"Business as usual" is no longer an option for companies, which will need to embrace integrated reporting – the next evolution of corporate reporting – if they want to thrive.
At least, that’s the view of Mervyn King, the chairman of the International Integrated Reporting Council (IIRC), who has devoted the past 20 years to improving global corporate governance practices.
Against a backdrop of extreme weather patterns, diminishing natural resources and economic instability, King said businesses need to prove to increasingly wary investors that they are sustainable. In other words, companies need to embrace integrated reporting and the transparency it provides.
With the first global incarnation of an integrated framework only a year away, corporate reporting is at an important juncture. We spoke with King to gauge his thoughts on the role it can play.
CGMA Magazine: The IIRC plans to issue its first version of the integrated reporting framework later this year or early 2014. Is this time frame realistic?
King: I believe it is, and in any event it is something that has to be achieved. It is generally accepted that corporate reporting, as we have known it for decades, is no longer fit for purpose. Audited financial statements in current annual reports can be anywhere up to 400 pages long and in a language that is only for an investor analyst, not the average user.
Today, ordinary people provide capital. If you look at shareholders of the great stock exchanges of the world, you’ll find that a very large shareholder is the pension fund and another is the financial institution. It is no longer only wealthy families.
Because the provider of capital has changed, you need to present a report from which a pension fund investor can make an informed assessment that their money will go into a business that can create value for the long term. Pension fund trustees are investing for people who need to realise their investment in 20 to 30 years. In other words, we are looking at sustainable capitalism rather than short-term capitalism.
CGMA Magazine: What makes a good integrated report?
King: The test of a good-quality integrated report is that, once you have read 30 or 40 pages, you will not need to go online and look in detail at the financial statements or the sustainability report. The material matter will be in the integrated report, enabling you to gain a quick understanding of the state of play of a company and to make informed assessments about how it will sustain value creation.
Will integrated reporting spread?
CGMA Magazine: Given that many Western economies, particularly in Europe, are still buckling under economic pressure, do you think integrated reporting will gain traction at a time when many companies are just trying to remain profitable?
King: Yes, it has to. It’s a changed world. You’ve got a financial crisis, a climate-change crisis and an ecological overshoot, which is the use of natural assets faster than they’re being regenerated. You’ve got population growth going up and natural assets going down. So, if you think you can carry on doing business as usual, welcome to the age of stupidity. Your business is not going to survive.
Chief executives of boards are being driven to think differently. You can see how Google and Unilever, in the past few years, have been carrying on business as unusual. They’re using renewable energy in a lot of their factories and are re-engineering their products. Coca-Cola Co. has water engineers all over the place. SAB Miller has a thought that maybe its next big brewery should be a ship at sea, taking on ocean water and desalinating it to make beer.
[SABMiller, as part of a scenario planning exercise, has predicted how its breweries may look in 2030, given a range of different scenarios determined by the cost and availability of water and energy. In the most extreme conditions, where there is a severe water and energy shortage, SABMiller has thought its next big brewery should be a ship at sea, taking on ocean water and desalinating it to make beer.]
The trickle-down effect
CGMA Magazine: These are all large multinational companies. Is integrated reporting only for the blue-chip firms, or should it apply to SMEs (small and medium-size entities)?
King: There are trillions of dollars that are now being invested responsibly as part of the UN’s Principles for Responsible Investment, and they will not invest in the equity of a company that they think is not acting as a good corporate citizen. This includes looking at the supply chain of a company in which you are going to invest your money.
Companies purchasing a product from their SME suppliers are saying: “Change, otherwise you won’t remain an SME supplier.” For example, Walmart asked the Global Reporting Initiative to open an office in Beijing province China. Walmart wants its SME supply chain to complete sustainability reports. This is because a Norwegian pension fund, one of Walmart’s big providers of capital, said it would not support a company that is buying products from manufacturers that are adding to the crisis of the planet.
CGMA Magazine: What have been some of the benefits of integrated reporting for companies taking part in the IIRC’s pilot programme?
King: Some of the benefits that have been experienced, and this is all detailed in the Black Sun report (Understanding Transformation: Building the Business Case for Integrated Reporting), are improved internal processes leading to a better understanding of the business and greater visibility across business activities. Companies have also said it has helped their leaders to understand better how an organisation can create value in a broader sense. There has also been more long-term thinking and planning.
The South African experience
CGMA Magazine: Companies listed on the Johannesburg Stock Exchange (JSE) must produce an integrated report as part of their listing requirements. How has integrated reporting changed the business mind-set in South Africa?
King: It’s been very well-received, and we’ve now got a code for responsible investment in South Africa, which adopts the UN’s Principles for Responsible Investment. The first principle is that all financial institutions, including pension funds and financial institutions, must ask companies questions, like if they have done an integrated report or a sustainability report and if they have a supply-chain code of conduct. Companies that want to list on the JSE, or want to raise more capital through financial institutions, have to attend to this because financial institutions are going through these issues before advancing capital. The major companies that are listed are, in turn, putting market pressure on their SME suppliers for this information.
CGMA Magazine: Do you think regulation is needed elsewhere for integrated reporting to become common practice?
King: The World Federation of Stock Exchanges (WFSE), is as we speak, considering recommending to all stock exchanges that they make integrated reporting a requirement. No stock exchange is obliged to follow that recommendation, but the WFSE and World Economic Forum selected the JSE as the world’s best-regulated stock exchange, and with the best listing requirements.
I’m in favour of regulation – such as listing requirements, but not legislation – because then it becomes a mindless issue and you’ve got a bureaucrat telling you if it’s an integrated report or not.
From lawyer to governance champion
CGMA Magazine: Corporate legislation is an area you know well, as you were a corporate lawyer and then a Supreme Court judge in South Africa. At what point in your career did you decide to focus your efforts on tackling corporate governance?
King: I was placed in a very privileged position of having an academic background in the corporate legal scene, being an adviser, and then working as both an executive and a non-executive, so I was seeing both sides of the coin.
There was a time when I was the executive chairman of a listed company – not something that is advocated by good governance today. I was executive chair, and I wanted to raise about $400 million to buy new plant for the company. I did the presentation to major shareholders who were present, and then the board had to vote. I thought this was crazy because I knew how I was going to vote – I was presenting it. I felt that could affect the independence of my thinking and intellectual honesty. That’s when I started thinking that you cannot be a leader of the board and an executive.
CGMA Magazine: If you had to look into a crystal ball, what would corporate governance look like in 2020?
King: I believe there will still be a structure of a board and management as we know it today. Integrated thinking will be common practice, and integrated reporting will be universal. Companies will carry on business as unusual, because if they don’t, they won’t be there in 2020.
Editor's note: An earlier version of this story incorrectly stated that the São Paulo Stock Exchange has moved to make integrated reporting a listed requirement. The exchange has an initiative to stimulate companies to publish sustainable reports that it calls “Report or Explain”, which encourages companies to register in their reference forms that they will publish sustainability reports. As a result, the public has access to links to the reports of the companies that publish this information, the explanations given by the companies that have not done so yet, as well as links to those that have left the answer blank.