Three Stages of Integration: How The CFO Can Drive Sustainability Transformation

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Jeff Waller Senior Director, Head of Sustainable Finance
Adrien Couton Director, Sustainability Solutions - Americas
Sustainability Strategy
Sustainability Transformation
Green Finance
Sustainable Finance

As corporate sustainability ambitions increase and investors demand increased accountability, companies must shift the traditional responsibility and activities of the CFO and broader finance function.

Since 2005, companies disclosing to CDP have increased carbon reduction targets threefold, from an average reduction of two percent per year to six percent per year today. Timelines to achieve these goals have also narrowed, instead of setting goals 25 years in the future, companies now state an average duration of just eight years to meet their goals. The ambition didn’t stop there. Companies are now looking beyond their own operations to include the entire value chain, as we’ve seen in recent announcements from companies like Apple, BMW, Microsoft, and UPS.

This shift has persisted even through the COVID-19 pandemic, with companies and their stakeholders doubling down on sustainable action. Six months after Larry Fink’s cautionary, climate-centered letter to CEOs in January of 2020, BlackRock took decisive voting action against 53 companies over climate concerns and placed 191 companies “on watch” for insufficient progress on climate considerations.

Yet even with the increased ambition and accountability, few companies are on track. The question is, why? When reviewing our work with Fortune 500 companies across the globe, we see a common hurdle: Many leaders have bold targets, but when it comes time to implement, they struggle to establish the right capital allocation models and governance structures needed to match their strategic intent.

The finance department lies squarely at the heart of this challenge. As goals become more ambitious and investors demand increasing accountability, there must be a shift in the traditional responsibility and activities of the Chief Financial Officer and the broader finance function.

In this article, we’ll first examine the traditional structures that limit finance’s role in sustainability transformation. Second, we’ll focus on how organizations can evolve their financial activities according to the proposed Three Stages of Sustainability Integration Framework.

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Four Barriers Limiting Progress to Sustainability Transformation

To unlock progress to sustainability transformation at the necessary speed and scale of today’s ambitious targets, the finance function needs to share accountability for achieving these goals. Drawing on our experience working with global multi-national organizations, we see four main barriers, spanning strategic, organizational, and cultural dimensions, that slow the progress of sustainability transformation in the finance function.

1. Businesses are not integrating environmental factors, such as climate change and water scarcity, into risk management strategy.

Historically, sustainability issues were tackled within the CSO function, receiving only occasional attention from financial leadership. This reality is quickly evolving. In Davos this year, 3,000 global leaders convened to discuss their roles as stakeholders in a sustainable world. For the first time, climate change contributed to all five of the top global risks in The World Economic Forum’s Global Risk Report. But for many companies, sustainability still is not considered a core competitiveness issue, and fails to receive the financial and human capital necessary to tackle a challenge of its size.

2. Reporting systems are not in place to capture the data needed to account for environmental sustainability in capital allocation decisions.

Even with improved access to environmental data, companies often lack adequate mechanisms to value the benefits of managing environmental sustainability. This is critical to managing exposure to energy price volatility, water scarcity risks, water and waste regulations, and more generally environmental footprints in their supply chains. A long-term lens, captured in adequate pricing mechanisms, is essential to making the right decisions.

3. Existing processes and metrics are not designed to foster engagement between sustainability and finance functions.

Sustainability teams are often brought into project planning too late to influence project design and cannot make an effective case to financial decision makers. Conversely, the benefits of sustainability strategies are not readily captured in the financial criteria typically used, which leads finance teams to overlook meaningful short- and long-term financial benefits of sustainability strategies, such as enhanced reputation and reduced climate risk. Without having shared, quantifiable success metrics, such as reduced carbon emissions, teams lack the incentive to innovate and collaborate across departments.

4. Businesses are slow to embrace new financing mechanisms.

For years, corporations have cited lack of available capital as the primary barrier that slows or halts the implementation of critical sustainability projects. As a result, a myriad of service models, debt instruments, and new forms of capital have emerged to lessen the financial burden, share risks, shift the needs for upfront capital, and even reconsider the importance of asset ownership.

While there’s broad awareness of sustainable finance measures like sustainability-linked loans or internal carbon pricing, knowing when and how best to implement them remains a challenge.

