Episode 054: An Intro to Environmental, Social and Governance (ESG) Reporting for Savvy Businesses

(00:00:00) Commentators: Hey, I’m Paul Perry. I’m Kim Hartsock and you are listening to The Wrap, a Warren Averett podcast for business leaders, designed to help you access vital business information and trends when you need it. So, you can listen, learn and then get on with your day. Now, let’s get down to business.

(00:00:17) Kim Hartsock: Hi, everyone, and welcome to The Wrap!

(00:00:23) Paul Perry: Today, we are talking about ESG and sustainability for businesses. What that means and what is to come in the future and what do people need to be thinking about?

Today, we have a very special guest with us, Barry Melancon, who is the CEO of the AICPA. That’s both the American Institute of CPAs, as well as the Association of International Certified Professional Accountants. I think I got that right. So welcome, Barry. We’re glad to have you with us.

(00:00:49) Barry Melancon: Paul and Kim, it’s great to be with both of you. And it’s a very timely topic. And over the years, I’ve worked very closely with the firm, and I’m just really happy to be with you today.

(00:01:03) Kim Hartsock: Thank you, Barry, for being with us. We’ll let our listeners know that you’re actually joining us from London today, and we really appreciate you taking time to be with us.

(00:01:11) Barry Melancon: Yeah. I was in a series of meetings in London this week. And you may not find it surprising given our topic, but a lot of the meetings had a pretty strong ESG topic associated with.

(00:01:23) Kim Hartsock: So, Barry, you know we have a variety of listeners on our podcast, and some have probably a differing level of understanding of what ESG is.

So, can you just start by giving us some basics of ESG and what that means to business owners and leaders?

(00:01:41) Barry Melancon: Yeah, Kim, glad to do that. So, Environmental, Social and Governance is the ESG. That’s the watch word of the era that has come together, but it’s really broader than those three words in a lot of ways. The reality is, I think we start with the basics. The basics are that entities and corporations around the world are given permission to operate from governments. So, you’re organized in a state, or you’re organized under the laws of the United States in this case, but it’s the same everywhere.

Basically, entities are given permission and there’s a quid pro quo that comes with that. There’s a certain way you have to act, right? You have to pay taxes and you have to file financial information. There’s a certain way that you have to act. And for hundreds of years, it’s been a pretty simple relationship and that relationship is changing pretty dramatically with a lot of external forces today.

Some of the social issues that we’re facing in the world are a lot of concern about the environment, diversity in governance, how you treat employees and how you look at your business models. There are different levels of expectations from what we call a multi-stakeholder group. So, you know, traditionally the stakeholder group of a company was primarily the people who owned it, right?

Either shareholders as a public company or the entrepreneurs in a privately-held company, but in a world of everything social media and communications and travel on a global connected world; that is changing. And the expectations that businesses have to be responsible to is a multi-stakeholder class.

So, it’s investors, but it’s also regulators. It’s employees. It’s other players in your supply chain, either providers or your customer base, it’s the community that you operate in. It’s the expectation of people who work, who are spouses and children of people who work for a company.

So, this notion of multi-stakeholder has expanded. And with that what you’re expected to and how you’re supposed to act is set by three different things. It’s set by market expectations. It’s set in some cases by regulation or legislation. It’s set by standards or standard operating procedures and expectations in this space.

That’s really what’s happening in the world. And what I like to say, and I know, Kim, you and Paul both have heard me say this when we focus on the environmental part, it’s very emotional in this country, right? And there are people listening to this podcast who I can guarantee you believe the most important thing in their lifetimes that’s being addressed is the environmental issue.

There are people totally on the other end of the spectrum that believe it is a made-up issue. The science doesn’t support it. It’s being overblown, whatever words and adjectives you want to put into that environment, I would say is looking at it from a business perspective and the role of really how it is accounted for that doesn’t matter.

The expectations are up. People are expecting things. We’ll talk about this, but measurement, reporting and actually understanding what I would say is: the truth can prove either side, right? Frankly, that’s the beauty of, I think, what’s gelling in society today.

(00:05:31) Paul Perry: I think that’s a really good way to look at it, Barry. We appreciate that idea and that concept from a business perspective, but let’s go a little bit: this really is not a new idea. This is not a new concept of the idea of sustainability. ESG has been around for some time.

