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Cover story: The rise of integrated reporting
Thursday, 19 December 2013 15:13


Let's get together

The movement to integrate financial and sustainability reporting continues to gain momentum. David Benady discovers whether the finish line is set for a 200m sprint or a 1500m track event

integrated_reporting_2.jpgMark Gough, The Crown Estate's head of sustainability, is in the unusual position of trying to do himself out of a job by getting rid of the organisation's sustainability report.

Gough believes that concerns for the environmental and social impacts of a business should not be confined to some separate department. They must to be integrated into all of an organisation’s working practices.

To this end, The Crown Estate, the £8bn property portfolio owned by the Sovereign that pays all its surpluses to the UK Treasury, has created one of the UK’s first integrated annual reports. Rather than producing separate reports on finance and sustainability, The Crown Estate has combined the information and presents it in one over-arching document.

The 2013 integrated report, entitled Imagine, has received the ultimate accolade, according to Gough – people actually enjoy reading it.

“Annual Reports and Sustainability Reports often take a lot of time to produce internally, but they aren’t read cover to cover by investors and stakeholders. Managing agents and stakeholders have come back to us this year saying they enjoyed reading the integrated report, which is the best compliment we could get,” he says.

Gough believes the greatest benefit of integrated reporting is that it has forced the organisation to change the way it thinks and behaves. “You can’t do integrated reporting without having integrated thinking,” he says. “It is no longer enough just to have a sustainability strategy and a business strategy – you can’t deliver two strategies at a time. So we have ripped up our sustainability strategy.

“The problem many companies face is that you can’t produce an integrated report unless you’ve got an integrated organisation. We are moving towards that. For instance, we are hiring a head of investment and I am on the panel to help choose that person – this shows we are trying to put sustainability at the heart of our investments,” he says.

Integrated reporting is yet another attempt to encourage businesses to account for their social and environmental impacts in their reports to investors. There is a widespread belief that annual reports are too focused on short-term financial elements and leave out information that is crucial for investors – such as the long term prospects for the company’s business model.

The International Integrated Reporting Council (IIRC) was established in 2010 to promote the new style of reporting, following the mandatory introduction of integrated reporting in South Africa in 2009. The body has the support of 100 corporations globally including Unilever, J. Sainsbury and Marks & Spencer in the UK, and numerous international investors such as Aviva Investors and Hermes.

The IIRC is conducting pilot schemes for participating companies to produce integrated reports and has just run a consultation on its planned integrated reporting framework, which it plans to publish at the end of this year.

The reports should aim to provide a concise view of how the business creates value in the short, medium and long-term. This is achieved by revealing the business models and strategies at the heart of the business. The reports describe the impact of six types of “capital” which are crucial to businesses – financial, manufactured, human, social, relationship and natural. Analysing these provides a means for companies to assess how they are creating and destroying value over time.

It’s all very well for an organisation like The Crown Estate, which is effectively owned by all of us, to create an integrated report. But what of companies that need to attract investment and convince hard-nosed fund managers and traders that they will provide a competitive return on capital?

integrated reporting_1.PNGSome sceptics see integrated reporting as politically correct accounting which puts fluffy, soft and irrelevant information into the mix. What investors really crave is a clear guide to the return on investment not in some distant future but next quarter or next year. Some wonder whether investors will ever really care about integrated reporting.

As Steve Waygood, chief responsible investment officer at Aviva Investors, which is backing the IIRC’s work, says: “It would be wrong to suggest that all investors will care about the integrated report. Many investors just follow an index and do no company research. Others look at algorithms and quant investors don’t even need to know what a company does.

“That said, longer term investors look for real value. Aviva are long term investors with a long term perspective on underlying assets. Integrated reporting encourages companies to demonstrate that their boards have thought through the implications for different capitals used by the company. If they do this at board level, it enables fund managers to integrate those issues into why they invest money.”

Waygood believes that integrated reports are just the start and that ultimately there needs to be a push for integrated capital markets, where broader social and environmental issues become embedded in the daily grind of capitalism. He adds: “I do believe in capitalism, it is incredibly powerful but there are flaws in the market.” He thinks integrated reporting is one way of making the processes of business more transparent.

The IIRC hopes that as integrated reporting becomes part of the accepted behaviour of corporates, it will be seen as the international gold standard for long-term investors who will naturally gravitate towards companies that publish integrated reports.

