Sustainability and Financial Reporting

Kyle Hulme:

By doing good, you can also do well. You're reevaluating your operations. You're reevaluating the way you approach your talent. You're reevaluating your culture. You're reevaluating your purpose as an organization. And I think by doing that exercise, it's opening up new ways of performance that organizations have not seen in the past and creating like creativity and innovation and just that sense of purpose that gets people up in the morning and really excited to go to work.

Narrator:

Welcome to Accounting for the Future, A BDO Canada podcast for financial leaders to navigate, change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but will definitely have to manage for the future.

Armand Capisciolto:

Hello and welcome to Accounting for the Future. I am your host, Armand Capisciolto, BDO Canada's National Accounting Standards partner and leader of Accounting Advisory Services. On today's episode, I'm joined by Kyle Hulme. Kyle is a BDO alumni who is previously a member of our strategy and sustainability consulting team. Kyle has recently joined a BDO Canada client in the real estate industry. Today we will be discussing the link between sustainability and financial reporting. Kyle, welcome to Accounting for the Future.

Kyle Hulme:

Thanks, Armand, happy to be here.

Armand Capisciolto:

And Kyle, as I said, this is my first time doing this, hosting a podcast. So, there might be some bumps along the way, but this is a topic you and I talk about a lot, so I think it's just going to be one of our normal conversations, except someone's recording it.

Kyle Hulme:

Excellent. I'm looking forward to digging in. And like you said, we chat about this all the time. So, it's nice to share some of those conversations we're having behind the scenes with the world.

Armand Capisciolto:

Okay, so let's start off with something really basic. And this is something I do and I'm not sure if it's right or wrong, but I often refer to sustainability and ESG interchangeably. And is that right? Should I be referring to them interchangeably?

Kyle Hulme:

So, I look at sustainability as the what and ESG as the how. So, the concept of sustainability is what organizations are try trying to achieve. It's what they're striving for day in, day out. It's the long-term sustainability of their organization.

I think what's changed, though, is that sustainability doesn't equal performance. I think sustainability equals performance and purpose these days. So long-term sustainability of an organization is being able to achieve that performance while having that environmental and social impact and a strong governance foundation that an organization should have to enable that long-term sustainability.

When I look at ESG, ESG is really the how. So, it's a set of tools, frameworks, and principles that help an organization to achieve that long-term sustainability. I think right now you're seeing a large, significant change in markets, and that's really around societal transformation. And I think organizations and organization stakeholders really care about the purpose that organizations are serving, so that environmental and social impact that they're having on the world around them. And that weaves into sustainability. So, sustainability is the what, and ESG is how organizations can achieve that sustainability.

Armand Capisciolto:

Okay. And you referred to a couple things there. You referred to change, and I think it's interesting because I don't think sustainability is a new concept, but it's a concept that's changing. And for yourself, it's definitely not a new concept. You used to work for a large REIT and were part of the team that worked on their initial sustainability report. Now at BDO, you're advising clients on sustainability. Can you give us just a bit of a background of when we say advising companies on sustainability, what does that entail? What are you doing when you're advising clients on sustainability?

Kyle Hulme:

Yeah, and I think Armand, it really starts with helping organizations achieve their long-term sustainability. And what we're really trying to do is help our clients activate those sustainability programs or further enable those sustainability programs along their journey.

And a large part of that starts with strategy. So really understanding what the market dynamics are at play, understanding what they want to achieve. What's the purpose of their organization? We're helping clients make sense of the ESG framework landscape that's out there right now and getting them ready for regulatory reporting requirements that coming.

I think what's really interesting, and when we look at the world of sustainability, and the World Economic Forum has noted this as well, is that data is one of the largest, call it roadblocks or challenges to enabling sustainability programs. And so, we're trying to help organizations unlock that data to quantify emissions, quantify their impact, understand where they currently are, and then set that promise or the commitments for the future. So, there's lots of different things that we're doing to help our clients in the space, but when I kind of sum it up, it's really activating their sustainability journey so that they can have the impact that they want in the world around them.

Armand Capisciolto:

It's really interesting data. I think data comes up in almost everything we do, regardless of what topic we're talking about. But sustainability's a really interesting one because it's probably an area where data's been collected in the past, potentially by organizations, but maybe not with the same rigor that it's collected for other purposes.

Kyle Hulme:

Yeah, fully agreed. And I think there's a new dynamic at play, too. And of course, that's around organizations committing to net-zero and trying to quantify their emissions footprint. That's a new skillset that's looking at new sets of data and looking at their business in a new way. And then, so understanding where their emission footprint is today and then building out a roadmap for remediation reduction, moving forward is going to continue to be, and even be even more important in the years to come, especially with financial reporting requirements coming.

