2023 Articles - Suits the C-Suite - Page 2 | SGV & Co. | EY

02 October 2023

Jan Ray G. Manlapaz and Mary Andrea T. Bacani

Reimagining the digital supply chain

In recent years, there has been a substantial change in the global landscape of supply chains. Companies are dealing with a wide range of challenges that are changing the way they see supply chain strategy, from geopolitical conflicts to digital disruptions and pressures from climate change and the sustainability agenda. A new paradigm reimagining supply chains is emerging in reaction to these disruptions, forcing businesses to reconsider their existing strategies and adopt a comprehensive approach to capitalize upon new opportunities while ensuring resilience.Because of this, traditional and analog supply chain strategies may no longer be capable of effectively responding to supply chain shocks. Instead, an agile, digital supply chain consisting of intelligent monitoring, real-time data visibility and management, and crisis and exception management frameworks, among other things, can be a massive game-changer. However, there are no shortcuts to the digital transformation of the supply chain, as merely adding technology to existing supply chain management systems and processes for the sake of supply chain digitalization will not deliver the real value that businesses desire.This is the second article in a supply chain series that previously looked at integrated supply chain planning.SUPPLY CHAIN CHALLENGESAccording to an EY report, exponential data growth is another fundamental problem that continues to overwhelm most businesses at an accelerated pace. Companies that can effectively navigate the increasing complexity of new digital business models will be able to maintain a competitive advantage, but companies that are unable to do so will inhibit their ability to derive meaningful insights, leading to a barrier to achieving automation and efficiency.The disruption brought about by digital technology has significantly reshaped supply chains, accelerating supply chain digitalization. According to the Evolution to Revolution: MHI Annual Industry Report, 78% of supply chain executives in the study acknowledge the revolutionary value of digital technologies. The whole supply chain will benefit from the new opportunities for efficiency improvements as well as improved decision-making brought forth by this shift toward digitalization.Digital supply chain reimagination has also become defined by the mounting demand to improve resiliency, combat climate change, and promote sustainability. Consumers are more aware of how products affect the environment, with 75% of US consumers voicing worries in this area, according to an article titled “Majority of US Consumers Say They Will Pay More for Sustainable Products” by Sustainable Brands, a community of brand innovators shaping the future of commerce. In order to meet these changing customer expectations, businesses are adopting supply chain redesign driven by sustainability.THE FOUR PILLARS OF SUPPLY CHAIN REIMAGINATIONIn order to navigate these complexities and seize opportunities, companies have to embrace a comprehensive approach to supply chain reimagination, utilizing a framework that revolves around the following four key pillars.Supply chain sustainability and resiliency. This pillar emphasizes tech-led process excellence to build resilient supply chains through enhanced visibility and improved agility. To guarantee continuous operations and satisfy customer demands, integrated business planning, manufacturing reliability, and secure alternative bill of materials (BoMs) and sources of supply all play critical roles.End-to-end (E2E) cost optimization. For a company to stay competitive, better cost management along the entire supply chain is essential. Among the key levers necessary to achieve long-term cost reductions and operational efficiency are strategic sourcing, the elimination of manufacturing waste, and maximizing logistics expenditures. Adopting a centralized operating model for supply chain through Global Business Services (GBS) or Shared Services Center (SSC) solutions can also create significant cost savings.Supply chain process digitalization. The digitalization of supply chains opens up new opportunities for agility and efficiency. Real-time decision-making and enhanced collaboration are made possible by autonomous planning, digital factories, and procurement analytics. E2E visibility and quality management through the use of the Control Tower system also allow seamless integration between functions, enhancing the effectiveness and response of the supply chain as a whole. Leveraging a Digital Twin (a virtual model of the physical supply chain that includes a digital counterpart of every piece of the process) enables companies to run a parallel version of the supply network and simulate scenarios for better insights before making transformative changes.Strategic interventions. This final pillar includes supply chain redesign driven by sustainability, carbon footprint optimization, and segmentation and portfolio optimization. Companies can future-proof their operations and align their supply chains with shifting market dynamics by carefully reevaluating their operations and implementing asset-light solutions.Companies may significantly affect their profit and loss statements by concentrating on these four supply chain reimagination areas.UNLOCKING BENEFITS FOR BUSINESSESAccording to an assessment of prior supply chain engagements conducted by EY, adopting a supply chain reimagination framework has had a substantial positive impact on customers in four areas.First, implementing strong resilience measures can result in gains in total revenue of 3% to 5%, a forecasting accuracy of 5%, supplier lead times of 50% to 60%, and overall equipment efficiency (OEE) of 15% to 30%.Second, through route optimization and freight rate benchmarking, focusing on cost optimization can result in reductions of 4% to 6% in direct material costs, 5% to 10% in manufacturing expenses, and 6% to 10% in transportation costs.Third, embracing digital transformation in the supply chain can lower production costs by 5% to 10%, inventory carrying costs by 10% to 15%, and warehouse and distribution center operating expenses by 6% to 10%.Last, through network redesign, strategic interventions can reduce transportation costs by 10% to 25% and increase on-time-in-full (OTIF) performance so that it reaches 95% or higher.REIMAGINING THE FUTURE OF SUPPLY CHAIN MANAGEMENTThe supply chain landscape is rapidly changing as a result of a convergence of major disruptions and the demand for sustainability and resilience. However, businesses that use the framework for supply chain reimagination can elevate themselves to a leading position during this change. Enhancing digitalization, building robust supply chains, controlling costs, and aligning operations with shifting market dynamics are all possible for firms that take a comprehensive approach and make full use of technology, process excellence, and strategic interventions.Reimagining the digital supply chain is no longer a choice — it is imperative for businesses seeking long-term success as the business climate continues to evolve. Organizations may maximize the potential of their supply chains and succeed in a complex and dynamic world by reevaluating their strategies and embracing these four pillars, charting a path to increased resilience, sustainability, and autonomous supply networks.The next article in this series will discuss why green supply chains are the key to long-term value. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Jan Ray G. Manlapaz is a consulting partner and Mary Andrea T. Bacani is a Supply Chain and Operations (SCO) senior manager of SGV & Co.

