Financial misconduct has been widely exposed after a series of bombshells, causing many to question the ethics of big institutions. Can IR (integrated reporting) restore trust?
By Tony Kaye
Scandals have rocked Australia’s corporate landscape throughout 2018, seriously shaking the confidence of many investors.
Revelations of widespread corporate law breaches, fraud and other unconscionable behaviour by the Financial Services Royal Commission have been prominent.
There has also been plenty of other high-profile cases outside the financial arena concerning breaches of Australian Securities Exchange listing rules and continuous disclosure regulations under corporations law.
The breaches have not only triggered sharp share price falls and, in some cases, director resignations, but led to an explosion of shareholder activist campaigns and a record number of class actions initiated by legal firms backed by litigation funders.
Investor trust has been severely eroded, despite the best efforts of governments, regulators and other bodies to further strengthen regulatory frameworks designed explicitly to instil investor confidence in capital markets.
Australia is not alone, of course. The trends are worldwide and the pressure is well and truly on. Corporations and directors are under greater investor scrutiny than ever before; not just in terms of their financial scorecard, but records around setting and practising strong environmental, social and corporate governance policies.
Investors at all levels – from fund managers to “mum and dad” shareholders – are demanding greater corporate transparency to assess a company’s current position and to better understand its long-term vision and investment value proposition.
The world’s two largest asset management firms, BlackRock and Vanguard, for example, have even created investment stewardship teams to engage directly with company boards to ensure they adhere to the highest corporate governance standards and make decisions accordingly.
Integrated reporting (IR) gains traction
Engendering trust among stakeholders – internal and external – is the key challenge for boards around the world. It is also facilitating global efforts to encourage more public and private corporations to transition to a fully integrated reporting (sometimes called IR) structure.
The international framework for IR was launched in December 2013 with the objective of changing the communications mindset within organisations so they can better explain to financial capital providers how they plan to create value moving forward.
Integrated reporting goes beyond traditional company financial reporting requirements to the extent that they need to provide insights into the resources and relationships that impact creating value over the short, medium, and long-term.
The framework encompasses six different elements of capital value that will effectively define the activities and outputs of corporations. These capitals are financial (funds available to an organisation), manufactured (plant and equipment), intellectual (systems, patents and licences), human (capabilities, experience and values), social and relationship (community and stakeholder linkages), and natural (renewable and non-renewable environmental resources).
“Boards naturally want to have a connective, holistic view of their business." Richard Howitt, International Integrated Reporting Council
Factoring in various capitals to its broader reporting will necessarily provide greater clarity around an organisation’s value creation processes and objectives, and importantly, build trust.
“More and more companies around the world are embracing the concepts of integrated thinking and reporting, because they fully understand the wider benefits of doing so,” says London-based International Integrated Reporting Council (IIRC) chief executive Richard Howitt.
“When we first published the International Integrated Reporting Framework in 2013, we had 160 companies on board,” Howitt reveals. “Today we have 10 times that number, 1600 companies in 62 countries, including 20 of the 28 European Union countries.
“There’s still a long way to go, of course. We wouldn’t pretend otherwise, but definitely there’s positive movement. Investors are asking for it, and in some cases regulators are asking for it, including in Australia.”
Strengthening corporate governance
In the context of diminished investor trust in corporations globally, Howitt agrees that one of the major impetuses for company boards to reach out to capital stakeholders should be to proactively harness the international integrated reporting framework.
“We say integrated reporting is a cornerstone in 21st century corporate governance, and an explicit part of integrated reporting is now going into corporate governance codes around the world,” Howitt says.
This includes a new recommendation to amend existing ASX Corporate Governance Principles by including the clause: “A listed company should have and disclose its process to validate that its annual directors’ report and any other corporate reports it releases to the market are accurate, balanced and understandable and provide investors with appropriate information to make informed investment decisions.”
Howitt says the ASX amendment directly points to the broader adoption of integrated reporting in Australia and is in line with moves to embed integrated reporting into corporative governance codes in other countries, including New Zealand, Netherlands, Philippines, South Africa, Japan, Malaysia and Brazil.
“It’s also part of the global principles for corporate governance, which are promoted by the International Corporate Governance Network [ICGN]. So, corporate governance and integrated reporting go together, and we’re seeing more evidence of that across the world.”
