Good corporate reporting has an important role to play in helping to restore the trust that has been lost. Stakeholders are demanding greater transparency around strategy, business models and risks, and the commercial prospects of the enterprise and institutions with which they engage. The current accounting framework fails to integrate strategy, governance, performance and long-term prospects into a coherent corporate outlook. More and more companies are issuing a sustainability report, but very few are incorporating its findings into a holistic view of the risks and opportunities that entities face.
Integrated reporting should be a process, not a product
To this end, integrated reporting represents a significant evolution of current corporate reporting and provides long-term vision for the future. The crux of the matter of new corporate reporting is the assessment of risk and opportunity. The point is not the exposure to risk, but what is being done about it, which boils down to strategy.
Investors are yet to be convinced about the sustainability of an entity’s business model, based on its strategy, the risks faced, and how they are managed. The financial crisis has underlined the importance of understanding systemic risk. Therefore, companies need to take a hard look at whether they are passing risk to another entity, if that is what they are intending to do. If so, what is the strength of the counterparty?
In the words of International Integrated Reporting Committee chairman Mervyn King, the current reporting model is like “looking in the rear view mirror”, when “the road ahead is turbulent and there are huge impacts on the company, both societal and environmental”.
The idea of IR is to enable an entity to show what its long-run strategic plan is and how this strategy will create future value, enabling the investor to make an informed assessment about whether the entity will be able to sustain value creation in the changed world we live in. In a nutshell, the information in an integrated report should be fundamental to the creation of value.
“Integrated reporting is a fundamental prerequisite for a company being able to present a forward-looking picture,” King continues. “When you come to measure risk with a (comprehensive) reporting model, you can invest more efficiently.”
The common concern is that corporate reports, as they stand, are being used to “dump” excess information, which makes them more of a marketing document than a tool for investors to make informed decisions. To this effect, one of the aims of integrated reporting is to reduce the clutter so that the real story shines more evidently, avoiding the risk that such emerging reporting will itself be marketing in nature.
The directors’ report should be key in providing forward-looking information in a way that is useful for readers. It provides a platform for executives to explain the business model and the entity’s strategy for pursuing its business objectives. It should provide a clear assessment of the potential risks faced by the entity in aiming to reach those objectives and how it plans to prepare for these possible eventualities.
Integrated reporting should be envisaged as a process, not a product. Companies need to avoid the common trap of focusing only on individual stakeholders.
A broader range of stakeholders are influencing how companies create and sustain value. The data being disclosed should be chosen carefully; the focus should be on what companies use to create value.
In its June 2012 publication What is Integrated Reporting?, UBS has put forward six core drivers which it believes are relevant to most businesses – external dependencies, customers, product, supply chain, human capital and reputation – also suggesting possible financial indicators as well as environmental and social metrics or narrative for each input.
Once these issues pertinent to an entity and its stakeholders have been identified, the analysis of each should become routine. Successful integrated reporting requires its own integrated strategy and integrated systems.
Integrated reporting holds the potential to change the game, creating a more powerful feedback loop that aligns stakeholder and shareholder expectations for corporate performance.
Done well, integrated reporting will spur companies to rethink how they function within society and can become a platform for communicating with financial analysts about the long-term drivers of the business.
If the corporate reporting system is due for an overhaul, the rules for auditing and reporting on the effectiveness of internal control over financial reporting should be considered as well. As the focus shifts from financial statements to other communication, the key question is whether the latter should be subject to some kind of assurance.
Joachim Schindler, global head of audit for KPMG International, suggests that the need for assurance depends on whether it has a value to whomever it is provided. If this assurance provides insight and comfort to the audit committees, then it is likely that auditors will be requested to review this additional information. In addition, audit committees will benefit from the auditor’s insight into areas of improvement in the entity’s risk management and internal control processes.
The discussion on integrated reporting is still in its infancy and it remains to be seen whether it represents the best solution. It would depend on the answers to some questions: Does it remain appropriate that the fiduciary duty of directors is primarily focused on shareholders? How will an evolving model affect the responsibilities of boards and audit committees?
As the focus shifts to other forms of reporting, with more emphasis on forward-looking information and story-telling, will there be a need for more, or other forms of assurance beyond the financial statement audit? Good corporate governance remains the imperative.
Hilary Galea-Lauri is a partner and co-head of audit at KPMG in Malta. Diane Vella is a manager in the risk consulting advisory services team at KPMG in Malta.