25 September 2023

Jan Ray G. Manlapaz and Mary Andrea T. Bacani

Navigating the supply chain maze

Supply chain management is regarded as a critical function focused on operational efficiency and controlling costs, but it has been elevated into a board-level discussion in the wake of the pandemic. Supply chain professionals are now managing significant disruptions like inflation and price increases stemming from a volatile economy, labor shortages, and the growing consumer demand for faster and more dependable deliveries. The desire for better, more cohesive planning might be a priority for professionals — but it can be difficult given the day-to-day challenges from pressures and unplanned disruptions.The pandemic truly underscored how connected the world is and the vulnerability of the supply chain process. As noted at the World Economic Forum, supply chain disruptions have resulted from factors that include geopolitical uncertainties, climate change, and inflation. The rising cost of living could also reduce the availability of goods and impact demand.With these pressures mounting, the need to optimize supply chains with new and emerging technologies becomes clear. This makes it imperative to consider integrated supply chain planning in organization planning cycles.This is the first article in a supply chain series that will first look at integrated supply chain planning, the digital supply chain, greening the supply chain, and finally, how the Regional Comprehensive Economic Partnership (RCEP) can impact supply chains in ASEAN.The digital world is constantly evolving, with innovative technologies ranging from AI to the metaverse. Yet, the logistics industry still relies on antiquated systems and processes, creating risks for organizations. Businesses must consider adopting digital solutions to create value, mitigate risks, and optimize trade flows.Given the growing pressure to optimize supply chains with novel tools and technologies, it is imperative for organizations to prioritize their integrated supply chain planning. Accordingly, companies should balance two critical areas: sales and operations. It will be vital to focus on a sustainable planning approach that underscores stability and long-term growth with the following priorities:PEOPLE: CROSS-FUNCTION COLLABORATIONManaging talent effectively is crucial to integrated planning. Organizations should first consider how they can leverage their people to truly collaborate in creating, executing and monitoring plans to realize strategic objectives. It is essential to upskill key individuals across business functions to boost collaboration, identify gaps in skills, and prepare them for the increasing pace of the modern supply chain.It is also crucial for organizations not to execute plans in silos but in a holistic alignment with various business functions. Businesses must build plans by aligning the sales and marketing, procurement, operations, supply chain, and finance functions. Furthermore, having a cohesive business plan can help companies optimize inventory, manage resources, and cut costs. Bridging customer service and fulfillment functions can also enable further strategic planning to meet developing consumer demands and instill stakeholder trust.PROCESSES: INCREMENTAL IMPROVEMENTS VERSUS A SIGNIFICANT OVERHAULThe supply chain process depends on technology, but this may involve legacy platforms and outdated applications that are incompatible. It could be time for organizations to overhaul their platforms, though this will be costly and may not be a priority in the budget yet. Alternatively, gradually adopting intelligent tools could improve process outputs without putting a heavy financial strain on organizations. Proper planning and using an integrated business planning (IBP) tool could also help. IBPs can capitalize on the Cloud’s considerable data processing capabilities, driving significant progress in crucial areas.IBPs tools can bridge enterprise resource planning (ERP), customer relationship management (CRM), and financial planning platforms to provide a comprehensive business view, allowing organizations to track their progress versus their plans. These tools also facilitate scenario planning for a dynamic landscape, tactical planning that utilizes historical and market data, predictive analytics for trend forecasting, and machine learning algorithms to forecast demand that will help businesses plan and operate more effectively.DATA AND METRICS: INPUTS AND PROGRESS MEASUREMENTWhile planning tools can be helpful, high-quality data and experience-led dashboards are imperative to create a timely and accurate internal business view that appraises external market conditions and generates meaningful business insights. Consequently, organizations should define standard terms for consistency and suitable key performance indicators (KPIs) to measure progress. Board oversight and data governance will be requisite to establish appropriate policies and practices, thereby managing standards, guidelines, and data security. Finally, organizations must use data quality assessments, documentation and dashboarding tools, and lifecycle management to reduce the risks of data degradation and loss.While managing supply chain issues is a complex task, addressing the pain points of this manifold process is necessary to drive long-term value and results.OPTIMIZING THE SUPPLY CHAINSupply chain disruptions are ubiquitous — and staying abreast of these developments is vital to identifying opportunities, managing risks, and future-proofing organizations.Volatile economies, more complex and interconnected regional and global supply chain ecosystems, and highly evolving consumer demands signify that business leaders should focus on integrated supply chain planning. Embracing the IBP concept and leveraging available tools could be a game-changer because digital solutions can elevate and streamline the supply chain process, significantly improving user and customer experiences, while outdated systems can compound business risks. However, businesses should integrate technologies into existing infrastructures in an end-to-end manner and not in silos.Optimizing the supply chain entails focusing on significant areas like people, processes, and data and metrics. It is crucial to find the balance between planning and execution while carving a path for sustainability and long-term growth.The next article in this series will discuss what is next for the digital supply chain and how supply chain leaders have the opportunity to reimagine their supply chains for the future. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Jan Ray G. Manlapaz is a consulting partner and Mary Andrea T. Bacani is a supply chain and operations (SCO) senior manager of SGV & Co.