Of course, none of this is really new. The IIRC describes itself as an “evolution” of current practices and Waygood agrees that integrated reporting is not so different from the many other ways of making companies ‘fess up about the externalised costs which boost their profits.

The IIRC stresses that it is not pushing for statutory adoption of integrated reports. In the UK, attempts to impose the Operating and Financial Review (OFR) as part of the 2006 Companies Act came to a sticky end after opposition from the Confederation of British Industry. Instead of the mandatory OFR, companies were advised to stick to “best practice reporting” where they could optionally include those elements as they saw fit.

Kate Jefferies, head of programmes for the IIRC, says trying to make integrated reporting mandatory too soon could lead to the whole thing become a box-ticking exercise. “The pilot programme participants are seeking to test and track the models we are developing, sharing their involvement and building momentum towards integrated reporting.

“If you don’t regulate too early, you allow the opportunity to innovate and experiment. The focus is not on compliance, it is about a business communicating its own story. Standard setting internationally on this scale could take ten years.”

She says that the IIRC has backing from many international bodies, from the Global Reporting Initiative to The World Bank, the International Federation of Accountants and The World Federation of Exchanges.

To help businesses understand how they can set on the journey to integrated reporting, the IIRC has created a helpful database with examples of how other companies have approached the task. The database was created by consultancy Black Sun and brings together extracts from reports which illustrate emerging practices in integrated reporting.

Meanwhile, the Financial Reporting Council, the UK’s corporate governance regulator, is consulting on new guidance about strategy reporting by companies following an update to the 2006 Companies Act introduced in July which require companies to do more narrative reporting. From October, reports will be required to include information on human rights issues, gender representation and environmental issues.

Melanie Mclaren, FRC director of codes and standards, says: “In developing our guidance, we have had regard to the IIRC framework. The important thing about the IIRC framework is that they highlight that you should think very strategically and broadly about report information that is relevant to investors. Sometimes people think integrated reporting is about addressing a wide range of stakeholders which is not the case. So if tackling human rights issues is important to the business model or strategy or is a key risk, it should be included in the strategy report because of its impact on investors. But it shouldn’t just be reported on per se.”

But some believe that integrated reporting threatens to create confusion in companies and among investors by introducing a new standard just as existing attempts at social and environmental reporting are being understood.

“People are getting more familiar with best practice in annual reporting in the UK, then they see a new initiative, which carries a certain mystery about it and companies start wondering how they can factor it into their reporting plans,” says David Ritsema of communications agency Radley Yeldar, which helped create The Crown Estate’s first integrated report. He believes that over the years many companies have raised the standard of their reporting but would like to see a more a more common language, and maybe one shared vision for what is best in reporting..... having different organization with different points of view might diminishes the chance that investors and companies will grasp it. “It would be great if there was just one voice, rather than a Think Tank here, recommendation there and then additional regulation - it would be less confusing ” he says.

He also points out that the new social and environmental reporting requirements, along with demands for more detail about financial dealings, accounting standards and remuneration have driven up the size of annual reports. “There’s been so much going on in compliance that has driven reports to become unwieldy and fail to tell a strong story. There is a view that it is too much for an investor to digest, so one way round that is to publish a more material strategic report and put more detail online.”

Meanwhile, Richard Carpenter, managing partner of MerchantCantos says: “The latest IIRC consultation has some really good stuff in it and some bad stuff. Its big problem is that it is quite academic and the practicalities and logistics haven’t been taken into account. “How will integrated reporting happen for the vast majority of companies? Beyond the FTSE Top 30m companies struggle to monitor sustainability.” Looking at the South African experience, where integrated reporting was made mandatory in 2009 under the King Code on corporate governance, Carpenter believes it has had mixed results. “We’ve looked at some of the companies reporting before and after and I think it has led to a lack of clarity in reporting because they are trying to put too much in and the simplicity of the message is getting confused.”

Another problem he identifies is the use of initials “IR” to describe integrated reporting, since for many in the investment world, “IR” has always stood for investor relations, which can only add to the confusion.

It seems that integrated reporting will gain ground over the coming years, given the backing it has from the biggest companies, investors and global bodies. Annual reports are unlikely to be getting any slimmer since IR requires piling in extra information. There is hope, however, that the reports could become more readable as integrated reporting allows businesses to clearly relate their corporate story. Even the most sceptical of investors would welcome that.