You can go back to the series of principles that were created by Exxon after their spill. You can go back to any investment policy that any corporation has, right? If a nonprofit said, “I don’t want to invest in these types of companies, I’m not going to.” They were in essence following the idea or the concept of ESG.

Our daily actions need to coincide with what our values and our cultures are. So, why the hype now? Why are we seeing people either buying into this or really jumping on the bandwagon? But there’s really not a bandwagon because it’s something that is here to stay for a while probably in looking at companies and how they’re valued. Why the hype now?

(00:06:36) Barry Melancon: Actually, in your history points there, I would say the real substantive change actually goes all the way back to 1995. And when it was sort of a general consensus that the information flow of businesses is much broader than just what’s in financial statement or tax returns.

So, that was really the genesis, and it didn’t pick up very quickly, but you’re right. It is picking up. Why now? I think there’s a lot of parts to this. I mean, clearly environment. There’s been a lot of activity that people are concerned about and there’s certainty we’re living in an era in which the environment is changing.

Now we could debate the causes of it, but it’s clearly changing. I think I would say the world is a much more transparent place and so the expectations are really driving it in this multistakeholder notion, right? I mean, you know, social media is a big driver of how much people know.

Employees. You’ve got a new generation of employees who have a different expectation of: what is a company that I’m going to work for? How are they going to act? What’s going to be their role in society? Clearly, you know, we’ve had major social issues in the diversity, equity and inclusion area that has driven a lot of this.

I would say the world has become a much smaller place as a bigger driver of it as well. What a company may be required to do, you know. Almost any size company has some attributes to their business that’s global today.

I mean, you can think about, the impact of channels of distribution or supply chains and how it’s affecting us or how it affects our phones. You know, all of these technological and geographic issues of reliability are just changing the population of people who are watching and asking questions.

That’s a major change. Clearly, then that moves onto the government or regulatory environment that people who get elected have policies that they wish to see and enacted along these lines. And frankly, they’re leading companies that are embracing and improving that decision-making. More diversity and being more attuned to some of these issues actually produces better returns and longer-term value.

That’s that cause and effect that plays out in that.

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(00:09:13) Kim Hartsock: So, we just talked a little bit about the history of where this started, how it’s grown and some significant things that have happened in our world recently that have shifted people’s thinking. But where do you see this going in three, five and 10 years? What do you think the short-term impact will be?

Where do you see this going long term? Talk about this will be integrated within the United States. Even how that interacts slowly with what you just talked about: how every business now has some aspect of their business that is global. You can’t really get away from that even if you consider yourself a small business, right?

(00:10:00) Barry Melancon: Yeah. So, I think where it’s going to go. So, if you want to think about the quid pro quo point that I made, you know, you can think about the government, the public or stakeholders expecting certain things. How does that manifest? That’s really your question, Kim, how does that play out? One way to think about it is just a whole bunch of broad rules that people have to apply or regulations or laws that come about.

There’ll be a lot of rhetoric around that. But that’s really, really hard to execute because what is the trigger to doing that? If we think about it (and this is where our profession comes into play), if you really think about what the most common thing is globally about business information, it’s financial reporting.

Essentially, the standards for financial reporting are the same. They’re not exactly the same globally, but essentially the same standardization has occurred over 60 or 70 years in the accounting space. And it is just commonly accepted that businesses provide financial information as a cost of doing business or a way that they they’re allowed to do business.

So, I actually think it’ll be one step below these sorts of broad-based sematic type of things. It will be delivered through requirements about information flow.

That information flow will be much more about the integrated components, not just financial components. We actually have a term that we call integrated thinking and reporting.

What it means is that there’s six elements to how you run a business. I don’t care if it’s a big business or tiny business. Two of those we’ve traditionally complied with around the world, which are what’s called financial capital and manufacturing capital. It’s the financial resources of the business, but the other four are not things that have been traditionally measured and reported on and they are what we would call natural capital, which the environment that we’re talking about falls into.

Human capital, which you could bring in any CEO and you say, “What’s your most important asset?” They would say, “My people.” Which is a great thing for them to say, but we don’t do a lot to measure and look at that.