By developing a strong understanding of the benefits and drawbacks of each potential lever, finance leaders have an arsenal of tools at the ready to minimize the costs and risks associated with sustainability projects.

When these measures are successfully sequenced across the portfolio of necessary investments, organizations can successfully capture both the environmental and financial benefits at stake.

Three Stages of Integration: A Framework to Align Finance Activities to Sustainability Ambition

The rise in increasingly ambitious sustainability goals clearly demonstrates that corporate leaders see value in climate action—both to address stakeholder demands and to mitigate near- and long-term risks. They see opportunity in implementing new technologies and business models, particularly if they seize opportunities early.

The finance team plays a critical role in realizing this value, but to do so, they must be fully integrated into—and feel a sense of accountability for—the company’s sustainability transformation. In our work with global organizations, we’ve commonly seen three stages of evolution in this integration process: opportunistic, thematic, and holistic. Progression through these integration stages is essential for companies to achieve their sustainability goals on the necessary timeline and unlock the direct and indirect benefits.

To place themselves along this spectrum, finance leaders should start by considering the following questions:

  • Investment decisions. In what ways do our current investment criteria inhibit our ability to achieve our sustainability goals? How can we reframe these criteria to incorporate holistic and long-term value?
  • Asset ownership. Do we want to own and operate non-core energy or water assets? What business models might help us meet our sustainability goals while limiting our risk exposure?
  • Climate risks. Do we have a solid understanding of what climate-related risks our company is exposed to? Have we quantified the financial impacts of those risks?
  • Internalizing GHG emissions. What mechanisms can we introduce to recognize the cost of carbon in our company’s activities?
  • Sustainable finance. How can our company’s sustainability plans be leveraged in our everyday corporate finance activities?

Use the framework below to assess the current maturity of your company’s finance function and set goals to track progress to ensure that the finance team is keeping pace with the company’s overall sustainability objectives.

Evolving Finance to Enable Sustainable Outcomes: Three Stages of Integration

To provide additional context for the Stages of Integration, we’ve leveraged insights from our decades of experience working with large multi-national corporations to offer the following scenarios.

Stage 1: Opportunistic

Stage 1 details

At Company A, the leadership team understands the high-level benefits of sustainability programs and releases a general environmental, social, and governance (ESG) policy on an annual basis, overseen by a newly hired corporate sustainability director. Day-to-day operations and broader corporate strategy continue to be driven by short-term profitability goals focused on efficiency. Company A has not committed to any measurable sustainability targets. Instead, sustainability initiatives are evaluated on an ad-hoc basis, assuming they provide clear cost savings.

In support of its efforts to minimize costs and long-term liabilities, the finance group has set a narrow constraint for its operators: any proposed project should pay itself back in less than two years, regardless of whatever other values it delivers. As projects are presented, the finance team helps operators verify project costs to determine whether Company A has budget available.

One of its facilities managers recommends that they replace the building's incandescent and halogen bulbs with LEDs. The costs are relatively low and the whole replacement can be done with minimal business disruption over a weekend. The bulbs each cost $10 to replace but generate $20/yr/bulb in savings, paying for themselves in just six months. The finance organization approves the change and funds the project using cash-on-hand or tapping into its working capital facilities.

Though Company A sees a 70% reduction in energy consumed by lighting, lighting is a relatively small proportion of its overall operating expenses and carbon emissions. In total, the projects that meet the thresholds set by finance make a positive, yet minimal, overall impact.

Stage 2: Thematic

Stage 2 details

Company B has communicated sustainability progress for the past five years. This year, Company B has introduced a specific, quantifiable goal: sourcing 50% of its global energy consumption from renewable energy sources by 2025.

Company B recognizes the significant financing effort required to execute this multi-year initiative and has involved the CFO in early-stage conversations as they explore on- and off-site renewable generation options with developers. One of the CFO’s first priorities is to evaluate the suitability of power purchase agreements (PPAs) to finance the up-front capital costs for the expected portfolio of projects.

