Workday Podcast: Understanding the Finance Role in ESG Transformation

Bruno Navarro: Climate change, inclusivity, responsible governance. No longer are such pressing issues as these and related topics mere items on a do-gooder's wish list. Increasingly, environmental, social, and governance, or ESG efforts, are becoming priorities for stakeholders, shareholders, regulators, and C-suite leaders. So how can executives go about quantifying success and achieving ESG goals? And what critical elements do they need to know?

I’m your host, Bruno Navarro, and today I’m talking to Brigham McNaughton, partner in PwC’s ESG practice. Today, we'll discuss the current wave of ESG regulations and investor expectations, as well as how organizational leaders can navigate them. Welcome, Brigham. Thanks so much for joining us today. 

Could you please start us off by telling us a bit more about yourself and your role at PwC?

Brigham McNaughton: Thank you, and it’s an absolute privilege to be with you, Bruno. Really appreciate you taking the time and for the opportunity to work with Workday at Rising recently on your executive symposium bringing leaders together around the country to talk about ESG. So really appreciate the opportunity. At the firm, my role is really to work with large public companies as they’re facing a whole range of shifting expectations on ESG reporting, transparency, goals and commitments from everything from climate change to diversity, equity, and inclusion, and making sure that they’ve got the right programs in place, the right commitments, the right infrastructure to measure their, their progress and to make sure that they have the, the accountability cascaded through their organization.

Navarro: Could you provide a brief overview of what you're seeing around ESG regulations and investor expectations, both here and in the UK and the EU?

McNaughton: Happy to. And it feels a little bit like a climate pun, but we’re seeing either a hurricane or a tsunami that’s coming at our clients. So in the U.S., you certainly have a proposed rule on climate disclosures that follows a proposal on cybersecurity, and we’re expecting a human capital disclosure proposal to come later in the year. That climate role is very expansive, 500 pages, and really affects both the heart of the financial statements with the footnote that requires companies to basically go through every transaction and classify whether or not they are working toward advance their goals and commitments or whether or not they’re in response to climate change or climate risks, written quite broadly. As well as adding a whole other section to the 10-K akin to an NDA-type disclosure walking through the governance over climate risk, walking through discussion about how they’re managing those risks, the risk concentration. If it’s material, that starts with a discussion of assets that are going to be impacted by climate change at a ZIP code level. So, very granular, very detailed information.

And new requirements around metrics and transparency. So that could be your Scope 1, Scope 2 greenhouse gas emissions from your direct operations. That could be material or if you have a goal that covers your broader value chain impacts, your Scope 3 emissions from either your supply chain or your products and impacts on customers. As well as a pretty robust discussion around any goals and targets that you might have and asking for baseline for those updates on progress, what your actions are, your plans are to, to meet those goals. So a very significant interconnected and complex proposal in the U.S., but narrowly focused on climate change. That’s a little different in the EU, where we have the corporate sustainability reporting directive that is now in place, which will require certain legal entities for U.S.-headquartered companies and for large EU companies—to look across the really wide set of sustainability issues, certainly on the environmental side around workforce and social matters, and to go through a materiality assessment process to look at which of those topics are going to be material for society and which are going to be material for their financial condition, and to have a very expansive disclosure around that. A client said they’ve counted 500 distinct disclosure obligations that are written into the rule and with an audit opinion attached to it. So it’s very challenging. Those are the two major ones, I think, that are keeping most of my clients up at night. There are also, like, the UK has a climate change proposal that is also going to be challenging at a legal entity level. I think Switzerland is also similarly looking at that. I had one last week for Liechtenstein. So for a client, that’s going to be a challenge to just monitor their global footprint.

Navarro: I’d love to learn about what major trends you’re seeing in the market, specifically those that affect finance leaders. So how has the tension from regulators and investors affected the thinking about ESG and organizational strategy?