Yeah, we have employment laws, but it doesn’t fit into that scope. Human capital is one. Actually, relationship capital; the whole notion of how you function in a supply chain, how you function with customers, how you function with third parties and how you function in your community is a third thing that is a resource of companies today.

That’s a very important element. And the sixth is the notion of intangibles, right? Intangible capitals, which is such a big part of what businesses manage today. So, what I think will happen is actually first in the environment, because I think the environment is leading the charge today. But ultimately in all of those areas over the next decade plus, you’ll see mechanisms in which businesses will report in an integrated thing how they’re managing their businesses along those capitals. For public companies, because public company information is very transparent because you have wide base shareholders, that will be very transparent information like an audited financial statement that’s public today except in all of those areas.

For private companies in which that information is more private. It may be only shared in a more limited scope, maybe to your suppliers who may require that or maybe to employees who want to know who they are working for in that particular space.

Some of the forces that are going to impact that might be… If you are a distributor of someone else’s product, a retailer or you’re a wholesaler or something along those lines, they may be a public company and they may have this notion. (These are called level three type of calculations.)

They may have a need to talk about their entire footprint, which means your footprint is part of their footprint. So that the forces in the channel will drive some of that as well. I think the world is gravitating to the way to get to all of this is through an already situated and effective information flow around finance information that gets added onto because that’s the most effective way to do it.

Instead of us seeing a new infrastructure being built around the globe.

(00:14:57) Kim Hartsock: So, I just want to say that this reiterates, why accounting is such an integral part of our economy. So, young people as they’re going into college and trying to figure out what their career path is… Obviously, I’m a huge fan of being an accountant and having an accounting degree, but I just think it shows that the world will continue to change. And accounting will adapt to that, right?

You’ve got behind your head adapt and thrive, which are two keywords for our industry, but it just shows you that even as you’re talking about environmental, sustainability, social and all these things. The world still revolves around accounting. That continues to be kind of a common language that unites us.

We have a challenge of trying to grow our industry in terms of getting people to follow into this career and see the future in this career, I think this just goes to show how important it is.

(00:15:59) Barry Melancon: You’re absolutely right. And let me define why that’s really even at a more granular level that what you said is absolutely right.

All of the things that we just talked about are: How do you gather information? What’s the right information? What’s the necessary information? How’s this reported on? There are five elements to how all of this is going to develop. It starts with controls in an organization. How do you obtain this information?

How financial information starts is with controls. The second is how do you measure it? How do you measure it against standards? Is there a process now to establish standards on a global basis for this? Well, just like accounting standards, you have to measure it against the standards.

Then, the third thing is what does that information tell you for decision-making? That again is a sweet spot of the financial profession, because we know how to do that. We look at financial information to investment decisions or business decisions.

The fourth thing is where you have an external reporting responsibility. How do you gather that information and put it in a cogent way to report externally? So, that’s what financial statements have done for hundreds of years. Then, the final thing is: How do you have assurance associated with that?

That the people who see the information know that it’s consistent and reliable, and that’s what the attest function over financial information is all about. So, Kim, your point is 100 percent accurate and the components of where this is moving basically go to the core competency of our profession.

Now, it’ll be supplemented for instance in carbon areas. You’re probably going to have engineers that are going to be part of that process to help measure it. But the control and consistency aspect are around those five points.

(00:17:46) Paul Perry: I think that that is, you know, a lot of people talk about the AICPA being there for CPA firms and for auditors.

But this to me proves even further that AICPA is there for the betterment, the advocacy of business and how business is done and run. For the business owners that are listening, they’re probably sitting there and thinking, “Well, what are those frameworks Barry’s talking about?”

I think the globe is coming up with a lot of different types of frameworks. You can follow the SASB, which has been picked up by the value reporting foundation, which I know you’re also a part of. There’s lots of groups, foundations and nonprofits coming together to say, “What is that global standard for this?”

That is what companies need to be looking at. You could go out there and there’s probably 47 areas that somebody could report on, but are those material for your type of business and for your type of service? The SASB is the Sustainability Accounting Standards Board.

Their framework really breaks it down in 77 different industries and says, “If this is your industry, these are the four or five things that are material and important, and that’s how we’re going to apply it across the board.” I think that the business leaders are thinking about: “What is my takeaway from this discussion?” It’s that there are frameworks out there and there are ways you can get into what do I need to be reporting on and how do I need to function?

