archer

And just sticking with that theme, what consumer and broader trends are we actually seeing when it comes to ESG right now?

Himashini Weeraratne

To add to John's point very broadly, there are a couple of trends that we have noticed. Number one, Millennials now represent the largest component of consumer purchasing power and are in the position to influence corporate purchasing decisions as well.

Majority of Millennials won't work for companies that doesn't have a strong corporate social responsibility value. Gen Z, in particular, believe companies have an obligation to solve environmental and social problems – like, they have a belief that companies that focus on creating value for all stakeholders are better positioned for favorable long-term returns.

Mounting investor pressures obviously something everyone's talking about, especially focusing on sustainability. Institutional investors and private equity investors are now seeing ESG as being the most critical in involving their investment decisions. Some institutional investors have started excluding companies from their selection criteria who they perceive to be noncompliant from an ESG and tax transparency point of view.

And now I saw in recent research where it said that Millennials are said to inherit approximately 30 trillion over the next few decades. Given the ESG trends I spoke to just now, from an ESG point of view, these important trends will clearly have an impact on our ESG agenda going forward.

Rebecca Archer

We're hearing a lot about the shortage of workers, the inability to be able to secure and hold on to and really retain good workers. I would imagine that having a very strong ESG profile is going to be in your favour if you're trying to recruit that generation of workers, particularly, as you said Himi, the Millennials and Generation z.

John Askham

It's absolutely right that ESG is a critical thing that particularly younger employees have at the front of mind when they're looking for an employer. Certainly, graduates and other prospective employees that I'm interviewing are all asking about Grant Thornton's own commitments to ESG, and we're actually going through our own internal exercise now of how do we do a bit of a stock count of the great things that we're already doing and make sure that our reporting reflects that.

By way of example, we've recently moved to – initially on a trial – to a nine-day fortnight. So, that not only has delivered the benefits to our people that we were looking for, but it's actually improving our brand in the market, and helping us attract talent that we perhaps otherwise wouldn't. And I think that goes for all companies waking up to the fact that it really is key to attract people, particularly in the social and governance, but also climate change. At the moment, a company's commitment to social issues is a really important thing and it means a lot to people when they're looking for somewhere to work.

Himashini Weeraratne

I couldn't have put it in a better way.

Rebecca Archer

And just on this same theme, when we look at a company's record when it comes to paying their taxes and doing the right thing, those generations that we're talking about, the Millennials and Generation z, are characterized as having a very strong social justice streak.

So, I would imagine that companies that are doing the right thing and have got a very clean, admirable record when it comes to taxation, are also going to be far more attractive to future employees from those generations.

Himashini Weeraratne

Absolutely, because what they see it as, rather than a tick in a box, they just want to see that they are sticking to the commitments, as John alluded to before, in terms of if they've paid the right amount of taxes – it’s a vicious cycle. These taxes come back into the economy, the money that is actually paid so that the social ethos of that economy can be taken care of as well.

So, the Millennials, the Gen Z, they are actually thinking about, in a more holistic point of view, what it means for the economy rather than just the company actually paying the right amount of tax. It's a holistic point of view rather than what they're focusing on.

Rebecca Archer

I certainly know that maybe 10,15 even 20 years ago, a lot was being written in the media and I guess speculated about in terms of where multinational companies would move headquarters to try to secure the best possible tax rate.

Are we seeing less of that happening now that there is such a focus on ESG? Is it the case that businesses are better off not looking for those sorts of havens, I suppose, for want of a better word, in order to boost their profile as someone with a strong ESG principle?

Himashini Weeraratne

I totally agree, because the focus is not just the ESG point of view and all the tax authorities in different jurisdictions are now talking to each other to ensure that the Global Governance Framework actually plays an important and a significant role here as well.

So, they're not focusing on one jurisdiction, but all the jurisdictions are talking to each other in terms of implementing a more robust framework so that the correct taxes are paid in each jurisdiction – so that type of structuring I see will be avoided in the future going forward.

John Askham

And I think just to add to that, it's a really good example of an issue where the natural reaction might be to see ESG and financial goals as being in conflict with each other. So how can you have good ESG strategic responses, but also long-term financial returns?