Armand Capisciolto:

So, when you're talking to organizations, and I assume you're talking to multiple people in the organizations you work with, but who generally owns these projects? When you're dealing with one of your strategy clients and you're talking with sustainability, who's the primary kind of department or individuals you're dealing with?

Kyle Hulme:

Well, I think what's important is, is that sustainability is owned by the organization. And so, the board has a role. Senior leaders have a role. Employees have a role, and stakeholders have a role. And so, when we look at who owns sustainability, it's the organization at large. If I think of sustainability and ESG and how it's going to impact business, many facets of an organization are going to going to have to adjust or be disrupted because of environmental and social impact.

So, if you think of the finance department and the mandatory reporting requirements that are coming, they're going to have to be able to actually disclose information around emissions. If I look at marketing departments, they're going to be pulling together sustainability reporting and key concepts of the environmental and social programs to tell the organization's story. If I look at human resources, they're going to be leveraging and understanding their talent and weaving sustainability into their talent development and retention programs, creating cultures of social awareness and creating cultures of environmental awareness.

And so, when I look at sustainability and ESG programs, the organization owns it. But what's really interesting is that accountability within an organization for its execution is falling more and more to the office of the CFO or the office of the accounting team. And that's largely because a key outcome of ESG programs is sustainability reporting. And with mandatory reporting coming, it's expected that sustainability is going to find its way into external reporting requirements.

Armand Capisciolto:

Yeah, I think anytime you talk about external reporting requirements, it's typically the finance department. It's typically the CFO who has responsibility for that, for executing it. And really, as you know, Kyle, my background and my role at BDO is accounting standards. So sometimes I get asked, "Well, why are you talking about sustainability? Why are you taking such interest in this topic? Aren't you just care about dollars and cents, the accounting and the debits and credits?"

But it's very much related to the disclosures a company has to make. And I care more... I care just as much about disclosures companies have to make as I do about the amounts that are recognized in their financial statements. And to me, this type of reporting or type of data that has to be collected, it really... And that rigor, again, if it's going to end up in external reporting, that rigor that the finance department is used to dealing with, with getting their financial statements audited, with releasing MD and As, with all the public disclosures they have to do, it seems very consistent with what they are going to be asked to do with regards to sustainability.

Kyle Hulme:

Yeah, I couldn't agree more. And I think what's going to happen is, is you're going to see the finance department evolve. You're going to see a heightened focus on understanding what the regulations that are coming and the expected reporting requirements and looking in market as well and understanding what your peers are doing. And so, when I look at the world of impending regulation, I think there's going to be, a kind of new finance transformation, especially from a technical perspective to be able to make sense of what the requirements are and then being able to weave that into financial reporting and into the MD&A.

Armand Capisciolto:

Yeah, so let's, you brought up regulation, impending regulation, there is a lot going on right now. So, from prior to Christmas, the Canadian Securities Administrators released proposals for climate related disclosures for Canadian listed companies.

I think it was two weeks ago or approximately two weeks ago. From the date of recording this, the Securities and Exchange Commission in the US released proposed rules related to climate related disclosures. And on March 31st, the IFRS Foundation that established the International Sustainability Standards Board, they issued their first two exposure drafts for what they are hoping to be the globally accepted sustainability standards. So, there's a lot going on from impending regulation.

And when I think about all this going on and everything happening, obviously when I think about regulation, I think about public companies. And they're going to have to react and they're going to have to prepare and to comply with these regulations. However, the one thing that I think gets lost in that narrative, when we've just talked about the reporting requirements, is reporting is just kind of a byproduct of what the company should be doing. And companies that aren't necessarily having to comply with mandatory reporting, they're going to be impacted by this movement and this change that's happening in society and stakeholders caring more about sustainability.

So, when we talk about how this impacts companies and we talk about sustainability, we often, at least I often hear people talking about the risks and opportunities created by sustainability. What are these risks and opportunities that we're talking about, that you spend a lot of time helping clients build strategies for?

Kyle Hulme:

Yeah, so Armand, you raise a really good point. I think yes, as a public listed entity, you're going to have regulatory reporting requirements. But I think the byproduct of that is organizations that are in those public list entities, value chains are also going to have to transition their responsibilities to align with the expectations of those publicly listed organizations.