(00:19:13) Barry Melancon: The key component is you use frameworks with the plural. We need to narrow those down. About two years ago, there were 200 different frameworks. And as a CEO of a company, there’s an awful lot of people, public companies and private companies that say I want to comply with this but tell me what to comply with.

That’s really what’s happening right now. You referenced SASB, the Sustainability Accounting Standards Board. So, I co-chaired a group that has merged SASB, effective June 30th, into the formation of the International Sustainability Standards Board that’s independently going to set these compliance standards in a way that does what you said.

Which looks at it on an industry basis and looks at it on a sematic basis in some cases. And the hope is that we don’t have this alphabet soup of hundreds of different frameworks that we can rationalize in some ways and simplify these measures in these standards.

Businesses that are going to be required to comply have a set of answers as to what they need to comply with instead of being second-guessed on what they’re complying with. That is really the goal. That really has to be global because the environment doesn’t stop at the Atlantic Ocean, the Pacific Ocean, the Gulf of Mexico or the Canadian border.

Companies and subsidiaries around the world have supply chain components around the world as we talked about with Kim just now. And so, it is a notion of: Can’t we get in this environment to something that is measurable and consistently done so that it has a better rationale of doing it on a global basis?

That doesn’t mean global drives because this new board that’s being set up is going to have a U.S. component, offices in Canada, offices in continental Europe, offices in London and offices in Asia. The really important part is that businesses will have an opportunity to feed into proposals that come about.

So, if something is crazy or whatever, they have an opportunity to deliver that feedback. It’s going to be done in an independent way. Not by the government, but by an independent standard-setting board that really is designed to interact with the market and to be doing that on a global basis.

Now, that’s a hopeful sort of great outcome. We may see some governments add more requirements on top. But at least if they do it from a building block approach, then we can have a core that is the starting point, which reduces the cost to implement and creates consistency.

I would make one more point. Paul, you used this industry point as the reality. If you write just generic standards in all these areas, particularly in the environmental areas, then if I’m in financial services, how do I apply that? Versus extraction industries, manufacturing or retail, et cetera.

One of the things in putting this together… an imperative that we brought forward was there has to be a notion of industry-based types of approaches. With the people implementing it, you want them to be able to go into one place and say, “I’m in financial services or I’m in oil and gas. These are the measures that I need to be looking at.”

(00:22:39) Kim Hartsock: Barry, here on The Wrap, we always try to wrap it up in 60 seconds or less. So, what is the main thing you want our listeners to leave with today after hearing this discussion?

(00:22:51) Barry Melancon: Well, you know, what I would say is the U.S. has probably got more naysayers to all of this than any other place in the globe.

I have a global role and I get to see that. I would say it this way and I’ll tell you a really good story. I was in a meeting that had a person from the UN., an organization that you would think you would label as a liberal organization. That person made a strong case that an electric automobile is actually a net negative cost to the environment. He made that point.

The general consensus would be a net positive to the environment. Right? Well, the truth is that I don’t think anybody really knows what’s the right answer to that. I certainly don’t know the right answer, whether it’s the net positive or a net negative.

But the building of a set of standards and consistent measurements, whether you believe either side of that equation standards produces the information that will let us in a transparent and consistent way answer those types of questions.

If you’re in the camp that it’s the most important thing we can do. It may prove that, but it might prove the other side of the camp. Our country has been a leader in this notion of transparency proves that in finances, in business models and businesses throughout decades and decades. This is a good evolution in that space.

You can embrace it from whatever side of the political spectrum you might actually subscribe to. That’s what I would leave for people.

(00:24:29) Paul Perry: Barry, this was a wonderful discussion. It’s been a pleasure to follow you for so many years. I do want to say thank you for all that you do for this profession, but also for business advocacy as a whole from the accounting perspective.

We appreciate what you’ve done, and we appreciate what you’re going to do going forward. And thank you very much for being a part of The Wrap with Kim and I.

(00:24:51) Barry Melancon: Glad to be here. It’s always great to be with both of you and thanks for the great comments. I hope the listeners get something out of this as well. Thank you all. See you soon. Bye.

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