ESG, sustainability and non-financial risks a call for action

PRMIA is pleased to announce its membership of the Joint Initiative on Accounting Reform (JIAR), an ESG & Sustainability program that is researching new methods of quantifying and accounting for nonfinancial risks. PRMIA is partnering with the Association of Chartered Certified Accountants (ACCA) in this initiative which is being coordinated by the Risk Accounting Standards Board (RASB) and the Durham University Business School (DUBS).

background

The universally adopted method of identifying non-financial risks and gauging their likely impact is through risk & control self-assessment (RCSA). RCSAs are the primary source of management information on the status of risk and risk mitigation that is typically reported via an assessment metric comprised of three colors: red, amber and green or “RAG”.

This raises two issues in connection with programs aimed at resolving ongoing ESG & sustainability reporting challenges:

First, color-coding risk exposures in place of their explicit quantification and aggregation inhibits boards and C-suite executives in their exercising of effective risk governance… the “G” in “ESG”. Most significantly, color-coding disenables portfolio views of accepted risks: colors cannot be tied to official accounting records, or aggregated and compared, or used to budget and set operating limits, or provide inputs to quantitative modeling and analysis.

Second, accountants need reliable and auditable aggregations of all forms of exposure to non-financial risk to risk-adjust financial statements, a fundamental requirement of ESG and sustainability reporting.

risk and profit taking now… losses later

The absent risk-adjustment of financial statements results in a “risk and profit taking now - losses later” representation of corporate performance. This has undermined confidence in accounting profit and, consequently, the reliability of audited financial statements. Such loss of confidence has escalated to a point where the investor community and other stakeholders are demanding change, the most significant being the replacement of “financial profit” with “corporate sustainability” as the primary accounting measure of corporate performance.

The JIAR’s definition of corporate sustainability is: “An organization’s capacity to provide investors with reliably predictable returns on their investment in financial, environmental and social terms.”

In other words, corporate sustainability is an organization’s accounting profit, which is the backward-looking or ‘historic’ perspective, adjusted for the expected losses associated with accumulating non-financial risks reduced by the positive offsetting effects of ESG attributes which is the forward-looking or ‘future’ perspective. In short, corporate sustainability is the blending of backward- and forward-looking financial performance within a common measurement, accounting and reporting framework.

JIAR’s research is focused on Risk Accounting, a standardized and integrated non-financial risk management and accounting framework that identifies, quantifies, aggregates, values and reports all forms of nonfinancial risk. Risk Accounting provides a foundation on which expected losses associated with accepted non-financial risk, including the positive offsetting impacts of ESG attributes, can be accounted for.

Risk Accounting incorporates a novel non-financial risk quantification technique first pioneered in the banking sector as a production (operations) risk measurement and management tool. In a research collaboration between RASB and DUBS the technique has been extended and codified as an integrated non-financial risk management and accounting solution that has been proven for application in banks through laboratory testing.

The researchers are now satisfied it is ready for proofs-of-concept and other forms of field-testing.

To progress to the next critical stage of the research program, the JIAR is dependent on CFOs and CROs sponsoring the research and enabling access to their operating environments and risk management and accounting subject matter experts. Hence this Call for Action whose mission is to: “Conclude, based on empirical evidence, whether risk accounting provides a viable accounting-based foundation on which “financial profit” can securely transition to “corporate sustainability” as the primary accounting measure of corporate performance”.

For a detailed description of Risk Accounting there’s a step-by-step walkthrough in the form of a selfstudy guide in Section IV of the book, “Where Next for Operational Risk? – A Guide for Risk Managers and Accountants” written by the RASB chairman and PRMIA Sustaining member, Peter Hughes.

We urge our members to actively support this important research initiative. You can do so by emailing getinvolved@rasb.org with “Call for Action” in the subject header and you’ll be sent a link to our ‘Call for Action Information Pack’ via return email.

welcome to risk accounting

a call for action

INTELLIGENT RISK

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