I think the answer to that is to really not see ESG as a compliance exercise – some reporting to kind of make the issue go away and actually integrating the two. Once you've worked out what your material ESG topics are and formulated your response, if you integrate those properly into your core business plan, will actually improve financial returns in the long run because of the things that we've talked about – so attracting talent, also attracting customers, so customers, consumers, choosing ESG positive companies, and then avoiding the compliance issues that come with not doing that further down the track. So better regulatory compliance and avoiding the sort of brand damage that comes from governance failures actually improves financial returns in the long run.

So definitely would encourage people to not see them as in conflict with each other.

Rebecca Archer

That kind of cultural change that you're talking about, where it becomes not just a box to tick, but part of the way that people behave in the business and the expectations and values of that particular organisation, it can take a while to make that change and really see it come to fruition.

So, I'm curious what you think the outlook might be for ESG, particularly here in Australia, in terms of businesses that maybe are lagging a bit or haven't quite gotten on to figure out how to improve their profile and really start to live up to the expectations that they have from shareholders or employees or just the general public?

John Askham

The reality is it's not going away, it's not a fad that there will be a backlash against and will disappear. I think companies that haven't got on board to this point will either have to because of the mandatory reporting requirements or because of the financial impact on the business of not doing it. The reality is, Australia, until recently, was probably behind the rest of the world in terms of reporting. The US and the EU have driven that and we're now rapidly catching up. So, the reality is companies will be left behind if they don't.

Himashini Weeraratne

To add to that – so regardless of jurisdiction or size of your organisation, there are some really basic principles that you can stand in good stead, but from an ESG perspective specifically, as you said, it shouldn't be just a tick in the box, but because there are tangible benefits from having a good ESG ethos, it’s good to be embedded in your organisation at the forefront as part of your policy and your good governance framework. That's how I see it.

Rebecca Archer

So, it's certainly not something that's going away, it's something that really is going to affect businesses across the board, regardless of industry. What would you say to a perhaps small business that might be listening to this podcast and thinking this is something that we really need to address and take care of as a matter of urgency? What should they do? How can they get help?

John Askham

Really, to speak from a reporting point of view, it doesn't have to be a huge exercise and a very expensive exercise. It can really be as simple as talking to your stakeholders.

So, surveying some customers, surveying some employees, find out what those topics are that they care about, and then look to structure a report around those issues. So that might not be extensive carbon emissions, and it might not be climate change scenario analysis at this point in time.

It might be, we want to hear more about what you do in the local community, or we want to know what percentage of your employees come from a particular community and getting some data and reporting on that. And that is an ESG topic that is important to people.

So, it doesn't have to be this huge exercise. I think the climate reporting is a big deal, but it doesn't have to be the starting point. I think you can start smaller and work up to that.

Himashini Weeraratne

From a tax point of view, as I said earlier, we're already doing it. It's just having that sort of reporting and the framework in place which, as John alluded to, it doesn't have to be the Rolls Royce, but it's the simplest of fashion. Have the recording and the reporting done properly, and also making sure that when you are abiding by this, to have that tax office in mind where they have their guiding principles, just making sure that you align yourselves with the expectation of the tax authorities as well.

Rebecca Archer

And just before we wrap up, I'm wondering, is there anything else you'd like to cover that we haven't yet talked about?

John Askham

The only other point I would make is that ESG isn't a new topic. A lot of this has been around for a long time. It's just not perhaps been badged in this way. Some of the newer aspects to it, like the climate reporting, are new for everybody, so everybody's learning. We're learning as well. I think anybody now that claims to be an expert in the new standards probably hasn't had long enough because they've only been around for literally a few weeks for the Australian proposals. So, we don't have to start, as Himi said, we don't have to start at the Rolls Royce. We can start small and work our way up to it.

Rebecca Archer

John and Himi, thank you so much for your time today. If people are wanting to get in touch with you who are listening and are interested in hearing a bit more or learning more specifically about what it is that you do and how you might be able to help them, how should they find you?

John Askham

My details are on the Grant Thornton website. I'm very happy to connect with people on LinkedIn, or to reach out if anybody would like to send me a message through there.

Himashini Weeraratne

And we are your sounding board. We are not here to sort of sell a product. We are here to help you in that journey and partner with you to ensure that you are future assured in terms of ESG as a concept.

Rebecca Archer

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