July 16, 2018

Integrated Reporting

Singapore Stock Exchange Weighs Mandatory Sustainability Reporting

This story is republished from CFOZone, where you’ll find news, analysis and professional networking tools for finance executives.

Moves are underway around the world to define and mandate reporting on the sustainability of companies’ operations. Using the aftermath of the crisis as a cover, securities regulators, industry bodies such as FASB and IASB and investor groups are looking at how companies can usefully report on the sustainability – environmental, operational and financial – of their businesses.

The latest move comes from Singapore where the stock exchange SGX has issued a policy paper on whether or nor to mandate sustainability reporting for all companies listed on the exchange. The policy paper calls for expressions from the public prior to a deadline of October 29. SGX does not say whether or not it will introduce mandatory sustainability reporting, but it hints that it might.

“Investors who lead world opinion expect listed companies to be accountable for their financial results, how they achieve the results, and what impact they have on the communities within which they operate. SGX encourages more listed companies to commit to sustainability practices and reporting,” it says in the preamble to the policy document.

The move comes a few weeks after the creation of the International Integrated Reporting Committee (IIRC), a working group of companies, investors and industry bodies to find ways to improve corporate reporting.

The scope of the IIRC is wider than sustainability, but sustainability is nevertheless likely to form a major part of any upheaval in the reporting process. Indeed, no less a body than the G20 has said that it wants changes to the global system of reporting so that all company reports follow the same global standard. Such an overhaul is likely to be very protracted. But in the meantime, it looks as if sustainability reports will form part of the eventual package. CFOs who are still behind the curve had better start planning now.

Integrated Reporting Will Gain Momentum as Banks, Private Equity Increase Their Focus on ESG Issues

In the first part of our conversation with Michael Krzus, co-author of One Report, Integrated Reporting for a Sustainable Strategy, we discussed the nature of integrated reporting, how it will change corporate reporting as it is commonly known and some of the benefits to both stakeholders and companies.

The second part of our discussion looks at how small and midsize entities will benefit from integrated reporting, the feedback received from clients, and what the future holds.

Going Concern: Do you see a point in time when companiessults for sustainability issues on a reoccurring basis similar to quarterly earnings reporting?

Michael Krzus: I know enough about this to be dangerous, so I’ll give you that caveat, but I am aware of the somewhat recent EPA rule making that is going to require companies to report emissions and things of that nature. There are some limitations, but there will be more frequent reporting for U.S. domiciled companies. I think some of it will depend on the technology available. I don’t know what it takes for a coal-fired electric plant to account for CO2 emissions. So I’m not really in a good position to tell you that in five years whether that will evolve into more regular reporting or not.

GC: What kind of companies will be able to utilize integrate reporting? Can any size company embrace it or will it start with the largest players and work its way down?

MK: As a practical matter, it will have to be large, public traded companies, particularly the global players. On the other hand, I think small and mid-cap companies, especially private ones, have as much or more skin in the game and a lot more upside than the big guys. And that’s because of the complexity of information and the complexity of accounting standards. If you’re Microsoft, you’ve got a lot of issues that can be addressed by your large accounting department but if you’re a $400 million manufacturer of widgets, you don’t have those kind of resources. But you do want to tell stakeholders your story clearly and succinctly. I think the idea of the integrated report gives them the opportunity to do that.

Additionally, in the last couple of years, I’ve developed a good working relationship with the Society of Investment Professionals in Germany and one of the things that group has done is build example reports of what an integrated report could look like for a small or mid-cap sized company. If you think about it from the German perspective, much of their market base is small and medium sized companies and analysts there are very interested in the benefits that an integrated reporting can provide. So, there’s a lot upside for companies that fall outside the Fortune 500.

GC: Do you see a point in time where banks start requesting more non-financial information (i.e. ESG information) in order to qualify for lending?

MK: The short answer is “Yes.” To me, sustainability really has to do with long term viability of an entity. I don’t think a company can be viable for the long term without understanding and managing their environmental, social and governance risks because those three risk types specifically translate to reputation.

To some degree a lender will have to start considering non-financial factors. The price of admission is opening your heart and soul, as a company, to the banker. A banker can ask all kinds of question whether its about CO2 emissions or manufacturing location in Thailand that may cause child labor problems because you’re running a sweat shop.

To parallel that, I recently attended a conference of institutional investors. I found it interesting that a group of people that wanted to know more about integrated reporting were private equity folks. These private equity people are in the same boat as the bankers. If they are going to make an investment, they will open up everything. It’s not just about getting the 10-K, it’s about understanding everything from financial projections and processes to social and environmental risks in China. So, the markets in general, not just bankers, but also private equity and traditional sources of capital have become more and more interested in a broad set of non-financial information.

GC: What has been the experience with clients?

