THE CFO MIDDLE EAST
Ironing out the creases
Posted 12 January, 2013 under The Insider
Challenges are beginning to emerge, a year since the International Integrated Reporting Council launched its pilot programme to help create the world's first integrated reporting framework. Nicola Maher reports on the developments so far…
IIRC Chairman Paul Druckman says it is the integrated thinking and silo effect that will be "the biggest issues for companies producing an integrated report to overcome
INTEGRATED REPORTING (IR) has come a relatively long way in a short time. It has been just over two years since the International Integrated Reporting Council (IIRC) was formed through collaboration between the Global Reporting Initiative and the Prince's Accounting for Sustainability Project.
The IIRC's task to develop the world's first globally accepted integrated reporting framework is gathering pace, driven by the need for corporate reporting to have fewer compliance requirements, with more integrated thinking and decision-making.
IR represents an evolution in corporate reporting which intends to build on recent developments in financial and non-financial reporting with the goal of producing an annual integrated report about the way in which an organisation's strategy, governance, performance and prospects lead to the creation and preservation of short, medium and long-term value.
Prototype framework
Through the help of a pilot programme, launched in June 2011, and now involving more than 80 businesses from different economic sectors across more than 20 countries, the IIRC has launched a draft outline of the IR framework, and will launch a prototype framework before the end of the year. Then a draft framework will be produced in mid-2013, followed by the definitive version in late 2013.
A year on from the launch of the pilot programme and challenges and trends are beginning to emerge. It is these which are expected to help enhance how the eventual framework will look and work.
At a recent IIRC pilot programme conference, The Accountant found some of the biggest challenges emerging include: linking non-financial information to core strategy, corporate silos, the changing of behaviour, and integrated thinking.
Challenges emerge
DWS Investments' senior investment manager on European equities Susana Peñarrubia Fraguas warns in the current economic climate it is not only business taking a short-term approach but "even investors are getting more short term" and unless the companies take a long-term approach to reporting "nothing will change".
"As soon as you have the connectivity then the long-term focus will return. This is exactly what we want. We don't want to invest for just one month," Peñarrubia Fraguas says.
"What we do as financial investors is we start looking at the business model of the company, then we look at the industrial environment, the context the company is operating on. We try to see the financials today, but much more importantly try to identify change, which will be important for the competitive position of this company going forward. And what integrated reporting actually is proposing is exactly that."
IIRC chairman Paul Druckman says it is the integrated thinking and silo effect (different divisions within a company having little knowledge of other parts of the business) which will be the biggest issues for companies producing an integrated report to overcome.
The other issue of compliance reporting means those in charge currently take a 'head-down' solitary approach to reporting and trying to break that habit to find a better way of reporting will also be hard, but, he stresses, one that must be done.
"Nonetheless it is being overcome," Druckman notes.
"I think those that join the pilot programme understand they need to lift their eyes, but those who are around the outside, are struggling. There's always the comment, certainly from the financial reporting community, which constantly say 'please no more reporting'. We are trying to bring about a change and evolution in corporate reporting, not create additional reporting."
Changing the culture of reporting in a company where individual departments produce their share of the information separately is another obstacle that will need to be tackled before an integrated report can be effectively produced.
Lack of quality
Peñarrubia Fraguas agrees, but adds that integrating the strategy of the company and "how management is integrating ESG factors in the strategy of the company" will also need to be worked on.
The other points Druckman notes are a company's controls and the lack of quality of the data that is currently being collected outside the financials.
"Companies will have to get better data and information and more controls over them, but that is currently proving to be difficult," he explains.
There are concerns. First, for companies already gathering non-financial information, to get this data to a level of quality comparable with the financials will take too long. Secondly, for companies that have yet to begin gathering this data, it would take even longer.
"It has taken the past 100 years to get financial data to where it is today, but we haven't got 100 years to get other data to that standard. We do live in a fast-paced world and it will take time. In my view you're talking about one or two or three years not a hundred," Druckman says confidently.
Brazilian Development Bank (BNDES) corporate reporting and governance advisor Vânia Maria da Costa Borgerth is confident that even if companies are not yet prepared to provide the non-financial data, once they start gathering this information their business will benefit.
"It can be a very powerful tool for managing the business in the future because it will give the manager a broader view of the business. Not only what affects profitability or not, but how the company behaves and impacts society and the environment. I think that decision-making in the future will be much more solid and responsible because of that," Da Costa Borgerth explains.
Druckman remarks that people need to remember the fact that it might be an "environmental indicator" a company is looking at, but "if it has an effect on the company's value, it is financial".
KPMG partner and IIRC member David Matthews thinks people should also focus on the difference between the financial end of annual reporting and the narrative end.
"The financial does tend to be driven by detailed requirements, whereas the narrative has quite a lot more flexibility in terms of the extent to which companies do report and the volume that they give," he explains.
"Integrated reporting in that sense is about better reporting rather than more reporting. I don't think realistically there is likely to be a substantive change in regulatory requirements in the short term; I think that it will take a longer period before integrated reporting becomes embedded and meets the capital markets' need for better information."
