Better corporate reporting, better decisions

Transcription

1 Better corporate reporting, better decisions By Leigh Roberts CA (SA) SAICA, Project Director So why should investors read a company s integrated report? ell mostly because it should be a darn fine read! And a quick read. And will tell you all about the company s business model and strategy, business risks, performance and prospects in a single document. It is the story of the company. An integrated report is not like a traditional annual report which quite honestly is a pretty pointless document giving historical financial information months after a listed company has released its results. The traditional annual report is just so last century. The integrated report is suited for the 21st century. The integrated report fits our modern day world because can the informed investor really invest in a company looking at its financial performance in isolation of the many and varied factors that can exert great influence on the company s financial future? Factors like its relationship with trade unions (a key stakeholder), its relationship with customers (a key stakeholder), its relationship with suppliers (a key stakeholder) and the control it has over their practices (a key reputational risk in the age of instant global communication), and its future plans to obtain natural assets such as fresh water (its essential resource) for its operations. A company is a part of society and the environment; it has impacts on society and the environment and it is impacted by society and the environment. That s the reality of the company and the integrated report explains this reality. Over 30 institutional investors from around the world (including Goldman Sachs and Calvert), as well 100 companies (including Microsoft, Unilever and Coca-Cola) are among those involved in developing the international framework for an integrated report. Their sharing and experience is under the auspices of the International Integrated Reporting Council (IIRC). The IIRC s members are the who s who from an array of august international bodies including the International Federation of Accountants, the International Accounting Standards Board, The Federation of Euro-Asian Stock Exchanges, and the Global Reporting Initiative. The IIRC s vision is that over the coming years integrated reporting will emerge as the corporate reporting norm for most businesses. In April 2013 the IIRC released a Consultation Draft (CD) of an international Framework for an integrated report this is the latest in a stream of four iterations that started with a Discussion Paper in September The CD was open for public comment for three months to July and is currently in the process of being updated to reflect those comments. The final Framework is scheduled for release on 5 December The final Framework will be version 1.0 as it is intended that the Framework be

2 regularly updated for developments and company and investor experience. South Africa s role Many JSE listed companies are now into their third year of issuing annual integrated reports. The move was kick started by the principles of King III falling into the JSE Listing Requirements. King III calls for integrated reporting on the recognition that strategy, risk, performance and sustainability issues are closely entwined. The Integrated Reporting Committee (IRC) of South Africa was formed in 2010 to provide guidance to companies on integrated reporting. The IRC released a Discussion Paper on a Framework (a world first) in January This Discussion Paper fed into the IIRC s first Discussion Paper released later that year. South Africa continues to play a role in the development of the international Framework. A number of South Africans serve on IIRC committees and feed through the experience of our listed and public sector companies. Our companies are, rightfully so, regarded as among the leaders in integrated reporting (with some of the international players even referring to South Africa as the Petri dish of integrated reporting!) Also, at least two of our institutional investors are a part of the IIRC s global investor network (the Government Employees Pension Fund and Element Investment Managers) with six local companies involved in the IIRC s global company pilot programme (Eskom, AngloGold Ashanti, Gold Fields, Sasol, Strate and Transnet). What does an integrated report look like? An integrated report tells a company s unique story; which is the reason why each integrated report is unique too. The IIRC s CD, however, offers useful guidance to companies on what to include in their report and the guiding principles that should be applied in preparing it. The CD lists 7 Content Elements and 6 Guiding Principles. These form part of the set of requirements that must be met if a company wants to claim that its integrated report has been prepared in accordance with the IIRC s Framework. (The CD is available on or ) The 7 Content Elements are: 1. Organisational overview and external environment Tells about what the company does and the circumstances under which it operates. It covers information like mission, vision, salients of the company, main products and services, competitive landscape and market positioning. The external environment gives important information covering significant factors in the regulatory, legal, social, environmental, commercial, economic and political context that affect the company s business and its future. 2. Governance Reams and reams of governance information could be given here but the integrated report should stick to that which tells users of how the governance structure supports the company s ability to create value now and in the future. So, expect to see information on the skills of the board directors, the processes in place to make strategic decisions, the attitude to risk, the responsibility for innovation, and how remuneration and incentives are linked to value creation over time. 3. Opportunities and risks The crux here is to inform about the specific risks and opportunities that affect the company s ability to create value over time and how the company is dealing with them. So, expect to see risks and opportunities stemming from the external environment, from the internal business activities, and those relating to the company s affects on the capitals it relies on and their continued availability, quality and affordability. Given an investor s focus on risk, they will be keen to read