18 September 2023

Carlo Kristle G. Dimarucut

How digital transformation enables green energy

Environmental, social and governance (ESG) considerations and digital transformation are critical issues that boards and management have to address, making it a natural decision to leverage solutions that address both. In line with this, large-scale digital transformation is driving the adoption of renewable energy in order to reduce the severity of global climate change risks — but such a transformation also introduces potentially heightened risks of cybercrime.According to The Global Risks Report 2023-18th Edition from the World Economic Forum, environmental risks are the chief concern of surveyed professionals. Of the top 10 long-term global risks ordered by severity over a 10-year period, six were classified as environmental (failure to mitigate climate change, failure of climate-chain adaptation, natural disasters and extreme weather events, biodiversity loss and ecosystem collapse, natural resource crisis, and large-scale environmental damage incidents), and one as technological (widespread cybercrime and cyber security). However, these risks are not always distinct from one another, and organizations must find ways to align environmental and technological risks. TRANSITIONING TO GREEN ENERGYRenewable energy is considered a crucial solution to address the climate crisis, although two factors have hindered the adoption of renewable energy sources — cost and reliability or dependence on weather conditions. Currently, renewable energy is more stable and economical due to technological developments like smart grids, energy storage capacities, and artificial intelligence (AI). According to the National Grid Group, an energy company operating in the UK and US working towards a clean energy future, green energy is created and sourced without damaging the environment. Conversely, renewable energy comes from sources that replenish themselves, such as the wind and sun. While the bulk of green energy sources are renewable, not all renewable energy sources are classified as green. For example, an energy source will not be considered green if carbon emissions are involved in the generation process.Hastening the transition to green energy through digital transformation in renewable energy depends on disruptive technologies and innovations integrating different kinds of renewable energy into the bulk grid. The transition to green energy requires a two-way flow of power and information, which can be managed by the smart grid.While the network topology of the smart grid has benefits like efficacious and stable power, they come with corresponding cyber considerations:• Various energy resources with no clear cybersecurity focus and ownership• Considerable interconnections with web-based or internet-facing platforms• Data security and privacy • Consumer data collection, processing, and analysis• Threat expansion with cyber attacks • Large digital landscape or increased attack surfaceCYBERSECURITY CHALLENGESTo minimize the impact of the six significant global environmental risks stipulated by the World Economic Forum, organizations should invest in renewable energy powered by large-scale digital transformation. At the same time, organizations should consider that this transformation could lead to many vulnerabilities and risks enabled by prolific cybercrime and cybersecurity. Thus, it is vital to identify and address these threats proactively.It can be challenging to build cyber resilience because digital infrastructure and systems may be antiquated in the face of ever-evolving cyber threats. The Internet of Things (IoT), the bridge between the physical and digital world, also increases vulnerabilities exponentially. To realize the benefits of green energy, large-scale digital transformation should be enabled by a resilience strategy, governance framework, and robust cybersecurity technologies.The EY Trust by Design methodology is an extensive approach to cybersecurity that can help organizations create secure digital environments, safeguard sensitive data, and foster consumer and stakeholder trust. Moreover, the methodology inculcates a risk optimization mindset and integrates trust into services and products from their inception.Overcoming cybersecurity challenges:• Governance and oversight are crucial for organizations to prevent cybersecurity incidents, manage risks, and support business objectives. • Asset visibility is requisite for a clear understanding of all organizational assets, including a comprehensive inventory.• Reliable technology is vital to creating secure systems that can safeguard data, applications, and infrastructure from cyber threats. • Trusted components and periodic assessments are essential for identifying security vulnerabilities and prioritizing technological remediation efforts governed by business impact and risk appetite. • Supply chain and third-party risk management help maintain organizational security and resilience in the face of constantly evolving cyber threats.• AI-based monitoring and detection can distinguish between operational and cyber events, helping businesses determine the root cause of the incident with minimal human effort.• Incident response plans allow organizations to promptly recognize and respond to security threats, thus minimizing the impact. GREEN ENERGY IN THE PHILIPPINESDeveloping and optimizing the country’s renewable energy sources underscores the Philippine sustainable energy agenda. As part of Republic Act 9513, the National Renewable Energy Program (NREP) seeks to drive energy security and improve access to clean energy. In line with this, the NREP aims to expand the country’s renewable energy-based capacity to 15,304 megawatts by 2030.In 2018, the Green Energy Option program was introduced as a way for consumers to purchase electricity from renewable energy facilities. By 2021, the Energy Regulatory Commission promulgated rules to govern the program, setting technical and interconnection standards and fees for the facilities supplying renewable energy. According to Reuters, the Philippines currently ranks second in Southeast Asia in combined solar and wind power generation. By 2030, it will have added 17,809 MW of solar capacity and 7,856 MW of wind power to emerge as the top green power producer in the region. THE WAY FORWARDWhile technological developments have made renewable energy and green energy more accessible and economical, they also increase vulnerability to cyber risks and threats. With the acceleration of digitalization, companies should build cyber resilience in key areas for business continuity.Digital transformation, enabled by disruptive technologies and innovations, has led to an increased adoption of renewable energy resources. Investing in green energy is a big step to reducing the gravity of global environmental risks. However, effective board governance will be imperative for organizations to mitigate the corresponding cybercrime and cybersecurity incidents and threats.Organizations should focus on creating cyber resilience strategies and governance frameworks to foster a risk-aware culture. Creating a comprehensive methodology is critical to achieving business objectives related to reliability, cybersecurity, and environmental sustainability. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Carlo Kristle G. Dimarucut is a technology consulting partner of SGV & Co.

11 September 2023

Rossana A. Fajardo

How can we harness digital public goods?

The digitalization of public services will radically change the way governments interact with the people they serve and help meet their growing expectations of online access to government services. Digital Public Goods (DPGs) have the power to meet citizen expectations and accelerate digital transformation around the world. They can create long-term value and a more efficient, equitable, and prosperous future for society, businesses, and governments.DPGs, as defined by the Digital Public Goods Alliance (DPGA), are “open-source software, open data, open artificial intelligence models, open standards, and open content” that should respect privacy and other relevant laws and best practices, do no harm, and help realize the United Nations’ Sustainable Development Goals (UN SDGs). This definition is actualized through the DPG Standard, a set of nine indicators used to determine whether or not a public solution is a digital public good. Given their open-source nature, DPGs are created by communities or organizations for public use and are readily available for all governments and other entities to use, customize, and adapt for their digital public infrastructures (DPIs). The potential of DPGs is far-reaching and can move beyond the digitalization of public services, making it a significant economic and societal opportunity. Nevertheless, collaboration between governments, the private sector, and other entities is crucial in order to truly capitalize on DPG-related opportunities.The benefits of DPGs are manifold, including but not limited to the following:• Scalability. Once established, they can be easily deployed across nations.• Flexibility. They are agile and swift to adapt and deploy.• Applicability. They can support governments of different income levels, from the most developed to the least.• Cost-effectiveness. They are economical. The total cost for large countries or populations exceeding 50 million can fall between $0.24 and $0.74 per individual.DPGs DEPLOYED/DEVELOPED GLOBALLYBetween February 2022 and March 2023, the number of registered DPGs on the DPGA’s DPG register increased from 87 to 142. The figure could grow even faster, given the momentum of DPG adoption. Several factors contributed to the growth: governments realize the cost-effectiveness and efficiency of progressing digital transformation, observe the positive effects of DPGs for themselves and others, and utilize DPGs to advance the UN SDGs.EXAMPLES OF DPGsEntities can augment DPGs to enhance service delivery across areas in the public sector, such as health and social services. The DPGs listed below are a few examples that illustrate their abilities and how they can facilitate change, improving people’s lives worldwide. DHIS2This open-source platform is the world’s largest health management information system (HMIS), utilized by 76 low and middle-income countries and capable of supporting 3.2 billion people. DHIS2 software development is a global collaboration developed and managed by the HISP Centre at the University of Oslo (UiO).MOJALOOPThis open-source software enables digital financial service providers (DFSPs) to connect to each other, aiming to address the digital financial needs of 1.7 billion unbanked people globally in a profitable and straightforward manner. Mojaloop is ready to use in Tanzania and Uganda, with pilots being launched in other countries. It was first established in 2017 by the Bill & Melinda Gates Foundation to support its financial inclusion work. It is funded by the Foundation and has more than 400 developers collaborating on the software.SINGPASSThis digital identity authentication system is utilized in Singapore to give citizens access to several online government services, creating opportunities for innovation and economic growth. For example, users can use the platform to file taxes, renew their passports, and apply for housing grants. The platform’s ease of use and convenience help Singapore establish its national digital identity. Managed by the Government Technology Agency of Singapore (GovTech), Singpass is one of Singapore’s Smart Nation projects, with a vision to improve the lives of citizens, create opportunities for businesses, and transform the capabilities of government agencies.MOSIPIndia’s Modular Open-Source Identification Platform (MOSIP) DPG, as part of the government’s Aadhaar biometric identification program, supplied 1.3 billion people with a digital ID. Consequently, this allowed many unbanked individuals to open bank accounts. According to a 2019 Bank of International Settlements report, it would have taken 47 years for 80% of adults to open a bank account had India relied on traditional processes.MOSIP was first initiated by the International Institute of Information Technology-Bangalore (IIIT-B) with the vision of developing a non-proprietary platform on which foundational ID systems could be built. It became a global project five years later, funded by The Bill & Melinda Gates Foundation, Tata Trust, Omidyar Network, NORAD, and the Pratiksha Trust.COMMERCIAL OPPORTUNITIES FOR DPGsThe DPG market is in its nascent stage, and EY teams researched to evaluate and understand the commercial opportunity it poses for the private sector. EY estimates that the annual DPG market will be $100 billion by 2030, potentially growing further. The forecast shows a considerable and lucrative market for many players — spanning roles across the creation, implementation, and integration of DPGs.THE LOCAL DPG LANDSCAPEBased on a study done by the DPGA in March 2023 for six test countries, the Philippines ranked 4th in the number of deployed DPGs. With support from the DPGA, the United Nations Children’s Fund (UNICEF) Philippines is working to foster awareness in the Philippine technology sector about DPGs and identify promising solutions that could reach DPG status. Currently, the country has one registered DPG – Project AEDES.Project AEDES is a dengue data modeling portal by CirroLytix, a social impact tech company based in the Philippines, working with the support of the Department of Science and Technology. It is used to monitor dengue cases and is being implemented in select pilot cities and other countries with high cases of dengue and similar data challenges. The AEDES prototype is an information portal that forecasts dengue hotspots using correlations from dengue cases and deaths, real-time climate data, and satellite maps. The portal is also the first local tech solution assessed by the DPGA as a digital public good.Another related example is PhilSys, the country’s national identification system. PhilSys is not a DPG but an implementation of the DPG MOSIP, customized to become part of the country’s DPI. THE FUTURE OF DPGsDPGs provide countries with opportunities to build accessible, inclusive, and secure digital public infrastructure and to achieve the UN SDGs. DPGs could transform business, deliver significant economic and social value, and create a dynamic public-private sector. While there are implementation challenges that include limited financing, limited manpower, and concerns around market incentives and data security, the benefits of DPG applications are significant.Collaboration, information sharing, and education are vital for future DPG growth, but this will require coordination among diverse entities, including private-sector tech firms, experts, government agencies, and civil society organizations. Governments, the private sector, and relevant communities must work together to capitalize on DPGs’ abilities to address issues, innovate solutions, and improve lives. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Rossana A. Fajardo is the EY ASEAN business consulting leader and the consulting service line leader of SGV & Co.