So, for instance, if you're a B2B business and the organization that you sell your product to or your service to is committing to ESG, is committing to sustainability requirements, has made making targets and commitments, they may be reaching out to you and asking you what your emissions profile is. Or what are you doing to make your product more sustainable? Or what are you doing as an organization do your values and environmental and social impact actually align with ours? So, it might actually either promote or hinder your ability to get new work. And so, I think the risks for organizations extend well beyond public entities in terms of what's the new way of doing business and what the expectations of your organization are in market.

Now from a risk perspective with regards to financial reporting, there's really two kind of key asks that are out there right now are expectations from a disclosure perspective. And that's really around transitional risk and physical risks. So, organizations are going to have to look at what is the material impact or cost associating with transitioning to net-zero or reducing your emissions significantly? And there's going to be a cost burden there, and there's going to be a material impact there for many organizations. Another would be just the physical risks of living in a world where we're dealing with climate situations or circumstances more than we are today.

So, a great example would be an insurance company. They're going to have to quantify their costs, the material impact of transitioning to net-zero, but they're also going to have to look at their business and say, "If we're living in a world where we have more significant natural disasters as a result of climate change, what is that going to do to the cost of our premiums? What is it going to have to do to our cost of our payouts?" And so those risks are pretty significant, and I think organizations have to really try to quantify that out and understand, as they move to net-zero or as they transition in the years to come, what's that going to cost as a business to be able to get there?

Armand Capisciolto:

It's interesting. We walk about this transition, and you talk about the physical risks, they're all about things that are going to happen in the future. And yes, things have happened in the past. We all witnessed what happened last summer in BC with wildfires and this fall with flooding, which are all physical risks related to climate change.

But many of these things that you also mentioned, the transition to net-zero, the future physical risks. Insurance premiums is a great example, right? Insurance is a cost to a business. So, what does that mean that your insurance premiums are going to be more going forward, even being the insured, not just the insurance company. And one of the things that I always find interesting in talking to people about financial statements is they always think financial statements are historic, and they are, right? Auditors, accountants we're the great historians of business. We tell the story after the fact.

But the reality is there are many items within financial statements, within the disclosures, within how we deal with impairment, going concern, even something as basic as the useful life of an asset is all forward-looking. So, we can't ignore these risks and opportunities that are forward-looking when we're dealing with financial reporting.

I guess one of the questions I have for you is when you look at these risks, what are we talking about with regards to timelines, right? Are we talking...? I always hear 2030 as being kind of a key date and 2050 as being a key date with company's targets. So, if we're in, what are we in 2022 right now? So, I have 18 years, is that what I'm looking at for the timing to 2050? Or what am I talking about with regards to timing of these risks and opportunities?

Kyle Hulme:

I think it depends. It depends on your stakeholders; it depends on your industry and largely depends on the types of assets you own. But I think with the commitments that the governments are making, and that companies or industry leaders are making, we're going to see progress, and we're going to see those risks being disclosed sooner rather than later.

And to put that into context, there was a great report that came out from RBC last October. It was titled The Two Trillion Dollar Transition, Canada's Road to Net-zero. And in summary, that article said, "We as a country know the consequences of climate change, but we're not moving fast enough." The article noted that, today organizations in general, so we're talking all facets of public and private sector, are spending roughly $15 billion annually to cut emissions. And for us to commit cut emissions by even 75% of our current levels, we need to increase our spending four times a year.

So, we need to increase our spending from $15 billion annually to $60 billion annually. So, at this time, it's kind of hard to see how we as a country are actually going to achieve the government of Canada's net-zero emissions target by 2050.

And just a quick example from an industry perspective, and you talk about timing of assets. So, what's interesting is if you look at the aviation industry, we don't have electric flight yet, and their aircraft are the highest emitters of most of those organizations. And so that to me is a material risk, because they can't get to 2050 unless they figure out how we get electric flight. And so, depending on your assets, like I said, depending on your industry, that timing is really going to play in... I'm sorry, that the type of assets really going to play into the timing.

Armand Capisciolto:

Well, it's interesting, too, even when you think about that, and we both work at BDO, professional services firm, when we think about what as an organization, what's our carbon footprint, do our emissions look like? A lot of them are the indirect. We spend money to fly to visit clients. We spend money to fly to go to conferences. So even that one, where you talk about the aviation industry, well, that issue actually impacts multiple industries. And what is the cost to fly visit a client going to be in the future if the cost of carbon increases, which it is going to, and we don't have electric vehicle, electric planes or hydrogen powered planes? Some sort of plane that doesn't use high emitting greenhouse gases.