MK: Clients have assisted us by presenting challenging questions to help us think more clearly about the situation. For example, some people have argued that we don’t need integrated reporting because the markets are efficient and already have all the information they need. I would argue that, even without the events of the last couple of years, markets aren’t efficient and don’t have all the information they need because we have so many firms employing armies of analysts, all of who are looking for that shred of information that will give their company an edge. There’s always something that the analysts don’t have.

Another argument is whether or not the integrated report somehow diminishes the corporate responsibility report. My response to that is that by not integrating the two types of reports, companies avoid an audit of non-financial information. In general, the companies that have an integrated report do have some assurance over the non-financial information; it’s not necessarily subject to the same standards as auditing standards but there is some kind of assurance. So I think some kind of audit over the information – and over time perhaps controls and processes – will elevate the quality of the reporting. So good questions from very sharp people like “Have you guys thought about this?” forces us to engage in some dialogue of our own so we do have a coherent responses.

GC: How does IFRS fit into integrated reporting?

MK: I’m one of those people who think that there should be one global set of accounting standards. To speculate just a little bit, I could envision a world that might have IFRS that govern the financial statements and perhaps an international non-financial reporting standard, because at some point we’re going to have to address that. I think the larger question of IFRS is to first, how do we develop a global standard of non-financial information? And secondly, can we develop some sort of benchmark for auditors? So, I remain optimistic that U.S. will eventually adopt IFRS and would hope in the next few years there would be some kind of move to adopt international standards for non-financial information.

GC: What’s next?

MK: There are a couple of major conferences coming up this year where integrated reporting will be a topic in several sessions. We use various conferences to spread the word and build some momentum behind the idea. The Harvard Business School and the Harvard University Center of the Environment are co-sponsoring an event on integrated reporting later this year. Two newspapers in Japan are hosting an event in November and the Prince of Wales Accounting for Sustainability has an annual event in December that hosts roundtables on various topics.

On the Accounting for Sustainability website, there are a number of press releases including a PDF on a governmental collaboration that calls for the establishing an international integrated reporting committee. I can tell you that the Accounting for Sustainability Group has the resources and, frankly, the brand name that could call for the IASB or some other group to undertake the idea of a global framework for reporting non-financial information. I could see us having this conversation a year from now and I’d be very disappointed if there was not some kind of formal announcement from an international integrated reporting committee.

So I’m cautiously optimistic about the future. The timing for this is right and integrated reporting is important when you believe in the concept of inter-generational responsibility. This is the only planet we’ve got and we should every intent to leave it in as good as condition as we found it.

But as a hard-headed capitalist I also think integrated reporting makes sense because you don’t want to invest in company that will go bust. A company simply cannot be viable for the long-term unless they are considering ESG issues.

Accounting Going Green? The Move to Integrated Reporting

Transparency is fast becoming the most important tool corporations can use. Not long ago, management determined what was relevant and stakeholders were notified on a need-to-know basis. Now the tables have turned and stakeholders have the ability to demand information of all types and if companies are not willing to provide it, those stakeholders now have the resources to discover (or in some cases, uncover) it for themselves.

Adding transparency to corporate reporting still seems to be a work in progress. As the SEC s ruminates over IFRS and its impact on financial reporting, corporate sustainability and responsibility reporting is fast becoming one of the popular ways for companies to give stakeholders a snapshot of its social, environmental, risk, and ce.

The problem from a practical perspective is that it’s difficult to consume all information in an efficient manner. That’s where the idea of integrated reporting comes in. Simply, it combines the the traditional financial report along with the non-financial information presented in the corporate responsibility, social responsibilty or ESG report.

One Report, Integrated Reporting for a Sustainable Strategy is a book written by Robert G. Eccles, senior lecturer of Business Administration at Harvard University and Michael P. Krzus, a public policy and external affairs partner with Grant Thornton.

We had the pleasure of speaking with Mr Krzus recently about One Report, covering topics like what kind of data it consists of, how it will change corporate reporting, and what the future holds. This is part one of a two part interview. Check back for part two tomorrow.

Going Concern: How can you best summarize what integrated reporting is, how it will be different and how it will improve corporate reporting.

Michael Krzus: On it’s face it’s a very simple idea – the notion of an integrated report really involves the combination of the traditional financial or corporate report and combining it with corporate sustainability, responsibility or ESG report and combing them into a single package. However, that doesn’t mean that companies will staple together two reports, each one about 150 pages long, that results in one report that’s 300 pages long.

If you look at one of the companies we talk about in the book, United Technologies here in the U.S. and Danish company Novo Nordisk, each of their integrated reports perhaps have 115-120 pages and what both have a very robust website. Just because something may not be deemed material for the integrated report, there is still a lot of information that both of those companies, as well as others, present in very easy-to-navigate websites. So one of the things that we’re seeing is that integrated reporting is really helping develop very advanced websites.