04 September 2023

Anurag Mishra

How generative AI can reshape the financial crime landscape

Financial crime is estimated to cost $1.4-3.5 trillion worldwide. With sophisticated methods deployed by criminals, government, regulators, and law enforcement often play catch-up to maintain trust in the financial system. There is an increasing need for change and innovation to tackle financial crime. Generative artificial intelligence (GenAI) has transformative capabilities for organizations, with business applications evolving rapidly. The financial industry is an early adopter of technology and is witnessing the increasing application of GenAI in fraud prevention, anti-money laundering (AML), counter terrorist and proliferation financing (CTPF), and cyber security, collectively referred to as FinCrime.THE CASE FOR GENAI ADOPTIONGenerative AI (GenAI) can boost efficiency across AML controls, allowing individuals to play a more prominent role in detecting and preventing FinCrime. Different entities are experimenting with large language models (LLMs), with results underscoring opportunities for FinCrime operations. LLMs are a type of AI algorithm that uses massively large data sets and deep learning predictive techniques to understand, summarize, and generate contextual content. GenAI is not limited to text, but can be used to extract, analyze and classify data, and augment case summaries.GenAI can train on large real-time data sets that include both normal and anomalous transactions, and can then perform statistical analysis to determine what is normal and what is anomalous.GenAI models can analyze behavioral data and process enormous amounts of customer transaction history to identify unusual events. Different fraud detection models can be evaluated to proactively detect emerging fraud patterns. GenAI can automatically flag a suspected fraud when deviations are found and trigger a case examination. This reduces the manual effort required to retrieve, analyze, and present case summaries for decision-making.Think of GenAI augmenting case examiners to detect fraud as it occurs, make faster and value-making decisions to prevent fraud, and reduce human error and biases.It is much easier to personalize fraud detection models to customer personas with GenAI. This not only allows for a personalized banking experience but also makes it harder for criminals to scale and exploit weaknesses in the system. Eventually, GenAI can generate insights to strengthen FinCrime controls. This helps banks stay ahead of the curve, detect, and prevent fraud.Malicious fraudsters are also employing GenAI technology to launch highly personalized and specific attacks on their victims. For example, fraudsters could use GenAI to analyze publicly available information and simulate fake accounts, e-mails, and calls. As such, the technology can also increase individual and organizational vulnerability and susceptibility to fraud.In the complex, digitally connected world, FinCrime poses systemic risks to the global economy. Business leaders can stay abreast of potential risks and respond with the power of GenAI to fight FinCrime. TURBOCHARGED FINCRIME CAREERSFinCrime operations are currently overly complex and manual. Detecting and preventing FinCrime is an onerous task compounded by complex policies, legacy technology, and inaccurate, voluminous and unstructured data. However, with GenAI, FinCrime roles are being elevated to the equivalent of the superhero status of saving the world in the following ways:• Auto-detection of FinCrime will reduce manual effort.• GenAI-generated case summaries will reduce manual effort and allow focus on investigation and decisions, solving and preventing FinCrimes.• Automated monitoring removes stress and allows focus on decisions and actions.• Remove the siloed view of fraud. Transactions occur across different product types, instruments, and modes. With GenAI, it’s possible to have one collaborative, informed view of customer and rogue transactions that are in deviation.• Regulatory changes and policies can be easily applied across customers, products, and modes of banking. Less time is required for compliance reporting to regulators.• Anxiety of human oversight gets eliminated with better insights and traceability.• Generates high-skilled jobs based on the interpretation of insights and faster augmented learning.• Better risk assessment, response, and efficient management.• Greater adaptability to changing strategies of criminals and fraudsters, ensuring trust in the financial system.GenAI can supplement risk assessments and detection. While FinCrime experts will still have to manage the output produced, they will have more tools and information to analyze the results, detect FinCrime, and safeguard against risk.While the technology significantly enhances organizations’ capacity to respond to FinCrime, employees and leaders should train on new skills, embrace collaboration of AI with humans to turbocharge outcomes and learn to deal with ethics, fairness, privacy, and AI-related bias and concerns.THE FUTURE OF FINCRIME AND GENAIFighting FinCrime was hostage to intrinsic human inefficiency, manual errors, and administrative burden. However, GenAI is empowering FinCrime fighting efforts with unprecedented speed and effectiveness. By utilizing LLM tools, professionals can seize opportunities to strengthen and expand the field.While GenAI has considerable promise, it may take time for specific industries to adopt the technology on a large scale. Consequently, organizations should delineate ethical considerations and data protection policies to safeguard their assets while capitalizing on the technology’s power.As FinCrime continues to evolve, business leaders must find the balance between efficiency and effectiveness, especially when dealing with risk. Organizations must be vigilant and utilize novel tools and technologies to adapt to and safeguard against the evolving digital landscape. Companies can remain competitive in the global market by seeking the advice of professionals with a deep understanding of FinCrime and AI and identifying GenAI-related opportunities and risks. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Anurag Mishra is a Financial Services Organization Technology partner of SGV & Co.

