Reporting Model – A Time for Change?

Published September 2012

The term 'responsible capitalism' has entered mainstream discourse following the economic crisis and its protracted fallout, bringing into sharp focus the major question of sustainability of policies and strategies in a world of diminishing resources.

Business is now cast as a force for sustainability. Stakeholders hold high expectations of business and demand much higher standards of transparency, disclosure and dialogue on how sustainability is being integrated into business strategies and management approaches.

There is a growing consensus that improved corporate transparency and effective disclosure on matters both financial and non-financial in corporate reporting must be achieved.

Paying for nature's services

An alarming statistic presented by the United Nations Environment Programme in its study entitled 'the Economics of Ecosystems and Biodiversity' is that the world is losing up to US$4.5 trillion worth of natural capital each year as a result of urban development, land change, resource consumption, pollution and climate change. Roughly 60% to 70% of the world's ecosystem functions are degrading faster than they can recover.

Policy makers are becoming more aware of the economic value of natural capital and are looking for mechanisms to create market-based incentives to appropriately value and protect natural capital. In the private sector, global businesses are making some efforts to value natural assets and services as part of their operating model. There is a considerable challenge in determining appropriate valuation and accounting models, and achieving consistency across industries and economic sectors.

Failure to redress this balance and preserve economically viable ecosystems will have potentially catastrophic consequences in such fundamental areas as timber regeneration, crop pollution, pest and disease control and water filtration.

The pressures with regard to commodity supply and price equilibrium will impose a massive burden across all business sectors and society in general. Many businesses will face ultimate failure and the consumer could likely be confronted with challenges not previously experienced.

The major question for investors and other stakeholders is how to identify, evaluate and select those businesses which are most economically viable and attractive as investment and/or business partner propositions. There is open debate about the role of business in society and businesses can either lose or gain trust with corporate and civil stakeholders depending on their business strategy, management approach and clarity of communication.

The value of extra-financial disclosure

A recent report commissioned by the Global Reporting Initiative (GRI) and the Accounting for Sustainability Project (A4S) explores how investors and analysts source, use and are influenced by so-called 'extra-financial information' which includes Environmental, Social and Governance (ESG) information and other non-financial information. The research is based on a global survey of investors and analysts, with 68% identifying themselves as being engaged in Socially Responsible Investment (SRI). The majority deem extra-financial information as very relevant to investment decision-making and analysis.

Some of the more interesting findings from the survey are:

• Governance is highlighted as being particularly important for investors and analysts - both rating it highest of their priorities. Natural resources are identified as being important to analysts and SRI investors, but less so to mainstream investors
• There is a strong preference for information sources which are more comprehensive and specialised, such as the governance and sustainability reporting information available on corporate websites
• There is also a strong preference for linear formats, with the on-screen PDF being the most preferred, compared to other more sophisticated digital formats, such as dedicated micro-sites
• Nearly half of the investors and analysts state that direct engagement with the CEO or CFO is very likely to influence their investment decisions or company analysis
• Nearly all state that integrated reporting will be useful for increasing the reliability, accessibility, relevance and comparability of extra-financial information as well as improving assessments of future company performance
• The majority find it difficult to compare and benchmark social information, possibly hindering its use in investment analysis
• Investors and analysts do not rely much on the content of limited assurance statements, but would value some form of positive assurance by external assurers

In seeking to contribute to fresh insight into an important debate, the research partners hope to influence how corporates report extra-financial information

Integrated Reporting Framework

A positive step on the way to improving corporate reporting is the publication by The International Integrated Reporting Committee (IIRC) in July of its Draft Framework Outline, moving towards publication of the actual framework in late 2013. The document is high-level but does establish for the first time the basic structure of the Framework and demonstrates the continuing intent of the IIRC to achieve its objectives.

The South African experience is likely to be a significant contributor to Framework development, with South Africa being the only jurisdiction where integrated reporting is already mandatory and has been a requirement for corporate reporting in 2010-2011. A recent research report by the Association of Chartered Certified Accountants (ACCA) based on analysing the corporate reports of ten major South African companies comments on some of the more significant findings, including:

• Integrated reporting sees significantly more social, environmental and ethical information in reports, appearing in more places throughout the report which may sometimes be excessive and undermined by repetition
• Some of the major reporting impacts are the crucial importance of materiality with an increasing tendency towards quantification, the emergence of new reporting items and new sections in reports, and the increasing integration of social, environmental and ethical considerations into corporate governance structures
• Companies have shifted from reporting that is aimed exclusively at their shareholders to reporting that expounds the directors' claimed belief in stakeholder accountability and stakeholder engagement

A telling comment in the report is that while the concept of integrated reporting should embed sustainability in the heart of the primary corporate reporting vehicle, the annual report, this does not necessarily imply that the reporting will either fulfil its potential for transforming corporate behaviour or that it will not produce empty rhetoric. Nonetheless, there is a firm belief that integrated reporting is moving in the right direction of improving transparency of information and effectiveness of disclosure - how it is dealt with in practice by companies is the key to its success.

The UK has moved to recently publishing a draft of its Greenhouse Gas Emissions (Disclosure) Reporting Regulations 2013, which proposes that a process will commence in 2014 where it will over time be compulsory for companies to include emissions data for their entire organisation in their annual reports. This is at the leading edge of European regulatory development in the area which will pose technical challenges for accounting, valuation and disclosure in the coming years.

Businesses need to consider how they can maintain growth and sustainability while becoming less reliant on scarce natural resources. Business leaders should seek to analyse their companies' reliance on natural resources and consider how this reliance could become a factor in the long term viability of their operating models.

The ability to communicate key messages effectively will call for quality disclosure with regard to ESG factors, seeking to use industry benchmarks and reporting methodologies, developed in collaboration with industry partners.

Interesting and challenging times lie ahead. Businesses that invest resources in maintaining awareness of developments and adopting leading edge reporting practices are likely to benefit from investor and stakeholder loyalty and continuing development.

First published in Finance Dublin Online.