Rear vision mirror no longer reasonable guide for investors

A couple of decades ago, a balance sheet might have provided useful insight into a company’s value. Today the listed value of most companies far exceeds of the value of the tangible assets reported in most balance sheets.

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Much more of the value is intangible and investors are looking for greater insight into off-balance sheet value. According to new research by Lloyds and KPMG, corporate brand and reputation – intangibles - account for 25.3 per cent of the market capitalisation of the world’s leading equity market indices.

"Historic reporting regimes, sound as they are, fall short of what investors require to make informed assessments of a business and its prospects.”

In July 2020, Ocean Tomo updated its intangible asset market value study to investigate the economic effects of COVID-19 and found it has accelerated the trend of increasing intangible asset market value share, with intangible assets now commanding over 90 per cent of the S&P500 market value.

The Australian Corporations Act has long required more than just financial reporting (under s299A of the Act) but the relevance of historic information for judging a business’s future prospects is in decline.

Moreover, directors’ reports for listed entities must contain information investors would reasonably require to make an informed assessment of, among other things, business strategies and prospects for future financial years.

Arguably, these historic reporting regimes, sound as they are, fall short of what investors require to make informed assessments of a business and its prospects.

So what reporting is more valuable? Investors should be looking for integrated reporting as their primary information source, a discipline which brings in a much wider range of business indicators. In fact, an EY survey indicated investors globally already see the benefits of integrated reporting with 88 per cent confirming integrated reporting is useful.

Over 20 investor organisations globally have signed a statement of support for integrated reporting indicating their demand for the more reliable reporting across the value creation chain that integrated reporting delivers. Integrated reporting has been adopted by around 2,500 organisations in over 70 countries.

Unravelling the strands

However, some organisations have indicated they are confused about which standard or framework they should be implementing given the range of options for reporting on sustainability related information and integrated reporting is the only global framework that helps build connectivity of information across the value chain and, crucially, with financial information.

Meanwhile, the International Integrated Reporting Council (IIRC) is working with the other big players in the reporting field to clarify how the different standards and frameworks work together and the unique role organisations such as Sustainability Accounting Standards Board (SASB), CDP, the Climate Disclosure Standards Board (CDSB) and Global Reporting Initiative (GRI) have to play. 

Setting the foundations

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As set out in a joint statement issued by SASB, CDP, CDSB, GRI and the IIRC earlier this year, the International Integrated Reporting <IR> Framework already plays a vital role in connecting sustainability disclosure to reporting on financial and other capitals. There are calls for the principles of the <IR> Framework to be used to build the conceptual framework linking reporting in a new, comprehensive reporting system.

The International Federation of Accountants (IFAC) says: “We encourage regulators and standard-setters to use the International <IR> Framework as a foundation for incorporating and organising information about value creation and impacts, including narrative reporting and metrics from the various standard-setting initiatives.”

A conceptual framework is vital to delivering consistency in:

  • narrative descriptions of the business – its purpose, strategy, resource allocation and relationship management, governance, business model, and risk and opportunity management;
  • financial and sustainability reporting standard setting processes;
  • de-selection of standardised financial and non-financial metrics which are judged to be not presently material to value creation, and which can be reported in connected other corporate reports directed to particular stakeholder groups; and
  • self-determination of business-critical metrics not required by financial or non-financial reporting standards using the materiality determination process in the <IR> Framework.

Furthermore, integrated reporting makes a distinctive contribution to the global corporate reporting system:

  • It has a business-based conceptual foundation – the <IR> Framework;
  • With its multi-capitals approach for all stakeholders, including investors, integrated reporting is broader than other reporting frameworks. Financial reporting tends to focus on financial and to some extent manufactured capitals. Sustainability reporting tends to focus on social & relationship and natural capitals. Integrated reporting also focuses on intellectual, manufactured and human capitals, and integration across all capitals; and
  • Materiality. What brings investors and other stakeholders together? What are their common information needs?  Their common needs can be the focus of the integrated report. Other less material information of interest to specific stakeholder groups can be provided in other connected reports which are signposted in the integrated report.

Convergence in 2020

There is still a lot of work for convergence of frameworks to come to fruition, if it does. It may, maybe with modifications, or another model may emerge.