Why? “Because boards naturally want to have a connective, holistic view of their business,” Howitt insists.
“Board members are concerned about the long-term as well as the short-term. Where there are concerns about failures in corporate governance, only in a very small number of cases does that involve deliberate acts at the top of the company.
“Typically these involve practices which are hidden or shielded away, and if there was full transparency within the company and a connected view within the company, it wouldn’t have happened. Therefore, integrated reporting is a very good, preventative measure against failures in corporate governance.”
Want to learn more about integrated reporting? Elizabeth Prescott, the IIRC's technical director, will speak at CPA Congress 2018 on the topic of IR. Learn more.
Directors and officers liability
CPA Australia’s Policy Adviser for Environmental, Social and Corporate Governance, Dr John Purcell, says one of the main impediments to the rapid adoption of integrated reporting in Australia has been “a fairly strong view, particularly among the company director fraternity, that integrated reporting presents litigation risks and challenges”.
Purcell says the concern is mainly around those parts of IR which are future-oriented, with some directors of a view that making forecasts on a company’s business model and its long-term sustainability potentially exposes them to director liability risks.
The Australian Institute of Company Directors (AICD) last year submitted to the IIRC that, because of this, it did not support forcing those charged with governance of an organisation having to include a statement around their responsibility and decision-making in preparing an integrated report.
“If you look at integrated reporting and the framework itself, particularly its content elements, they are quite distinguishable from other forms of corporate reporting requiring company directors to make statements about prospects and outlooks for the particular entity,” Purcell says.
“Once establised, the process of integrated reporting can actually lead to more efficient and less costly reporting." Dr John Purcell, CPA Australia
“It’s probably fair to say that the concerns among directors have been overstated. But, nevertheless, it has clouded willingness among many companies to experiment with integrated reporting.”
However, Purcell notes that “the level of uptake is less than what we would have wished for” and points to a number of heavyweight corporate champions of integrated reporting in Australia, including Stockland, NAB and BHP.
Other adopters include Lendlease, Australia Post, Macquarie Group, Bank Australia and industry superannuation funds such as Cbus.
“None of those blue chip listed companies have shied away from engaging in the journey [towards] integrated reporting,” Purcell maintains.
“But I’d also say that many of the companies in Australia that have led the charge have a long history of doing stuff like sustainability reporting. So, they’re comfortable with the practices of giving non-financial disclosures to the wider market.”
Balancing the cost of IR with efficiency gains
Purcell concedes that while implementing integrated reporting has been easier for some organisations because of their existing reporting systems and protocols, for others the process will be more extensive and costly.
“Particularly given the fact that it’s built around looking at the connectivity between different parts of the business, different components of what makes up the capitals of the company, and that it is directed around business model reporting there will be, invariably, some incremental costs associated with setting up the process for doing an integrated report,” he says.
“Nevertheless, once established, the process of integrated reporting can actually lead to more efficient and less costly reporting.
“We continue arguing that there is a business case for doing integrated reporting that both improves the quality of the reporting and indeed leads to better corporate governance.
Certainly some of the research done internationally, and research done by ourselves [CPA Australia], would indicate that this type of reporting can lead to a lower capital cost. There are distinct benefits which outweigh the incremental cost of putting it in place.”
Moving IR to the next level
Howitt says that while integrated reporting is focused on external reporting – showing transparency and accountability to stakeholders outside the business – it is also about transparency and taking a holistic view within the business.
“That’s probably the biggest guarantor of good corporate governance,” Howitt declares.
The IIRC is already progressing to the next stage of integrated reporting by extending its framework to incorporate intangible company assets such as corporate reputation and staff engagement.
“It goes right back to the trust agenda,” Howitt says. “It is going to make the link between multi-capitalism and the strictures and traditions and disciplines of financial reporting and financial capitalism, which will make sure those things need to be respected and taken into the new era.
“For [them] to become centre stage there has to be a shift in thinking at the level of governments, financial markets regulators and [also] at an economic level.
“It’s about sketching out a powerful way on how we move from traditional financial capitalism, as it’s seen today and yesterday, into a new era of multicapitalism. Very exciting stuff.”
Can integrated reporting find its way?