AFM and Sustainable Finance

Monday, February 8, 2021
by Jessica S., SAF student

In my past 4 years in AFM, terms such as environmental, social and corporate governance (ESG) and corporate social responsibility (CSR) have increased exponentially in importance and frequency when discussing any business. Given my past co-op work terms in finance, accounting, and most recently a not-for-profit organization (NPO), I was interested in how this renewed focus on sustainability would play out as we as a society continue to challenge the responsibilities and duties that a corporation should undertake. That’s why I choose ENBUS 310, Introduction to Sustainable Finance, as one of my courses this term. It’s been less than a month, and already I am excited by the connections and opportunities that arise by marrying my AFM knowledge with new learnings on sustainability. There are three aspects I want to dive deeper into in this blog post – 1) the shortcomings of financial / managerial accounting, 2) emerging frameworks for ESG reporting, and 3) the business case for sustainability.

jessica
One of the most valuable skills that we learn early in AFM is how to read financial statements to determine the financial health of a company. We learn the building blocks, like debits, credits, individual accounts, and professional judgement, which unlock our understanding of key ratios and metrics like ROI (return on investment), ROA (return on assets), EBITDA (earnings before interest, taxes, depreciation and amortization), IRR (internal rate of return), etc. However, one of the main criticisms with financial accounting is that it doesn’t account for impacts to the external environment or external costs, whether these are direct or indirect. Accounting standards often require disclosure for environmental remediation liabilities and asset retirement obligations, but what about the costs that don’t result in monetary liability? There are no standards or requirements for companies to disclose environmental/social/financial metrics such as CO2 emissions per sales in dollars, energy costs per product unit, or employee benefits per employee, just to name a few.

This brings me to my next point about emerging guidance and universal frameworks for ESG-centric reporting. We’ve been learning about the GRI Sustainability Reporting Standards in class, which aim to “provide a balanced and reasonable representation of an organization’s positive and negative contributions towards the goal of sustainable development” (GRI Standards, 2020, pg. 6) and it’s a step in the right direction for providing a common language for ESG disclosure; basically, IFRS (international financial reporting standards)/ASPE (accounting standards for private enterprises)/GAAP (generally accepted accounting principles) for ESG reporting. However, we aren’t yet close to establishing sustainability reporting as a mandatory requirement for companies. A company can claim that they referenced the GRI Standards even if they only used parts of it. With the influx of companies going carbon-neutral or carbon-negative (e.g., Microsoft, IKEA, General Motors), being environmentally friendly is the hot new trend for CEOs. But how do we verify and measure their carbon neutrality and disclosures if we don’t have a commonly accepted framework for reporting?

Finally, at the centre of this topic: Can you do well by doing good? Well, studies are mixed on this actually. There have been many research papers published trying to determine a causal link between environmental sustainability and the overall performance of a company; a paper by Friede et al. compiled over 2,000 studies exploring the connection between ESG and financial performance to find that over 60% reported positive findings, almost 30% reported mixed findings, and under 10% reported negative findings. But the underlying business case remains that investments into sustainability can and do drive growth, productivity, and risk management. I think that companies who don’t provide sustainability reporting to stakeholders may find themselves constrained in terms of capital resources, especially with commitments like the Net Zero Asset Managers Initiative that has seen 30 signatories, accounting for $9tn in assets under management thus far. According to Corporate Knights, the world’s top 100 sustainable companies perform significantly better than its benchmark, with a 263% return compared to the MSCI ACWI’s 220% total return, suggesting that these asset managers are indeed doing well by doing good.

This is just the tip of the iceberg when it comes to synergies between accounting/finance and sustainability knowledge; we’re likely to see many new industries and professions pop up as a result of this push for environmental responsibility, from carbon neutrality as a service to sustainability auditing. I’m excited to continue learning about sustainable finance, leveraging my accounting and finance background to harness a deeper understanding that will pay dividends for my career.