28 August 2023

Alden C. Labaguis

Megatrends impacting indirect tax

Indirect taxes, such as value-added tax (VAT) and customs duties, are the types of tax that may be shifted or passed on to the buyer, transferee or lessee of the goods, properties, or services. Indirect taxes are levied on goods and services (or consumption), whereas direct taxes are imposed on income and profits. Governments are now turning to indirect taxes to fill their revenue gaps as a result of the pandemic’s severe budgetary pressures.In a challenging year for the global economy, trade, transformation, and sustainability are three megatrends influencing indirect tax policy. While these megatrends are pressuring indirect tax teams to be flexible, use technology to adapt, and do more with less, these trends also provide opportunities for indirect tax and customs functions to help their organizations succeed.Indirect tax is receiving more attention as a result of global economic and geopolitical challenges. VAT/sales tax, excise and customs duty, and environmental taxes are becoming more demanding on a global scale. Governments are also leveraging tax and customs policies to advance political objectives and promote change in fields like sustainability.This has resulted in significant legislative change, additional obligations, and an increased emphasis on technology to support tax and customs compliance processes. Effective indirect tax management is more important than ever to control cash flow, costs, and the risk of audits and legal action from tax and customs authorities.TRADE DISRUPTIONGlobal trade and supply chain activities are inextricably linked to indirect taxes, which are significantly impacted by changes in the way businesses conduct their operations. Changes in these taxes could also significantly impact the supply chains of businesses.The disruption of trade has been a recurring trend in the last year; contributing factors include the war in Ukraine, the ongoing consequences of the pandemic, trade conflicts, new trade agreements and alliances, and a quickly changing regulatory environment. However, the trade function has never had such a strong opportunity to improve the performance of the company or been in such a strong focus than now.Indirect tax and customs functions can take action in the face of geopolitical uncertainty to remain agile while navigating disruptions, including driving out unnecessary duty costs, concentrating on cash flow, delivering cost-efficient tax processes, and using data analytics to compare indirect tax costs and opportunities from new supply chains.In the Philippines, in addition to the tax authorities’ resumption of audit investigations, there is an additional challenge of simultaneously managing the customs authorities’ intensification of post-clearance audits — which are geared towards sustaining increased revenue collection even after clearance of imported goods at the border. TRANSFORMATIONRising complexity, regulation, as well as the competition for talent are contributing to transformation, but technology is the main motivator. Tax and customs authorities all over the world are quickly embracing technology and automating manual procedures. They are demanding real-time transaction data, and several jurisdictions are starting to employ e-invoicing and real-time reporting. In the Philippines, this is consistent with the tax authorities’ adoption of the electronic invoicing and receipting system, which requires certain taxpayers to electronically report their sales data. Upon establishment of a system capable of storing and processing the required data used by electronic point-of-sale systems, certain categories of Philippine taxpayer will be required to use such electronic systems.In a mid-year report, Philippine customs authorities showed they are not far behind, highlighting programs focusing on digitizing customs processes, revolutionizing operations, and enhancing trade facilitation. Advanced information communication technology projects are lined up for implementation, such as automated export declaration and overstaying container tracking systems, among others.As a result, tax and customs authorities will have increased visibility on how businesses operate on a day-to-day basis, placing additional responsibility on corporations to enhance their data collecting and management. This frequently necessitates identifying data across the company and even throughout the supply chain as new taxes and reporting requirements are implemented.These demands are being made at a time when tax departments are under greater pressure to increase efficiency and provide genuine value. Along with effectively utilizing current technology, indirect tax teams must assess the need for extra resources and determine the right balance of in-house and outsourced work for their organizations to satisfy these demands.In order to help drive transformation within their own organizations, indirect tax and customs functions must become future-proof by implementing a data strategy, harnessing the right technology to support their operating model, creating a tax governance structure that defines responsibilities, considering a centralized approach to VAT management, and using the implementation of tax policies to address long-standing data issues.SUSTAINABILITYGovernments, businesses, and individuals around the world are prioritizing climate catastrophes and the need to safeguard the environment and human health. Governments are relying more on indirect taxes to support their environmental, social, and governance (ESG) initiatives, and indirect taxes are raising revenue to help fund green policies. New green taxes are also motivating people and companies to make the necessary changes in order to achieve sustainability goals.The functions of tax and customs are put under pressure by ever-evolving tax and customs regulations. They need to be aware of the taxes that are applicable to their companies, how to comply with their commitments, and how to account for them in costing and supply chain choices. As an example, they can assist in lowering expenses, reducing compliance risks, and finding opportunities for grants and incentives to finance green investments.Indirect tax and customs functions should consider understanding their organization’s plans to achieve its climate ambitions and get involved, as well as measure the impact of sustainability taxes and related policy measures on operations. Other key sustainability actions include identifying tax credits, grants, and incentives that will support the organization’s green agenda, assigning clear responsibilities, assessing exposure and liaising with relevant stakeholders within the value chain, and planning and implementing responses to the new measures impacting the business.THRIVING IN TRYING TIMESLeaders in indirect tax have never had a better chance to add more value to their organizations. By utilizing their abilities, creating connections within the organization, and utilizing innovative technology, they can bring about positive change and produce significant results.It is imperative that they take into account the bigger picture and how the megatrends of global trade, transformation, and sustainability affect the indirect tax function. This will allow them to better frame the indirect tax issue inside their organizations, navigate hurdles, and seize opportunities that will benefit the whole organization and allow it to thrive instead of merely surviving in trying times. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Alden C. Labaguis is a tax principal of SGV & Co.