McNaughton: The finance function is at the table now in a way that it has not been, or really wasn’t, even six months ago or a year ago. We’re seeing more and more clients establish ESG controllers. We’re seeing centers of excellence being stood up, bridging together controllership, financial reporting, and legal and sustainability teams to really grapple with this and understand the sustainability accounting mixed with SOX [Sarbanes-Oxley Act of 2002] controls, and the level of technology and discipline it takes to drive to a financial close process. All of that coming together, and that’s with the governance that you’d expect in financial reporting. So, boards and audit committees getting very involved, disclosure committees stepping in and setting expectations, looking at certifications of officers for the data that’s flowing into their reporting. So it’s been a very intensive pivot, and we’re expecting that to continue to escalate through the next couple of years.

Navarro: Now, is there a difference between the type of response we’re seeing from the finance function in the US and the EU? Are there significant differences?

McNaughton: In the U.S., the focus has been very narrow on individual topics. So, how do I get my climate data? How do I get my human capital data? How do I get cybersecurity disclosures to the point where I want them? That’s very different from in the EU, this organizational thinking and stakeholder input and the understanding the whole breadth of issues that could be important to me, understanding my whole value chain and where those issues impact across my value chain. So there’s a marked difference. I think in the U.S. because of the way securities laws work and the level of litigation, legal risk that people experience in the U.S., we’re seeing a very intense and deep focus on those targeted areas to make sure that the data quality is where they need it to be, et cetera. Versus in the EU, I think it’s requiring a bit more of a capability around just thinking about other stakeholders and thinking about transparency obligations and shifting that.

I think another major point that I would flag between the U.S. and Europe—the U.S. certainly has, the SEC’s requirements certainly expects a company to know what climate risk will impact the company and to speak to that, but then largely leaves it up to companies to discuss whether they set their own goals, strategies, targets. Just says, “If you do that, you’re expected to be able to speak on that and speak truthfully and fulsomely.” The EU’s very different. They are clearly trying to drive change in capital markets in society. This is not an investor protection exercise. It’s a societal protection exercise. And therefore, the expectations really are pushing companies to be able to talk about and assert how they’re aligned to the overall Paris Accord, that they have decarbonization, the expected trajectory, that the planet would need, et cetera. So it’s a very different tenor in expectation between the US and Europe.

Navarro: It sounds like quite a different tenor. What kind of effect will that have on how multinational organizations address ESG priorities?

McNaughton: It’s a really great question. One of the challenges is what is the granularity of data that I need to manage and to be able to support my goals for execution and my reporting obligations? Today, most large multinationals struggle to get a highly manual process of climate, water, and human capital data together by end-of-the-year financial close deadline and to put that in a voluntary report. We’re going to need the capability at this point to slice and dice by legal entity to have a view of statutory impacts over a much broader breadth. And then for SEC registrants, much faster with a higher level of quality and review, so this three-dimensional data view of highly reliable information. What that means is that our clients are shifting perhaps a little bit from their programmatic strategy focus and how they’ve been moving the needle on these commitments to foundational data technology infrastructure architecture, getting information all in one place, consolidating it, getting the right controls, et cetera, wrapped around it. I hope over the long term that means that it will accelerate momentum around actually achieving the goals, but in the near term, we’re seeing a little bit of a pivot away from some of the strategic focus around sustainability commitments, more to what the regulatory compliance and reporting infrastructure is going to be.

Navarro: You talked quite a bit about data and information. This sounds like a massive amount of information that organizations are going to have to deal with. How does technology factor in, and how are organizations employing technology in these efforts?

McNaughton: Fundamentally, we’re not going to be able to get this done on spreadsheets anymore. And when you think about, for example, the financial statement footnote that the SEC has proposed, what percentage of every single financial statement line item was driven because of a climate risk or climate event? That really requires thinking through at a transactional level in my GL, you know, in Workday Financials, thinking about how do I tag and classify, et cetera, from the beginning, and allowing that data to flow through versus going backwards in retrospect. What we’re seeing is a movement from clients who had either targeted point solutions around carbon calculation or were using spreadsheets. Now they’re looking at an overall technology blueprint and architecture. And they’re thinking through the capabilities they’re going to need to achieve this, and leveraging their existing enterprise systems to the extent that it’s possible. So, if you’re using Workday for human capital and using that as a basis for your diversity, equity, and inclusion as I mentioned on transaction tagging or even inputs for calculating Scope 1, Scope 2 greenhouse gas emissions, if you’re in Workday Financial, being able to open that up and try to do some degree of tagging and capture, having that flow through together in an enterprise-scale data environment, leveraging, for example, Prism's capabilities, it’s going to take all of that coming together to be able to manage through this in a reliable way.