Standardisation of a selected group of sustainability metrics can bring consistency to the reporting of these metrics, which is a good thing. However, reporting those metrics in isolation will bring little insight for investors on where the underlying drivers of these metrics fit within a company’s overall business strategy and model - and hence its prospects. These metrics are best reported in the strategic business context of an integrated report.

The contribution of integrated reporting in relation to reporting on sustainability matters can be summarised as follows:

  • Claims as to sustainability matters must be put into the context of the strategy-based description of the business in an integrated report. Investors should demand integrated reports for the assistance they provide them in understanding the business;
  • Boards of directors must include a statement in integrated reports prepared in accordance with the <IR> Framework as to their responsibility for the integrity and reliability of the report. Investors should look carefully at these statements as an indicator of the quality of governance and management;
  • Integrated reports prepared in accordance with the <IR> Framework lend themselves to assurance as a credibility-enhancing technique. Investors should look to the assurance report on an integrated report for the credibility it adds to claims made in the report about strategy, governance, resource allocation and relationship management, the business model, and risk and opportunity management;
  • Integrated reporting is a process founded on integrated thinking. Better business practice results from adopting integrated reporting. The integrated report is another outcome. Investors can look to the integrated report for signals about how a business is improving its performance.

In KPMG’s 2019 ASX corporate reporting survey, Michelle Jablko, CFO of ANZ, said:

“When Shayne Elliott became CEO in 2016, he led ANZ in questioning its Purpose as a bank. Integrated reporting is consistent with considering, ‘Why do we exist?’ Integrated reporting also helps us to balance shareholder understanding of our reporting.

There have been well publicised pressures on the financial services industry, and findings that as an industry, the industry is not proud of. One of the areas relating to this was that corporate reporting was not very clear. Integrated reporting is an effective tool here, and it reinforces the need for simplicity across all of the Bank.

Previously, it was not clear how our different reports ‘hung together’. Integrated reporting provides an opportunity to address this.”

In September 2020, the Trustees of the International Financial Reporting Standards Foundation published a consultation paper to assess demand for global sustainability standards and, if demand is strong, assess whether and to what extent it might contribute to the development of such a standard.

Later in November 2020, the IIRC and SASB announced their intention to merge into a unified organisation, the Value Reporting Foundation, providing investors and corporates with a comprehensive corporate reporting framework across the full range of enterprise value drivers and standards to drive global sustainability performance.

In December 2020, the same group of organisations (CDP, CDSB, GRI, SASB and the IIRC) will publish a further report to show how the frameworks and standards can be used together, along with a tangible example of how the proposed architecture can be applied to climate change, by integrating the content of the standards and frameworks along with the elements set out by the Task Force on Climate-related Financial Disclosures (TCFD).

Complementary local developments

Australian developments continue as Australia considers the implications of the global system convergence.  Two are worthy of note:

  • The ASX Corporate Governance Council had in 2014 acknowledged a broadening reporting landscape. The 3rd Edition of its Corporate Governance Principles & Recommendations (2014) changed Principle 4 by replacing the term ‘financial reporting’ with ‘corporate reporting’, without defining ‘corporate reporting’ or introducing any recommendations in relation to the change. Accordingly, the 3rd Edition drove little change.

In 2019 the Council went further in relation to corporate reporting by acknowledging investors have access to a wider variety of information sources and also the growing investor demand for greater credibility of broader corporate reporting, through the addition of further measures. The new Recommendation 4.3 will see boards of directors reporting on their processes to ensure the integrity of corporate reports in 2021.

  • The Australian Sustainable Finance Initiative - a corporate collective which explicitly endorses integrated reporting as an enabler of sustainable financing - recommendations will be a strong driver of integrating sustainability into business planning and stewardship codes.

Investor and stakeholder implications

Australia has always taken a proactive and aligned approach when such global developments occur. Australia again needs to consider whether it is to be proactive or whether it will wait until developments are locked in before doing anything; that is, the convergence is completed.

As always, the risk of not being proactive and being part of the global voice is the Australian environment may not be taken into account. A converged global corporate reporting system may be put in place which does not suit Australia and may be imposed on Australia with sub-optimal results.

Michael Bray is Director of In-Country Engagement for the International Integrated Reporting Council

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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