In terms of how the IR framework will work, Druckman explains the IIRC's intention is to make the framework "extremely flexible, while pointing to the metrics those companies may want to use".
There is however a fine line the IIRC needs to walk because by making the framework too flexible and less comparative there is a risk people would use different metrics to suit their own needs.
"It's a balance. If we're too flexible then you won't have any comparability. If we're too rigid then I think integrated reporting will not be effective. We have to find a balance," Druckman says.
Relevant metric
Matthews adds that if you "try and set out and find every relevant metric for every industry we won't be talking just two years, it will be a lot more".
"I do think it has to be principles-based and I think the reality is the market will end up dictating what is relevant. As companies in particular industry sectors report on things, there will be a demand for comparability and consistency, so we will get that pull for innovation as time progresses," he explains.
"In many ways I think it will come from investors and from capital providers like big development banks that will insist on metrics, rather than IIRC insisting. I think it's dangerous for us to insist."
Da Costa Borgerth adds that at BNDES there are also a large number of "qualitative indicators that we take into consideration before financing a company in Brazil".
"I think there's a danger that if you define what should be reported on then you're too specific. Rather than leaving it to principles, preparers will look at things just through the lens of what they're required to report. One of the criticisms that have been around corporate reporting is, it has become very compliance-focused, rather than getting companies to tell their value story the way that they see it, which is going to be most relevant for a community base to understand your value," Matthews notes.
Five key projects
Materiality is also being debated as to who should determine what is material and what is not, but there is consensus among the IIRC members that this should be market-led.
"I hope management decides what material is for the company and for the business model going forward in the short, medium and long term," Peñarrubia Fraguas says.
Druckman says there are five key projects for the IIRC to resolve before it can settle on a framework. These include: business model, materiality, capital connectivity, and value.
"We're also doing a project on assurance," he says.
"Those four plus assurance are the ones we have to bed down. Within the IIRC the one that causes the most thought is the one over value, but the most critical in terms of foundation is the business model. This is because it's how business creates value. Unless we create some guidance on what we are looking for them to report, and there is consensus, we will struggle. The preliminary work on the business model has been well received, so I don't think it's going to be a problem, but nonetheless it's a very critical plank."
Another concern is assurance because if you have a company reporting on lots of metrics and following the IR framework then without independent assurance it raises the question of whether people trust that information.
Druckman says assurance can be undertaken on any sort of metrics now, but the main challenge will be on the "broader range of things being assured, and the more work that's involved, which someone has got to pay for".
Some will argue that if the financials continue to be assured, but the rest of the information is not assured, then it could lack integrity. However, Druckman points out that at the moment the corporate social responsibility report is not being assured, although he anticipates this being developed in the second stage of IR.
"I personally feel that without assurance, integrated reporting lacks credibility. But let's not assume we're talking about the same type of assurance as we're talking about with the current financial reporting because we're not assuring data, he explains.
"That's already being done. What we're doing is assuring that the information and the narrative that's describing the strategy of the business is actually the strategy of the business. It's not actually saying if it's right or wrong, just that this is what they're doing and we can assure you this is their path."
"The other piece of that is they're not just telling us the good news, they're telling us the whole news. The assurance is absolutely critical to the process. It's a shame you can't find a different word for it, because I think we have to think outside the box in terms of what is the assurance. It's still within the remit of the assurance providers. It's not new science it is just a slightly different take on it."
Sustaining interest
There were initial worries that in the wake of the Global Financial Crisis (GFC) it would be difficult to create the momentum to launch an IR framework and sustain interest in the project. These concerns have been laid to rest as a growing number of Fortune 500 companies take part in the pilot programme.
There are also leaders from corporate, investment, accounting, securities, regulatory, academic and standard-setting sectors as well as the third sector on the council itself.
IIRC communication director Jonathan Labrey thinks it's easier to get the conversation about IR started since the GFC began.
"The crisis has probably helped us to open that conversation with investors and say 'look there's going to be change' – from banking regulation right through to corporate governance codes being tightened up, to a new focus on risk in banks and financial institutions. I think it's probably a lot easier for us to say that's part of sorting out the financial crisis. And can we think about corporate reporting as well, because it deals with some of the issues, by no means all of them, but deals with some of the issues that pose a risk to your investment," Labrey says.
It is this market-led impetus that is expected to get IR off the ground rather than a regulatory one, unlike in South Africa, where IR became a mandatory requirement for Johannesburg Stock Exchange-listed companies to produce an integrated report or explain why not.
However, at some point there will be a need to push IR out to a wider net of companies if there is to be a global change in the way corporations report, and regulation is likely to be the nudge to get this done.
"Regulators watch what happens in the market as well. They'll be watching these trends because regulators like the UK Financial Reporting Council's initiatives stay very close to market trends and developments. They will be watching, particularly given the scale and size of the organisations involved in this IR movement," Labrey concludes.
There is still a way to go in getting the challenges ironed out and the IR framework off the ground but with so much interest from the top level of business and the investor community it is hard not to believe this is the future of corporate reporting.
(For more info; visit http://www.theaccountant-online.com/)
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