Climate accountability reaches the CFO suite

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It started with intangibles.

I spent about a decade of my life writing about corporate accounting before I began focusing on sustainability and sustainable finance. In between all the conversations on accounting for stock options and leases, one megatrend in corporate accounting beat them all: the rise of intangible assets.

In the 1970s, when the U.S. accounting rule-making body, the Financial Accounting Standards Board, was formed, tangible assets such as cash, buildings and inventory made up 83 percent of corporate balance sheets in the S&P 500. Just 17 percent of the value stemmed from intangible assets, such as patents, trademarks, brands, software and customer lists.

Somewhat rapidly, everything switched. By 1995, almost 70 percent of corporate assets were considered intangibles. In 2020, fully 90 percent of the value of S&P 500 companies stemmed from intangibles.

In 2020, fully 90% of the value of S&P 500 companies stemmed from intangibles.

That’s the megatrend underpinning the rise of ESG, and the one that has brought it to the forefront for chief financial officers. Corporate reputation is a bigger asset than a plant or a headquarters and a company today means something totally different than it meant 50 years ago. The task of a company in the 1970s was to manage its plants, labor and equipment to get shareholder returns, but today companies get much more value from managing their reputation, brands and data.

Those intangibles are much more sensitive to environmental and social risks, which makes ESG issues that much more important for both companies and shareholders. And the choices companies make about what they disclose, invest in and finance have a bigger impact on the future direction of the world. That’s increasingly brought CFOs and the sustainability goals together. And in just the past few years, it’s been elevated to something companies are financially accountable for.

The U.S. Securities and Exchange Commission and the International Financial Reporting Standards Foundation this year said they want to start seeing better disclosure from companies on climate change. Importantly, the SEC’s enforcement unit’s new climate and ESG task force likely will add more clarity to corporate climate and ESG disclosures. On S&P 500 earnings calls in the fourth quarter, 28 companies discussed climate change and energy policy, outpacing the 19 that mentioned COVID-19 policy, according to Factset.

At the same time, the financial markets are creatively building sustainability incentives into loans, debt and financial instruments at an unprecedented rate — an effort to reduce the intangible risks lurking on their own balance sheets.

Just the beginning

Before the recent rise of sustainability-linked loans, precious few mechanisms in the market could truly hold companies accountable for reaching their sustainability goals. A shareholder proposal, even if it gets approved, often led to reports on how companies were performing — but not necessarily to better performance. The market for these loans, which specifically tie funding to achieving sustainability or environmental goals, is likely to grow twentyfold this year, representing up to $150 billion in financing, JPMorgan said.

A better rate on corporate debt when interest rates already are low is a modest incentive, but banks are betting these loans will lead to better ESG performance because missing out on a better deal for your cost of capital can be pretty frustrating for CFOs.

I plan to unpack this growing market in my plenary conversation next week at GreenFin 21, with Enel CFO Alberto De Paoli, AB InBev CFO Fernando Tennenbaum and Pimco CIO Scott Mather. The two corporates have issued billions of dollars of debt with sustainability-linked guarantees and requirements in the past few years, and inquiring minds want to know how much of an impact these loans are having on corporate finance.

For CFOs, the multibillion-dollar shift to sustainable debt is really just the beginning. “As custodians of over $14 trillion a year in corporate investment, CFOS are a driving force for achievement of the SDGs,” said Marie Morice, head of sustainable finance at the United Nations Global Compact. “It is increasingly crucial for CFOs to help their companies shape credible, SDG-aligned corporate sustainability strategies.”

The corporate spending pool is actually enough to make a dent in reaching the Sustainable Development Goals.

Still, three out of four CEOs and CFOs say their company is underprepared for climate change. And to be honest, there are so many unknowns in climate change that it’s hard to think of many companies that truly would make it through a prepared checklist today:

(✓) Scenario plans

(✓) Independent energy supply

(✓) Negative emissions

(✓) Supply-chain contingencies

(✓) Critical business locations protected from flood, heat, fire, storms

In a world that is rapidly shifting, when corporate value is more ephemeral than ever before, it’s definitely worth trying.

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