Navarro: Without naming specifics, could you provide a hypothetical example of how you might help a large global company undertake an ESG transformation? Because that, that really sounds like what we’re talking about here, ESG transformation.

McNaughton: That’s exactly right. And what’s happening right now is the ESG reporting transformation, and I suspect the next flywheel that will come from that once the transparency and accountability is in place, will be the broader kind of strategic transformation on how we achieve and deliver the goals. I think we’re in phase 1 of a two-part transformation, if you will. But today, several large clients who started with gap assessments, looked across all the regulations, looked at what they’re doing today, and came to a conclusion with fairly senior steering committees—so, finance at the table, general counsel at the table, sustainability officer at the table—to come together and say, “This needs to change in a significant way.” And outlining a trajectory over the next coming years to get from good, better, best. What does that look like? What’s their ambition to move toward spending up dedicated program management offices, multiple workstreams, with a heavy focus on global policies and accounting decisions and materiality decisions, how the disclosure is going to work.

Dedicated workstreams around different dimensions of data—so, climate data, human capital data, et cetera. How do we accelerate that? How do we get the data gaps filled and alignment to the right scope and boundary for the organization? Dedicated workstreams around control, and what it’s going to look like to basically integrate non-financial measures in with SOX. And a huge amount of change management that’s happening at the same time to educate everyone and bring them on board because fundamentally you’re going to have financial reporting and control teams who don’t know anything about sustainability, and you’re going to have sustainability professionals who don’t know what a control is. So we’ve got to educate everybody through that process. We have clients that are in the upfront kinda current state, what is the world going to change phase, and we’ve got clients that were well into their transformation journey where we’re putting in technology in place to accelerate that data. We’re aligning on global governance for what the expectations for supporting data quality or even how the organization sets goals and what the approval process looks like.

Navarro: You mentioned change management. It seems like that is a discipline unto itself. So how do leadership structures and organizational culture play a role in ESG efforts?

McNaughton: Companies have set bold goals that are going to fundamentally require everybody in the organization to contribute to it. Sustainability is cross-functional in nature. I would struggle to think of a single client where a climate change commitment, for example, wouldn’t impact, you know, at least four or five different functions to be able to contribute to that. Whether that’s procurement in my supply chain, product design and development, when I’m thinking through considerations, my operations and manufacturing footprint, my distribution and logistics—all of it is going to have to come into play. So, fundamentally, my clients are starting at the board-level to think about what the oversight is at the very highest level in the organization, and then building out steering committees that bring together thematic leads and operational leads together that are going to have to make the right commitments and budget and execution to be able to deliver on the commitments that they’ve made. What that’s turning into now is: How do I take that maybe one giant greenhouse gas number that I had globally, and how do I break that out by business unit? How do I break that out by factory? How do I then cascade it through people’s performance management? And then how do I have the right reliability and trust and controls in that data now that I’m going to be holding people accountable and I’m going to be compensating people based on that data?

So that’s the journey that we’re starting to see evolve. There’s a lot of discussion right now around the role of sustainability functions versus finance and who owns what. We’re not seeing a clear norm that’s evolving yet. I would say the only thing that’s known at this point is that finance is going to have to be engaged in a very different way. I have some clients that are moving sustainability reporting, climate calculations, et cetera, they’re moving that into finance and maintaining it just like they would any other financial reporting obligation. I have others where they’re keeping it a sustainability function, but the finance colleagues are providing really good second-line challenge around controls and policies and process and leveraging the technology suites that they’ve developed and tools to be able to support their sustainability colleagues.

Navarro: Well, thank you, Brigham. That’s all the time we have today. I appreciate your time.

McNaughton: Thank you. It’s been an absolute pleasure, and really appreciate it.

Navarro: We’ve been talking with Brigham McNaughton of PwC about ESG transformation. Don’t forget to follow us wherever you get your favorite podcasts. And remember, you can find all of our episodes at Workday.com/podcasts. I’m your host, Bruno Navarro, and I hope you have a great workday.