21 August 2023

Christian G. Lauron

How generative AI creates value for financial services

The artificial intelligence (AI) landscape is constantly evolving, and large language models (LLMs) have gained global traction for their bespoke capabilities. Notably, ChatGPT reached 100 million users merely two months after its launch, making it the fastest-growing application in history. These developments showcase generative AI’s abilities, pushing the boundaries of what technology can do with text and language.However, the utilization of LLMs is controversial and has been the subject of debate among academia, regulatory bodies, and the general public. Skeptics point to hallucination as a significant drawback of AI models, which would be pronounced in cases where the model provides responses based on pattern recognition rather than reasoning. Various entities have urged the government to hasten AI-related regulation in response to the extensive adoption of generative AI models. Moreover, there are significant concerns with privacy, security, trust, and reliability. There is a serious threat of ‘model collapse’ when the knowledge base underpinning generative AI systems is inundated with imperfect information, deliberate misinformation, and uncontrolled synthetic data. The proverbial GIGO is at play — garbage in, garbage out.Despite these apprehensions, generative AI is a comprehensive technology that can transform work for different sectors. Corporations have been rapidly spending on AI, with several industries investing considerable time, money, and resources. While some organizations are moving at a steady pace, others have shared a multiyear commitment to integrating this technology across their functions. While there are sectors that find the current imperfections of generative AI unacceptable, there are those, such as financial institutions, that have actively experimented and deployed use cases in lower-risk areas.THE VALUE PROPOSITION FOR FINANCIAL SERVICESWhile banks and financial institutions have already been utilizing AI applications for different areas like credit risk and fraud, generative AI could further enhance other services, streamlining a broad array of business functions and uses that can elevate core offerings. Several applications and functions are suitable for AI adoption, including customer marketing, insurance claims processing, and financial planning. Internal services like application development, compliance monitoring, and maintenance also have potential.Technological advancements help expand business-use cases, particularly when dealing with unstructured data like text. Thus, organizations can create or refine business content using generative AI’s ability to query data in a natural, humanlike manner. However, the technology is still in its nascent stage, meaning AI should be synergized with human expertise to generate accurate insights and create long-term value.OPERATIONAL EFFICIENCY AND AUGMENTED INTELLIGENCE Financial services firms could slowly integrate AI in lower-risk areas like augmented intelligence and operational efficiency to minimize risk. Differing views have tempered AI adoption, but organizations have been experimenting with various use cases due to the technology’s reported benefits and strengths. To retain their competitive positioning, firms should assess and leverage AI in controlled environments.Operational efficiency involves enhancing productivity and reducing costs by automating tasks like information categorization, review, and synthesis. On the other hand, augmented intelligence entails assisting experts by providing content, insights, and recommendations for clients.CROSS-FUNCTIONAL CAPABILITIESIn the following areas, AI can support operational efficiency, reallocating human effort to other critical tasks:Tax and legal. Augment tax file generation, streamline contract organization and refine diligence processes for legal teams.Product, technology and IT. Create new product or service functionalities, generate natural-language-based code blocks and make test cases for evaluating code vulnerabilities.Risk and compliance. Map risk controls with corresponding regulations and flag missing disclosures or regulatory risks like fair customer treatment and sales practice concerns.FUNCTIONAL SOLUTIONSGenerative AI can also be leveraged in the following functions to streamline operations and innovate new ways of doing business:Chatbots and virtual assistants. Provide tailored, end-to-end support using natural language. Specialists can configure this functionality based on internal or external knowledge or information, subject to the organization’s discretion.Knowledge management and generation. Appropriately sift through and retrieve institutional knowledge and intellectual property. Organizations can utilize generative AI to augment and create content based on internal or external knowledge databases.Document intelligence. Execute advanced information extractions from unstructured or semi-structured data formats. The process can also focus on specific attributes and elements or generate insights from available information.THE FUTURE OF AI IN FINANCIAL SERVICESGenerative AI has the power to transform businesses. For financial services firms, transformation entails capitalizing on the technology’s strengths while managing the corresponding risks. Successfully creating value from AI involves a synergy between the latest technology and an organizational culture that invests in various capabilities and develops a framework for risk management.The financial services sector has a head start with deploying generative AI, given its experience with navigating AI-related regulation. Hence, many financial institutions have become market leaders in devising an AI governance framework, which includes setting policies, standards, and procedures. In the same vein, other industries and organizations should address critical areas like AI governance and oversight frameworks when integrating this technology into their operations.Lastly, effective board governance is crucial for the management of generative AI.While these practices will need to be polished and redefined, financial services institutions should use this time to identify and invest in potential applications for the technology. Organizations that successfully integrate generative AI into their organizational makeup can differentiate themselves and remain competitive. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Christian G. Lauron is the Financial Services Organization (FSO) leader of SGV & Co.

14 August 2023

Lee Carlo B. Abadia

Transforming with AI

The science for artificial intelligence (AI) has been around for almost a century. Although the concept of AI can be traced back to ancient stories from Greece and China, AI practitioners have only actively achieved significant progress within this century. The approach to applying AI has been continuously refined, from using symbolic or classical AI that is based on embedding knowledge and creating rules, to progressing statistical AI which involves pattern recognition, probabilities, and learning. Nonetheless, the challenges encountered in applying AI have forced renewed thinking among practitioners.With computing power increasing exponentially over the years, the discipline of AI now has an explosive opportunity to grow whatever the approach may be, but largely towards practical use cases. In addition, the growth of AI would not be centered solely around creating robots that think and behave like human beings, as is often portrayed in movies and books. Instead, it will revolve more around how it can fulfill specific objectives as agents in various forms to help humans achieve their work. This is where the current boom is coming from, but this unfortunately also raises concerns related to how AI may replace some jobs. On the other hand, there also are many who are actively pushing and exploring the possibilities for AI to make work more efficient for people.In the recent EY Tech Horizon report, where about 1,600 companies across the globe of varying sizes were surveyed quantitatively and qualitatively, respondents reported that AI and machine learning will be a significant part of their top technology investments within the next two years. AI can be considered a foundational technology, along with data and analytics, the cloud, and the Internet of Things. By combining these four as part of their technology strategy, organizations gain a good foundation to execute a tech-enabled transformation. As AI continues to gain more traction in development and adoption, however, its prominence as an expected technology stack will likely increase.CHALLENGES IN AI ADOPTIONThe recent Forrester’s Global AI Software Forecast predicted that off-the-shelf and custom AI software spend will double from $33 billion in 2021 to $64 billion in 2025. Moreover, AI software is projected to have an annual growth rate of 18%, which is 50% faster than the overall software market. However, based on one IDC survey, only 22% of organizations in 2022 reported that AI was implemented on a large scale in their enterprises.For all the reports around how AI will be a priority for investment and implementation in organizations, we have yet to see it leveraged at scale to transform businesses. This poses the question — why is AI, which is clearly a top-of-mind technology around the world, seemingly unable to make a strong breakthrough?A key challenge for widely adopting AI across an enterprise is the typical bottom-up approach taken by organizations. It often starts with technical teams building portfolios of projects on piloting AI on specific processes only, which is disconnected from the wider business. This creates siloed solutioning and tends to put the burden on technical teams to foster the business cases for AI to incrementally secure more funding. This also means that solutions may not look holistically at how the business works and can lead to an incoherent approach to delivering value across functions. This incoherence can lead to leadership and teams being disillusioned with what AI promises to deliver.Maximizing the potential of AI requires a refreshed approach. Businesses should include this as a strategy from the top to help differentiate themselves from competitors while simultaneously becoming more resilient to disruptors in their industry. Chief Executive Officers (CEOs) should drive the change in culture towards AI and align with their Chief Information Officers (CIOs) towards championing the importance of technology in meeting organizational goals.This means that there should not be a separate technology strategy, but one embedded into the business strategy itself. This approach can help answer questions such as whether AI allows the organization to enter a new market or re-imagine its business model. This will ensure that investments in technology will align and help meet the vision of the organization.LEVERAGING AIAs early as the 1970s, one of the first recognized knowledge systems (classical AI approach) was MYCIN. This system was intended as a doctor’s assistant refined over a period of five years and was designed to give input and explanations about blood diseases based on blood tests.The use of AI has since been developing across various industries and businesses should be more aware of how it can be deliberately leveraged while being driven by an organization’s leadership. The most common use is enabling it as a recommendation engine for online retail or search, which by now should start being a standard for most online stores.Fast forward to now: machine learning (statistical AI) can help identify diseases in medical surgery, from CT scans used to detect lung cancer to eye photographs to check for diabetes. Another example is in smart farming, where crop scanners and drones collect images and analyze them to determine if more water, pesticide, or fertilizer is needed. In short, regardless of the industry, AI can drive innovation to help humans.AI can clearly help enable CEOs innovate, but with it comes the responsibility of proper implementation. There are issues such as data privacy, embedded biases, and accountability in deploying this technology. While the strategy is defined from the top, along with it comes the necessary governance to help safeguard the organization from its risks. In 2023, seven leading AI companies in the US have agreed to voluntarily implement safeguards on AI development. They have committed to establishing new standards for safety, security, and trust for the technology.Being familiar with these movements can help business leadership navigate where to plan for AI adoption, and check for readiness on how to address potential regulations in their industries.EMBRACING THE IMMINENCE OF AIWe have come to a point in history where AI can be deployed as a day-to-day technology. This was made possible because the science now focuses more on specific use cases rather than creating general AI that strives for human-like intelligence. AI is going to be an imminent part of how businesses will be run today in the same way that machines in the industrial revolution moved workers from cottage industries to industrial factories and introduced new skills for people.CEOs must embrace this imminence and can do so by intentionally including this in their high-level strategy, understanding how the technology can be applied today, upskilling employees to work with AI, and more importantly being proactive on internal governance and external regulation. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Lee Carlo B. Abadia is a technology consulting principal of SGV & Co.