Similarly, I was working on a couple of presentations on the German chemical company BASF has a page on their website that will allow you to link to 200 different global social media outlets including the likes of Facebook and Twitter. So we’re really starting to see that kind of engagement develop from companies that are embracing integrated reporting as well.

Companies are using the idea of an integrated report to better understand their own internal concepts of materiality and by engaging with their stakeholders and understanding what they think is material or what their material risk exposures are. It’s a disservice to the broad stakeholder community that some mainstream analysts don’t give consideration to some of the environmental or social risks that exist.

From the perspective of the socially responsible investor or perhaps a non-governmental organization that follows a very narrow or very critical mission, they may not understand the trade-offs that these company have made. We think that the idea of a single integrated report will help broaden the perspective and help them make an informed decision.

GC: Considering a traditional corporate responsibility report, how the data change? Similarly, will the data change from the two separate reports combining into a single report?

MK: There are relationships between financial and non-financial performers and vice versa. Companies need to better explain what those relationships are.

One example is BMW. On one hand, water is a relatively small cost that goes into an automobile but in terms of water as a resource, it is an increasingly scarce resource in certain parts of the world. BMW has decided to make huge investments in reusing water and they actually have a plant in Austria that doesn’t bring fresh water to the plant, they just continually reuse it. The benefit, as it turns out, is because of their focus and because they’re a few steps ahead of other automobile manufacturers, they’ve got a cost advantage. Making that kind of discussion clear, it’s not just about cutting CO2 emissions, but also process improvements that enable companies to produce more at a lesser cost.

I think the other difference that you’ll see in the new reports is that the mainstream analysis will be giving more consideration to ESG issues. The traditional analyst has several companies that they’re following and these companies have different sectors in an annual report, corporate responsibility report, and many others. It’s extremely difficult to consume that many reports. My co-author and I interviewed an analyst once who brought in a stack of about 60 reports because some of the companies that she followed were issuing financial, environmental, and responsibility reports all separately, and she said “there’s no way.” So I think the integrated report will help that.

A couple more examples: last September Bloomberg launched a product that involves making global reporting initiatives that available on their Bloomberg terminals and CalPers’ board has undertaken a project to integrate ESG factors into their analysis better and in turn, push that down that to their asset managers. So we are starting to see some movement. That relationship between financial and non-financial performance and making things easier for the analysts to consider non-financial information will be the two biggest changes that will come about as result of wider adoption of integrated reporting.

GC: And CalPers is not a lightweight. If you see someone like someone like that setting an example, there are other companies or large holders of assets that will follow their lead.

MK: CalPers is not a lightweight at all. We’ve developed a good working relationship with a couple of people at CalPers and they are taking the idea of integrated reporting very, very seriously.

When you think about it, if CalPers goes to their asset managers and says we want you to integrate ESG into your traditional analysis and here’s the way we want you to come up with it. I think that’s going to have a ripple effect across other pension fund managers and assets managers other than those at CalPers.

GC: What would you say are the biggest benefits that stakeholders will get out of integrated reporting?

MK: I think the biggest benefit is actually going to be better engagement with companies they want information about. In my opinion, a company cannot undertake an integrated reporting project without really listening to the stakeholders. For a company to understand the perspectives, not that they’ll all be material, but that they’ll be willing to engage in that dialogue.

And it may not be in ways that companies are not comfortable with whether it’s Twitter or Facebook or something else, I think that process of stakeholder engagement is going to be mutually beneficial. The companies will better understand who’s out there and what they’re expectations are. And from the user perspective, it they will have a better understanding about what some of the tradeoffs are, as well as what some of the reporting implications might be. Overall, I think it will create a better overall understanding for both groups.

And by having more robust information, it’s going to allow for better decision making. I see that as a benefit on both sides. From the investor side, they’re going to have a much better understanding of the some the risks a company faces. An investor has to consider a lot of intangibles when making a decision. Whether its the business risks to climate change or the innovation process. If that kind of information is made available, it’s going to allow investors to make better decisions and who the winners and the losers are.

GC: Is there any risk that stakeholders might have too much information?

MK: Frankly, yes but I think in some ways it’s an overblown risk because when Bob and I looked at some of the oldest integrated reporters, you clearly see an evolution. A great example is BASF. Because of the diversity of their operations and the nature of the chemical business, there’s a lot of relevant information, especially about risk and materiality of certain exposures. About a year ago I spent half a day with their reporting team looking at both the financial and sustainability side. They do a very good job of looking in the mirror. One of the first comments was that the integrated report was still too long; that they needed to do a better job of getting their arms around materiality and again, the dialogue with the stakeholders helped them do that.

Over time as companies engage their stakeholder through various technologies, they will reduce the report down to a very information rich package. So yes, there’s a risk for too much information but I don’t think that will stop anyone.

Don’t forget to check back here tomorrow for part 2!