By: Calvin Benedict

*The views expressed herein are those of the person being interviewed and do not necessarily reflect those of the Organization to which she is affiliated.

Our Research Associate Calvin Benedict gained a unique insight into Integrated Reporting through his Q&A session with Superna Khosla. Ms. Khosla is an Integrated Reporting Policy and Network Lead at PwC, London. Prior to this, she was the Relationships Director at the International Integrated Reporting Council (IIRC). Ms. Khosla certainly brings a wealth of knowledge and experience in her field of expertise, where she has recently been involved in developing the IIRC’s pilot programme, and we are most thankful for her responses.

First, a brief background on Integrated Reporting.

1.    Corporate Accountability Drives Integrated Reporting

“[The] divorce between accountability and power strikes at the heart of any notion of democratic governance. [It] is not just economic. It is also constitutional” (January 14, 2014) – Martin Wolf, chief economics commentator at the Financial Times.

Conceptually, corporate accountability reporting is much broader than corporate accounting.  ‘Accountability’ reporting in contrast to corporate accounting, serves as a driver for corporations to disclose externalities not typically captured by conventional accounting definitions of revenues and expenses.[1]   The resulting externalities are classified as ‘positive’ (e.g., community development programs) or ‘negative’ (e.g., regulatory capture[2] and the destruction of ecosystems).[3] Once corporations are assessed in this manner, we can examine their behaviour, not only as just market players, but more generally within a societal context.[4]  Corporate accountability thus places a greater emphasis on a holistic view of performance including environmental, social and governance (ESG) issues.

Equally apposite to this discussion, is the global adoption of social accounting practices – whether voluntary or driven by market forces – which arise to address the need for corporations to assume higher levels of corporate accountability. By definition, social accounting as its name indicates is a process whereby corporations report on their social, environmental and economic (‘triple bottom line’) performance and impact.[5] Social accounting and sustainability have become inextricably linked. In this light, social accounting is a means to an end, not an end in itself[6] as it encourages the integration of sustainable business practices into core business strategy.

The relationship between social accounting and the law is, admittedly, rather vague. Recent advancements in social accounting norms, in the form of industry-led ESG codes and standards, tend to lack the enforcement mechanisms provided by regulatory regimes. The law is making some headway as evident by the, ‘apply or explain basis’ for companies listed on the Johannesburg Stock Exchange to publish an integrated report.[7] In this instance, an integrated reported is published in place of a company’s annual financial report and sustainability report.[8] That said, normative inquiries have surfaced in relation to whether advancements of this nature should in fact be regulated.

To this end, it is counter-argued that if social accounting is regulation-led, as opposed to market-led, then disclosures become more boiler-plate and compliance orientated. By all appearances, for a market-led initiative to be of value, it must be relevant to the firm engaging in it. Where social accounting results in highly esoteric, compliance-driven disclosures that really only serves the purpose of regulators there is almost no real social utility in such an endeavour.  However, where social accounting results in readily understandable and verifiable disclosures that promote an enlightened sense of stewardship and accountability there are obvious broader social benefits. This article limits the discussion of social accounting initiatives to work being carried out under the rubric of ‘integrated reporting’.

2.    Integrated Reporting <IR>

The International Integrated Reporting Council (IIRC) was formed in August 2010 with the remit to create a globally accepted integrated reporting framework for accounting that combines “financial, environmental, social and governance information in a clear, concise, consistent and comparable format – put briefly, in an ‘integrated’ format’”.[9] <IR> enables the assessment over time of how a corporation creates value and includes a description of: a corporation’s current and intended future use of capitals, its value drivers, and the implications on and trade-offs between those capitals over time.[10] Six forms of capitals are considered in the framework that corporations are said to use to create value: financial, manufactured, intellectual, human, social and relationship, and natural.[11] The framework is principles-based and future-orientated, thereby allowing for flexibility, and a detailed discussion of each capital is not required in a corporation’s integrated report.[12] Anecdotal evidence suggests if management incorporate ‘integrated thinking’ through linking the effects of different capitals in their decision-making, this should be reflected in the corporation’s <IR>.

The advantages of integrated reporting fall under three classes. First and foremost, there are “internal benefits” that allow for enhanced internal resource allocation decisions, more rigorous engagement with shareholders and other stakeholders, and lower reputational risk.[13] Second, there are “external market benefits”, including the provision of ESG reporting for interested mainstream investors and financial analysts.[14] Finally, the third advantage relates to the management and mitigation of “regulatory risk”.[15] This advantage acknowledges the increasing wave of global reforms in corporate accountability, and the consequential benefits of participating in the development of frameworks and standards.

The most recent undertaking of the IIRC is its Pilot Programme, an industry-led initiative designed to develop and test the principles, content and practical applications of integrated reporting.[16] The IIRC will run the programme until September 2014, following the publication of the “International <IR> Framework” in December 2013, to allow participants to test the effectiveness of the framework during their reporting cycle.[17]

The driving force behind initiatives like <IR> is the growing recognition globally, that the gap between traditional corporate reporting and social accounting initiatives must be bridged to provide a more complete perspective of performance and value. Following international momentum in examining the traditional domain of corporate accounting practices KPMG, one of the ‘Big Four’ auditors, has openly stated that:[18]

“The mismatch between current corporate reporting and business value has become increasingly apparent in the volatile business environment of the last five years. The focus on current year performance may go some way towards helping readers understand ‘business as usual’ but it is not enough to provide a complete picture of long-term value”.