3 the company s assessment of the likelihood of each listed risk, its magnitude of effect, and the steps taken to manage the risk. Risk information will be linked to the associated strategic objectives and targets. 4. Strategy and resource allocation Where is the company headed and what resources will it need and how does it plan to get them? The company s short, medium and long term strategic objectives should be given along with its strategy to achieve them. How the board will measure management s achievement (targets and KPIs for instance) will also be given. The strategy information will be linked to the company s business model (from which its strategy flows), and to its risks and opportunities. Also, the report should tell how the key stakeholders needs and interests have been used in formulating the company s strategy and resource allocation plans. Expect to see both financial and nonfinancial strategic objectives reflecting the company s acceptance that it is part of the society and environment in which it operates and that these greatly affect its financial future. 5. Business model The business model has received increased attention in many quarters in recent years. The integrated report, however, will describe the business model in terms of the company s major inputs (derived from the various capitals it uses), its business activities, the outputs it produces (products, services and waste), and the resulting outcomes for the various capitals. (Examples of the latter are an increase in financial capital, an increase in intellectual capital through greater brand recognition, an increase in social capital through taxes paid and benefits to customers of using the company s products, or a decrease in natural capital from the company s take of the local water supply and other negative environmental affects.) The company s key business value drivers, and its future value drivers, will be stated. 6. Performance This information tells users how the company has performed against its strategic objectives and of the resulting outcomes on the various capitals. The information will be both quantitative and qualitative. It will cover performance against targets and KPIs, and also the quality of the relationships with key stakeholders and if and how the company has responded to their needs and concerns. It will show the connections between past performance and current performance, and current performance to future outlook. It will show the links between financial performance and performance (impacts) on other capitals (for instance, the ratio of carbon emissions to sales). 7. Future outlook As the company has laid out its strategic objectives and strategy for the future in its report, it is helpful for users to know about the likely challenges and uncertainties that surround this strategy and the implications for the company s business model and performance. This includes the changes that management expects in the external environment and information on the future availability, quality and affordability of capitals in the future. While the 7 Content Elements are separately listed above, their information should be linked in order to reflect a holistic view of the company. And a company is free to change the sequence of the Content Elements to suit its unique value creation story. The CD gives 6 Guiding Principles that should be applied in preparing and presenting information to go into the Content Elements. They are: Strategic focus and future orientation the stated information should be significant to the company s strategy and to its use of its essential capitals, now and in the future.

4 Connectivity of information the stated information should show the connectivity between the components that are material to the company s ability to create value now and in the future. Stakeholder responsiveness the stated information should provide insight into the quality of relationships and how and to what extent the company understands and responds to their legitimate needs, interests and expectations. Materiality and conciseness the stated information should be concise and material to investors when assessing the company s ability to create value in the future. This principle is all important as it s the hurdle that determines which information and issues are included in the report or are left for disclosure in other more detailed reports (the annual financial statements, sustainability report, governance report etc). Materiality is different to that of financial reporting which is based purely on a rands and cents number. In the integrated report, what is material is determined by its relevance and importance to the company s ability to create value in the future (broadly, what affects its business model, strategy or the capitals the company uses or affects). Reliability and completeness the report should include all material matters (to ensure the report is complete) in a balanced way and without material error. A report will be balanced by showing both the good and bad performance and issues. Consistency and comparability the stated information should be presented on a basis that is consistent over time and where possible, enables comparison with other companies. You may have wondered at the terms value creation and capitals used throughout the above discussion of the Content Elements and Guiding Principles. These terms, along with the business model, are the three fundamental concepts of the IIRC s CD. Value creation is broader than the traditional view of a company creating financial value. It recognizes that a company is part of society and the environment and that key stakeholders can have a great impact on the company s financial returns. Hence, creating value includes the value to stakeholders as the custodians of the capitals used and relied on by the company. In other words, total value creation can be seen as the company s outcomes on the various capitals it uses or affects. When referring to capitals, the IIRC s CD lists various types: namely, financial, natural (the environment), manufactured, intellectual (brands, organisational know-how etc), human, and social and relationship (includes stakeholder relationships). A company is not obliged to adopt these categories of capital, but they should be used as a benchmark to ensure that no resources and relationships are overlooked. The IIRC s CD also refers to the term integrated thinking (which should really be repositioned in the final Framework as one of the fundamental concepts because it is thoroughly important). The integrated report should be the annual reporting result of integrated thinking in the company. That is, the board s strategy and the everyday management of the company (internal reporting, management review and decision-making) should be integrated considering all of the capitals used and affected by the company. Embedded integrated thinking ensures that management focuses on the true value drivers of the business; that internal reporting and external reporting are aligned; and that the company works towards the board s strategic objectives rather than departmental or divisional objectives. How does the integrated report fit into the corporate reporting suite? I often use the analogy of the octopus to explain this. The integrated report is the head of the octopus, with each of the company s many detailed reports (annual financial statements, sustainability report, governance report, remuneration report, regulatory filings etc) being an arm of the octopus. The integrated report as the head connects and gives direction to the information contained in the detailed reports. Many of these detailed reports need not be printed but can be housed on the company s website. Trends in integrated reporting in South Africa