07 August 2023

Aris C. Malantic

Reframing the CFO role

In today’s fast-evolving business environment, chief financial officers (CFOs) face myriad challenges such as driving long-term value, finding short-term cost efficiencies, and reinventing the finance function while grappling with complex and conflicting expectations from stakeholders.According to the 2023 Global EY DNA of the CFO report, CFOs and finance leaders have the potential to unlock more value if they can adeptly address three fundamental paradoxes within the CFO role: balancing near- and long-term investment priorities, balancing risk with innovation and transformation, and balancing the evolving CFO role with traditional skill sets. This article examines these issues using insights from 110 respondents in Southeast Asia, including finance leaders from the Philippines, Indonesia, Malaysia, Singapore, Thailand, and Vietnam.NEAR- AND LONG-TERM INVESTMENT PRIORITIESSome 84% of the Asean finance leaders surveyed say that the current market environment is putting increasing pressure on finance leaders to drive cost efficiencies and hit short-term earnings targets. This results in finance leaders having to pause or cut spending so that they can meet short-term earnings targets in areas that are also priorities for long-term value.The Asean respondents in the study rate the top three investment priorities driving long-term value as: technology and digital innovation (57%), ESG programs (50%), and customer experience and product and service offerings (47%). At the same time, more than 30% say they are pausing or cutting spend in these areas to meet short-term earnings targets.While balancing long-term with short-term priorities is a collective effort, 65% say that there are disagreements and tensions within their leadership team on how to balance these priorities. A CFO with the influence and credibility to challenge the CEO and executive team will likely be needed to build consensus, but finance leaders are not always prepared to do so. Only 38% of the respondents say they always speak up when they have a differing opinion from the consensus when the executive team is deciding how to balance short- and long-term priorities. For CFOs to effectively influence the executive team’s decision-making, the top two attributes identified are: using data-driven insights to inform decisions and trusted relationships with the board or key investors.BALANCING RISK WITH INNOVATION AND TRANSFORMATIONAsean CFOs are building digitized finance functions to drive long-term and sustainable growth. They identified the following top three priorities to transform their finance function over the next three years: technology transformation (such as transforming IT architecture, building cybersecurity resilience, and modernizing core finance technology), sustainability (such as building skills and capability in ESG data controls and assurance), and advanced data analytics (such as unlocking the value of financial and non-financial data to transform decision-making). However, only 17% of respondents say they deliver “best-in-class” performance when it comes to assessing how their finance function today performs against these priorities.Even though there is significant room for improvement, only 14% of respondents are making holistic and bold changes to transform their finance function. This could indicate potential tension in the CFO’s mindset: a conflict between a risk-averse nature versus the need to embrace greater risks associated with an ambitious vision for a leading finance function.BALANCING THE CFO ROLE WITH TRADITIONAL SKILLSThe survey also reveals a difference in the long-term career goals of respondents: 42% say the CFO role is their long-term goal, while 48% aspire to an even greater CEO role, whether in their current organization or in another. This aspiration to be CEO raises two key considerations: the need for finance leaders to elevate their skills, and the importance of developing the next generation to fill the CFO role when incumbents move to a CEO position.The respondents identified two key challenges in achieving their priorities: finding time to build knowledge and expertise through exposure to external expertise and thought leadership access, and managing a wide range of operational responsibilities, including IT and HR. These challenges can be interconnected — as CFOs expand their operational responsibilities, they need to expand their knowledge beyond finance by acquiring skills in fields such as HR and marketing. However, their busy schedules may hinder their ability to invest in building this knowledge.The evolving expectations for CFOs to expand their knowledge in other domains highlight a shift from domain expertise toward inspirational and strategic leadership skills, going beyond traditional finance skill sets. The study also highlights the importance of highly developed emotional intelligence and experience in people issues like diversity and well-being, which was chosen as the most critical attribute for the successful CFOs of tomorrow.At the same time, incumbent CFOs must prioritize developing the next generation of leaders. Asean finance leaders feel that they perform well here, especially when it comes to mentoring — as much as 64% say they are investing enough time in mentoring aspiring senior finance leaders.REFRAMING THE CFO ROLE FOR THE FUTUREAs CFOs confront the abovementioned issues, they should consider the following:Create value for the whole organization. CFOs must articulate a comprehensive strategy that maximizes long-term value while being supported by short- and medium-term objectives. They must also provide data-driven insights to support the organization’s strategic objectives and build relationships with C-suite colleagues and senior leaders.Drive the performance of the finance function. CFOs need to drive cultural change across the finance team to elevate the performance of the finance function. This can mean embracing new mindsets and incorporating cultural goals into leadership and incentives. Also, they can consider revising hiring, development, and upskilling approaches to future-proof finance skills. This may require assessing the current workforce to identify gaps and surpluses and implementing an appropriate workforce strategy.Achieve career ambitions while developing future CFOs. CFOs should focus on achieving their career aspirations while also nurturing the CFOs of tomorrow. External stakeholder engagement is imperative for gaining invaluable insights into market challenges, as is collaboration with the Chief Human Resources Officer for robust succession planning and training of potential candidates.By taking these areas into consideration, CFOs can help lead their organizations and deliver better performance, positioning themselves for success in the future. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) leader of SGV & Co.