Company B has not executed a PPA before, so there are a number of dimensions for the CFO to consider, including:

  • Asset ownership: Company B typically owns its assets, but, under PPA structures, they recognize that the generating assets will be owned by the developer.
  • Contract length: Unlike most contracts that Company B signs, the typical PPA tenor is considerably longer, at 12-20 years.
  • Price: Company B must consider the pros and cons of locking in a fixed price for electricity (e.g. electricity tariff) over the length of the contract.
  • Accounting treatment: The CFO consults with the company’s advisors to evaluate relevant accounting issues, including off-balance sheet treatment.

Now that the company has committed to long-term sustainability goals, the CFO is motivated to consider sustainable finance options that had not been feasible when the company’s sustainability goals were more opportunistic and less programmatic. In particular, the CFO evaluates use-of-proceeds instruments like green loans and green bonds. These options present an attractive way to raise capital now that the company is contributing to the creation of new sources of green energy.

The CFO found the process leading up to the execution of the company’s first PPA to be quite time-consuming. Moreover, navigating the complexities of this unfamiliar contractual arrangement was often frustrating. Still, that initial investment in analysis proved worthwhile as the company leverages that hard-earned experience to sign additional PPAs.

Moreover, the company’s expanded decarbonization goals create a rationale for the CFO to seriously investigate sustainable finance options for the first time, expanding the company’s bank and investor network, and laying the foundation to finance a broader range of decarbonization measures in the future.

Stage 3: Holistic

Stage 3 details

Company C has developed a comprehensive understanding of the importance of sustainability to the success of their organization and sees sustainability as embedded in the core of their business. They have set science-based decarbonization targets, data-driven goals in support of material social issues, a strong governance structure, and designed a roadmap to execute a strategic portfolio of projects. The CFO’s performance, like all members of the executive team, is measured against the success of these company-wide initiatives and plays a proactive role in driving progress.

The CFO has shifted expectations, processes, and tools to best align her team’s performance to corporate sustainability outcomes. Finance leads the conversation for sustainability as a source of value creation:

  • Expand the value equation: The finance function has built a matrix of material ways in which their organization will benefit from decarbonization efforts. Beyond the savings in operational expenses, they work closely with sales and marketing to measure brand value and customer retention. They collaborate to predict the impact of competitive differentiation, new business models, and revenue streams. When sustainability initiatives are communicated in annual reports, they are quantified and featured prominently as innovative projects key to the commercial objectives of the organization.
  • Adopt alternative asset ownership strategies: The finance team’s role extends beyond interfacing with internal functions to structure engagements with third parties to manage non-core assets with significant decarbonization potential. The finance team has developed a portfolio of partnership agreements structured to minimize risks associated with technology, performance, and maintenance needs.

  • Embed climate-related risk factors into enterprise risk activities: Working closely with operations, energy, and procurement teams, the finance team evaluates the financial impact of a range of climate scenarios. Following the risk assessment, the finance team identifies synergistic sustainability initiatives that advance both economic and environmental outcomes and preserve the long-term enterprise value of the business and its assets.
  • Introduce internal carbon valuation measures: The finance function calculates and institutes an internal carbon price and budget. With increased transparency, internal teams independently look for emissions reduction opportunities and new creative solutions emerge, such as workspace redesign, optimized shipping schedules, and carbon credit trading. The tool is also leveraged to help quantify and mitigate future risks and opportunities associated with changes in climate policy, thereby protecting the downsides that might be created in such scenarios.

Overall, Company C’s finance team leverages its broad understanding of the company to champion sustainability as a means to create incremental value and build sophisticated mechanisms across the organization to ensure that value is realized. In a two-way proposition, it can achieve its more ambitious goals with greater ease and, conversely, also ensures it captures the full commercial and risk mitigation benefits from these programs.

Driving change through CFO accountability

We are entering a new chapter of corporate sustainability. As investors hold companies increasingly accountable, business leaders can no longer rest on the laurels of their ambitious targets but must now deliver on the future they’ve promised.

With rising accountability comes increasing guidance. New principles are emerging as a result of the United Nations CFO Taskforce, which will provide new guidance for finance leaders to adopt changes that drive meaningful progress toward sustainable development.

CFOs should initiate a dialogue with their peers and sustainability experts to share ideas to best adapt these principles to meet the needs of their operations.

The world is changing quickly. As companies navigate this new normal together, it will be those that successfully structure their investments and prepare for risks that unlock the true value at stake.

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