5 The 2013 annual EY Excellence in Integrated Reporting Awards revealed some emerging trends in the 2012 integrated reports of the JSE Top 100 companies: Information is increasingly being referred to in the integrated report but is shown elsewhere. In other words, companies are differentiating between the integrated report as their primary report and other detailed reports. (The octopus model is gaining traction!) There is more diversity in the structure of integrated reports as companies experiment and innovate in telling their story. The risk disclosure by companies in their reports continues to improve, with discussion given of the processes for identifying, managing and mitigating risks that might affect the ability to create value. Many reports fall short on giving the good and the bad news equal prominence. Stakeholder responsiveness is generally poorly handled. Not enough information is given offering insight into the relationships with stakeholders. There is an increase in the number and variety of nonfinancial KPIs disclosed in reports, but the usefulness of many of the indicators is questioned. The KPIs should be material to the long-term sustainability of the business. Companies are coming up with new ways to present information in a meaningful and understandable way. For instance, a waterfall graph to explain the factors that influence movement in key measures. The remuneration of executive directors continues to be poorly handled by many companies. In most cases there is little information about how the variable portion of short-term bonuses is determined. Where KPIs are used to determine bonuses, there is often not enough indication of how the KPIs translate into the actual bonuses paid out. The top 10 reports in the EY Awards 2013 are: Gold Fields (the winner), Truworths International, Standard Bank Group, Royal Bafokeng Platinum, Sasol, Vodacom, Illovo Sugar, Nedbank Group, Exxaro Resources, and Liberty Holdings. In August 2012, PwC released its survey of the JSE top 40 companies relating to their integrated reports and came up with some interesting findings and emerging themes: Among the 7 Content Elements, the most effective communication was found in strategy and resource allocation, and business model. By contrast, governance needed the greatest improvement. Governance reporting tended towards things like board charters and terms of reference, rather than the actual activities of the board during the year. Historical reporting remains the focus with companies avoiding crystal ball gazing and talking about what the future holds for them. Some companies miss the opportunity to connect their stand alone sections of reporting. 29% embed sustainability in strategy. 84% explicitly identify their key performance measures. The average number of measures is % align measures with strategy. 52% report priorities for their nonfinancial capitals. 60% integrate the business model into other areas of their reporting. 52% integrate their risks into other areas of reporting. Assurance Given the importance of a company s integrated report, some users are calling for the report to be assured by an independent external provider. The IIRC has taken tentative steps to investigate this looming issue. It appointed a research group to look at the possible approaches to assurance. This research paper will be made available later in It is clear that the road to reasonable assurance on the integrated report is likely to be a journey, but it is an eventuality given the importance of the integrated report to the company

6 and its stakeholders. Leigh Roberts is SAICA s Project Director: Integrated and Sustainability Reporting. She is a member of the IIRC s Technical Task Force and a member of the IRC of South Africa s Working Group. She has co-authored a book with Mervyn King, entitled Integrate: Doing Business in the 21st Century (Juta, 2013).