31 July 2023

Aris C. Malantic

Effects of climate-related risks on financial statements

In our last article, “IFRS S1 and IFRS S2: Game changers in global sustainability reporting,” the author discussed the first two global sustainability reporting standards published by the International Sustainability Standards Board: IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures. These standards can be game changers by helping companies identify material sustainability risks and opportunities that will help investors, lenders, and creditors assess the entity’s resilience against changes and uncertainties driven by sustainability-related issues. In response to these new disclosure standards, the International Accounting Standards Board (IASB) republished in July 2023 a document on the effects of climate-related matters on financial statements.Due to the ubiquitous effects of climate change, there is an increased focus on the measurement and disclosure of climate-related matters in an entity’s financial statements. In effect, investors and stakeholders are keen to understand the potential impact of climate change on an entity’s business models, cash flows, financial position, and financial performance.While International Financial Reporting Standards (IFRS) do not explicitly touch on climate-related matters, businesses must consider the latter in preparing their financial statements when the effects of those matters are material. The determination of the effects of climate change on an entity’s financial statements may require significant effort and judgment.At a minimum, entities are required to follow the specific disclosure requirements in each IFRS standard. Entities may need to provide additional disclosures in their financial statements to meet the standards’ disclosure objectives. Hence, in determining the extent of disclosure, entities are required to carefully evaluate what information is required for users to be able to assess the effects of climate change on their financial position, financial performance, and cash flows.Key points for entities to consider are summarized below:Going concern, sources of estimation uncertainty, and significant judgmentsAs a major source of estimation uncertainty, climate risk could add complexity to the application of IFRS. Entities have to consider uncertainties associated with future climate-related developments when assessing an entity’s ability to continue as a going concern. They should therefore ensure they make the relevant disclosure of assumptions and estimates. Those disclosures must be entity-specific and avoid using boilerplate-type or generic language. Entity-specific disclosures include quantifiable information about assumptions, if relevant, and explanations of deviations from known market expectations regarding the same assumptions.If relevant, quantified sensitivity disclosures should be made to illustrate the uncertainty embedded in the estimates relied on by entities. It is also important that entities stay consistent in both the disclosures about climate-related matters outside the financial statements (e.g., in separate sustainability reports or management commentaries) and how they incorporate climate risk in the financial information (e.g., in measurements and disclosures in the financial statements). Long-term climate risk impacts should also be considered when assessing the uncertainty associated with an entity’s ability to continue as a going concern.InventoriesClimate-related matters may cause inventories to become obsolete, selling prices to decline, or costs-to-complete to increase. This may result in inventories needing to be written down to their net realizable values.Income taxesAn entity’s estimate of future taxable profits may be impacted by climate-related matters, resulting in the entity being unable to recognize deferred tax assets. The entity may also be required to derecognize deferred tax assets that were previously recognized. Moreover, an entity may find that climate-related matters affect its future taxable profits potentially resulting in the entity not being able to recognize deferred tax assets for any deductible temporary differences or unused tax losses.Property, plant and equipment, and intangible assetsTo adapt business activities, climate-related matters may lead to a change in expenditures. An entity will need to determine whether these expenditures satisfy the definition of an asset and can therefore be recognized as either property, plant and equipment or as an intangible asset. Both IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets require entities to review the estimated residual values and expected useful lives of assets at least annually. For example, climate-related matters may impact both of these estimates due to legal restrictions, obsolescence, or asset inaccessibility. Additionally, estimated residual values, expected useful lives, and changes thereto will also require disclosure.Asset impairmentSignificant judgment may be required in determining the extent to which certain assets, processes, or activities will be impacted by climate-related business requirements and how climate-related risks and opportunities will affect an entity’s forward-looking information, such as cash flow projections in the prognosis period. Entities must consider what information users rely on in assessing the entity’s exposure to climate-related risks.Provisions/contingent liabilities and assets/leviesThe recognition and measurement of provisions, as well as the need for disclosure of contingent liabilities, can be significantly impacted by climate-related matters. However, under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, only the obligations arising from past events that exist independently of an entity’s future actions can be recognized as a provision. Due to the significant uncertainties involved in assessing the extent and impact of climate change, entities should ensure that sufficient disclosures are provided to allow users of financial statements to understand said uncertainties. Sufficient disclosures are also necessary to allow users to understand how climate transition has been taken into account in the measurement of a provision or disclosure of a contingent liability, and the assumptions and judgments made by management in recognizing and measuring provisions.Financial instrumentsClimate-related matters such as environmental calamities or regulatory change may affect a lender’s exposure to credit losses, affecting a borrower’s ability to meet its debt obligations to the lender. This makes climate-related matters potentially relevant in the calculation of expected credit losses if, for example, they impact the range of potential future economic scenarios or the assessment of significant increases in credit risk.Climate-related matters may also affect the measurement and classification of loans as lenders may include terms linking contractual cash flows to an entity’s achievement of climate-related targets. The lender will have to consider the loan terms in assessing whether the contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding. Those climate-related targets may also give rise to embedded derivatives that have to be separated from the host contract.IFRS 7 Financial Instruments: Disclosures requires entities to disclose the nature and extent of risks arising from financial instruments and how the company manages them. It may be necessary for lenders to provide information about the effects of climate-related matters on the measurement of expected credit losses or on concentrations of credit risk. For holders of equity investments, on the other hand, it may be necessary to disclose their exposure to climate-related risks when disclosing concentrations of market risk.Fair value measurementMarket participant views of potential climate-related matters, including legislation, may affect the fair value measurement of assets and liabilities in the financial statements. Climate-related matters may also affect the disclosure of fair value measurements where relevant, particularly those categorized within Level 3 of the fair value hierarchy.Since IFRS 13 Fair Value Measurement requires disclosure of unobservable inputs used in fair value measurements, those inputs should reflect the assumptions that market participants would use, including assumptions about climate-related risk.Insurance contractsSince climate-related matters can increase the frequency or magnitude of insured events, there may be an impact on the assumptions used to measure insurance contract liabilities. Similar to other areas, disclosure of the judgments made in applying IFRS 17 Insurance Contracts and relevant risks is required.Final thoughtsThe IASB document provides guidance to preparers of financial statements about the areas they need to consider in relation to climate-related matters. Although it does not introduce any new requirements, knowing how climate-related risks can impact financial statements can help remind its preparers about the scope of existing requirements in IFRS. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) leader of SGV & Co.

2023

Reimagining the digital supply chain

Navigating the supply chain maze

How digital transformation enables green energy

How can we harness digital public goods?

How generative AI can reshape the financial crime landscape

Megatrends impacting indirect tax

How generative AI creates value for financial services

Transforming with AI

Reframing the CFO role

Effects of climate-related risks on financial statements

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