The interesting thing, too, that you talk about there is the spend. The spend that takes place. And one of the topics that I spend a lot of time on with regards to financial reporting is impairment. And the reason why spend is such an important word for me is because spend is cash outflows.

And typically, when we're dealing with an impairment assessment, we're looking at what are the future cash flows? And when I think about some of the things that you talked about related to the risks and increasing cost of carbon, customer preferences changing, having to make additional investment to continue to use the assets that you currently have, otherwise the negative impacts it could have not hitting those targets. All those are long-term issues.

If I'm dealing with an impairment assessment, I have to think about those today. And to me, this is one of the kind of counterintuitive things that I've been thinking about, is the longer the life remaining of the assets I have as an organization, the more uncertainty there is, the more risk there is going forward. So, I can actually have an entity that has very long-lived assets, is probably going to have financial reporting implications sooner because of that impairment assessment. I'm not saying they're going to be impaired, but there's a higher probability that they're going to be impaired because of the risk, whether it's physical or transitional.

So, for me, it really, that timing aspect of it and understanding the timing of when those risks are going to hit a company and the life, that the remaining life is assets, is actually a very important factor in determining how much of an impact this will have on their financial reporting today.

Now Kyle, and I'm assuming you're going to agree with me on this one, but one of the things I hear, and I really am hoping you can help me get this in the heads of people is people say, "Well, mandatory reporting is a few years away, so I don't have to worry about this yet." The even worse thing I hear is, "I'm not going to have to mandatorily report, therefore, why do I have to think about this at all?"

That is not the way I think about it. I think about everything that we've talked about so far in this to be business issues, issues that as you put it your first comments about the sustainability of the business, how do we get that message out there? Help me convince people that they need to think about this today regardless of whether or not they have to mandatorily report today

Kyle Hulme:

Yeah, so I think organizations in the truest sense want to be sustainable. And to be sustainable, a large element of that is investing in environmental, social and governance practices. And one great sign of just how important ESG is, if you look at the investor in capital communities, many studies show that investors believe that organizations who invest in sustainability actually represent better long-term returns.

CEOs are investing upwards of 5% of their revenue into environmental and social governance initiatives because they're seeing that translate into higher revenue growth, higher talent development, higher retention of talent as well. And so, you're starting to see environmental and social issues become top of mind for senior leaders and board members. And that's only going to continue.

What I think is so great is that environmental and social issues are now business issues. They're not treated separately. It's not off the side of the desk. It's in the executive boardroom. It's with the board members, and it's talked about in functional areas of the organization. And I think what's really interesting is some organizations approach sustainability as a bit of a compliance or a checkbox initiative. And that's unfortunately the way it sometimes starts. But I think as organizations kind of dig in a little deeper, they start seeing that by doing good, you can also do well.

You're reevaluating your operations; you're reevaluating the way you approach your talent. You're reevaluating your culture. You're reevaluating your purpose, purpose as an organization. And I think by doing that exercise, it's opening up new ways of performance that organizations have not seen in the past and creating creativity and innovation and just that sense of purpose that gets people up in the morning and really excited to go to work.

So, I look at ESG and sustainability and say, "It's sustainability equals business. And by doing so, that equals environmental social governance."

Armand Capisciolto:

I love that, sustainability equals business. And I think that for me, as someone who is looking at this very much from a financial reporting standpoint, I don't look at this as any different than any other business issue. If there's a business issue facing a company, it's ultimately going to have a financial reporting impact. Sustainability issues are business issues; therefore, they're going to have a financial reporting impact. And again, sustainability equals business. Love that. That's great.

So, I think with that, I think that's all the time we have for today. I'm really excited about this topic, as you know, Kyle. You and I talk about it all the time. We could probably go on for a couple more hours if we wanted too here. Not sure our listeners would want to hear us talk for a couple hours.

But for me, the one thing I would like to leave people with is, although the headlines, and these might just be the headlines, the weird headlines I read, is that it's all about sustainability reporting. I don't think it's about sustainability reporting because very few companies are going to have to report publicly, being listed companies. Most of the companies in Canada are not listed companies. That doesn't mean sustainability doesn't impact them.

So, although regardless of whether you have to deal with mandatory reporting or not, sustainability will impact your organization and therefore ultimately impact your financial statements, your results, and the sustainability of the business going forward. So, I think that's a message I would like to leave people with, is that this impacts everyone and it's not just about reporting.

So, Kyle, thank you very much. I and our audience, really appreciate your time, your expertise. I'd also like to thank you, our listeners for tuning in today. I'm Armand Capisciolto and this has been BDO's Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you liked it. We'll see you next time. Thanks, Kyle.