The leadership challenge of integrated reporting

Why now is not the time for corporate Australia to retreat from change.

By Elizabeth Fry

Australia’s fund managers are beginning to slowly embrace integrated reporting as it emerges as a key governance issue.

According to Dr Simon Longstaff AO, executive director of the St James Ethics Centre, there are some signs of movement taking place within the Australian fund management industry as trustees and super funds increasingly award mandates to fund managers who are able to report on environment, social and governance (ESG) matters.

“Trustees want to ensure that companies generate sustainable financial performance and they don’t think that can be achieved unless fund managers take into account some of the broader ESG issues,” Longstaff noted at the second annual IGAP/CPA Australia Forum on Integrated Reporting held in Sydney on 30 October 2013.

Integrated reporting is emerging as a key governance issue.

Integrated reporting is emerging as a key governance issue.

Longstaff warned, though, that while fund managers are starting to build ESG capacity, they live in a complicated equities market in which a variety of different groups combine to drive short-term activities. He added that structural issues work against equity markets, ensuring we have well-run companies providing sustainable investor returns.

“Fund managers have a number of different interests that at a practical level include earning fees and reducing costs, and which may be subject to short-term pressures that are not in the interest of investors.

“So we have this system that seems to fit together that assumes everyone is looking and pointing in the same direction. But it’s not necessarily the case and it’s one of the issues that hasn’t been resolved.”

He said integrated reporting – which brings together financial and sustainability reporting – focuses on materiality in the long term so it will help change the structural environment.

Longstaff acknowledged that Australian directors remain cautious and conservative about the idea of combining sustainability reporting with a company’s annual accounts. There is a degree of scepticism about the economic benefits as well as personal liability concerns. “These act as a brake,” Longstaff said.

"What is needed for progress is leadership." – Pablo Berutti, Colonial First State Asset Management

Yet, he pointed out what seems unthinkable today is not an impossibility down the track.

“If we had a major environmental disaster, the idea that society will pierce the corporate veil is not an impossibility, if losses are so significant because of the conduct of the corporation.

“Society will only take as much of companies privatising the upside and socialising the downside, and no-one would want to be in the shoes of a director who had access to risk data and did not use it."

Pablo Berutti, Head of Responsible Investment Asia Pacific for Colonial First State Global Asset Management, agrees. He wouldn’t quite say Australia was lagging behind the rest of the world, though.

In Berutti’s view, the leaders of integrated reporting in Australia are doing as well as their counterparts globally but the rest of the market is lagging behind the progress being made in some other regions.

As for investors, “There is a group of long-term investors who are lobbying for better disclosure standards but while they are large, they are in the minority, and sometimes struggle to elevate the issues above general market commentary,” says Berutti.

“But they are talking to companies and checking how well they manage their ESG risks because they view it as an opportunity to really understand what drives value in a business.”

Integrated reporting hasn't penetrated to the broader investment or corporate community; it’s still something that is being discussed. Berutti said that while the ASX Corporate Governance Council is keen to see companies disclosing how they identify and manage ESG risks, it called it “premature” to expect listed Australian companies to adopt integrated reporting until the international framework was better developed.

“It’s reasonable for companies to want to wait and see if a peak body isn't fully comfortable with the framework, but what is needed for progress is leadership, and so companies that want to demonstrate their long-term value creation story and attract more patient capital should consider how they can apply the IR framework.”

Berutti cited the July 2012 “Kay Review”, commissioned by the UK government, which outlined a set of measures to discourage short-termism in the UK equities market, partly through broadening the concept of stewardship between investors and companies, realigning incentives by better relating directors’ pay to long-term sustainable business performance and better aligning asset managers’ remuneration to client interests.

“Eventually, fund managers will be obliged to explain how they comply with these types of principles, in the same way companies increasingly are,” Berutti said.

He noted the widespread recognition that the whole investment value chain needs to be skewed towards longer-term outcomes and that managers need to view themselves as custodians of other peoples’ money.

“Stronger mandates from asset owners will help push for long-term investment strategies. Once those start coming to fruition, then integrated reporting will become a logical extension of that.”

John Purcell, CPA Australia's ESG policy adviser, pointed out that significant change has always been driven by significant failure, collapse and disaster.

“I honestly don’t think we can afford the luxury of waiting for a major adverse event to change our behaviour. I think unless Australia starts becoming proactive in this area, we risk losing our competitive edge. It will erode over time.”

Purcell says the loss of competitive advantage will affect Australia's ability to shift into new technology or diversify its stakeholder base. Australian companies risk being left behind by more progressive companies and economies if they fail to rise to the challenge immediately, says Purcell.

“We have a real opportunity ahead of us if corporate Australia doesn't retreat from change,” he said.