The financial sector has a strong presence in the Pilot Programme. According to a published, non-exhaustive list of the 104 participants, 16 are categorized as part of the financial industry, including:[19]

A November 2013 report by the Financial Stability Board provides for the latest list of global systemically important banks (G-SIBs).[20] The list names 29 banks[21] and of that list, HSBC Holdings plc, Deutsche Bank and BBVA are the only banks that have adopted the Pilot Programme. This amounts to just over a 10% uptake among the G-SIBS, which highlights some of the challenges on the industry-led initiative. As an organisation the IIRC has made commendable progress in bringing integrated reporting closer to being embedded within mainstream business practice and should be applauded for its efforts. But, as this is a market-led initiative, there is only so much the IIRC can achieve alone and a number of challenges remain to be addressed in the future. We discuss some of these challenges with Superna Khosla.

3.    An Interview with Superna Khosla

Calvin Benedict: What are the main benefits of <IR>?

Superna Khosla: Quality integrated reporting will enable a more transparent, meaningful dialogue between businesses and investors resulting in more efficient capital allocation. I believe it’s why we see stock exchanges globally beginning to embrace the concept.

It calls on businesses to demonstrate the resilience of their business model by considering all the resources they utilise (not just financial capital) over the short, medium and long term. The focus on value creation is different from the current focus of reporting how much profit is made. This enables greater accountability for all the outcomes of business activity.

CB: What areas of the new International <IR> framework need improving?

SK: It’s only just been released (December 2013) and has gone through a wide public consultation process showing significant support for its direction. As more businesses take on the challenge of <IR>, I think there will be further asks of the IIRC and others to support implementation e.g. industry relevant guidance, deeper examples of best practice etc. to complement the framework itself. It is version 1 and inevitably there will be enhancements as <IR> becomes more common practice and I believe there will be some nuances required for different jurisdictions at least in the short term.

CB: Given that <IR> is principles-based and therefore allows for flexibility, is it possible to compare the reports of, say, two competitors who engage in the framework?

SK: One of the fundamental principles of <IR> is comparability, not just internal to the organisation but compared to peers. The framework’s structure of content elements and requirements for consideration does form a basis for users to create expectations of what information is reported, and therefore enable meaningful comparison between businesses.

What marks the paradigm shift in corporate reporting with <IR> is the fact it should yield the business’s unique value creation story. Much of what should be considered, at least in the short term, will be qualitative and not quantitative and that will mean simplistic (and not always relevant) comparisons of data points won’t be possible.

CB: What has been the general attitude of banks towards <IR>? Is it becoming more popular among banks? Do you believe that post-Crisis banks should be held to a higher level of accountability and reporting of this nature may help achieve this?

SK: Post-crisis, I think it’s fair to say that most businesses have come under increased scrutiny in respect to both their own resilience and their net contribution to society, beyond profit earned for shareholders. How much money has been generated is no longer the absolute measure of value but also, how has the money been made and what have been the resulting outcomes.

Integrated Reporting encourages businesses to consider their wider impact on the world’s resources whether it be human, natural, intellectual, societal and over a longer time frame. This more holistic consideration of the trade-offs inevitable in each decision and the longer term perspective, will I believe, make businesses more accountable. It’s a tough one though and accountability has to start somewhere – businesses in the end are accountable to their shareholders and we’re all shareholders now through our pension funds!

The IIRC’s business network includes a number of banks. A concern often heard is that the length and complexity of current reporting requirements often leads to opaque reports and investors pricing in risks when actually these might be well managed. It’s hard to argue against a framework that enables Directors to explain how they run their business.

CB: Is there any external assurance process for <IR>? If not, do you think there is a need for one to verify the robustness and accuracy of disclosures?

SK: To my mind, some form of assurance is going to be essential for integrated reports to be regarded as reliable information upon which investors and other stakeholders can rely. While there isn’t an ‘integrated reporting assurance framework’ as yet, there is assurance guidance which has enabled sustainability and other reports to be assured and can be a starting point. Now the Framework has been released, I believe assurance experts will need to quickly establish assurance protocols for integrated reporting.

CB: Do you think <IR> should be regulation or market led?

SK: In the long run, I see integrated reporting or the tenets of it being adopted in legislation so there is uniformity in the markets. Already South Africa’s stock exchange has an integrated reporting requirement and aspects of the UK strategic report requirements resonate with integrated reporting.

For integrated reporting to be successful though, in the short to medium term, businesses need to explore on a voluntary basis its aspects and there needs to be a greater body of experience. This may influence a second iteration of the Framework before adoption by policy makers.

CB: Do you think there is some urgency for corporations to adopt <IR> and what are your hopes for the way integrated reporting develops in the future?

SK: Absolutely, the financial crisis has illustrated the connected world we live in and on how focusing on short term profits, can collapse economies globally like a house of cards, almost overnight. Businesses accounting for the resources they use and their impact is critical when by 2030 we could be looking at:

– A population of 8bn[22];

– A rise in temperatures of up to 1.5%[23]; and

– 50% more energy and 40% more water requirement.[24]

The signals from business are that they are ready to look at things differently. A recent PwC survey[25] of over 1300 global CEOs shows that near 50% of CEOs see resource scarcity and climate change as one of the top 3 trends that will transform their business over the next 5 years.

Over 75% of CEOs agree that measuring and reporting total (non-financial) impacts contributes to long term success for their business and a similar number agree that satisfying societal needs (beyond those of investors, customers and employees) and protecting the interests of future generations as important to their business.

CB: Thank you.