October 4, 2011
Authors
-
Virginia Terry
Former Director, Advisory Services, BSR
-
Senior Advisor, BSR
A better model of company reporting is needed. While traditional annual reports deliver reliable financial statements, they fail to capture critical information about the company’s long-term value. And sustainability reports often overload the reader with information, despite the growing emphasis on limiting the reports to what is “material” or relevant to that company’s core business.
But what if the reports could be combined to offer a concise accounting of the links between strategy and risk, financial and non-financial performance, and the organization’s own performance and that of its value chain?
That’s the rationale behind the International Integrated Reporting Committee’s (IIRC) vision of a new reporting framework, which is outlined in its recent discussion paper. The IIRC will test its proposed "Guiding Principles" and "Content Elements" by asking for feedback on its paper and launching a two-year pilot program this month.
In the past few years, companies such as Pfizer, UTC, and Novo Nordisk have pioneered integrated reporting, but it is still at the early phase of development. And although there is an emerging consensus about what integrated reporting should aim to achieve, we still don’t know what it should look like in practice.
That’s why the IIRC’s program is such a critical road test. It is especially important now that the Global Reporting Initiative (GRI) is beginning work on its “G4” guidelines (suggestions for which we outlined in a previous feature article). With both standards evolving, companies are rightly asking what integrated reporting means for the future of sustainability reporting.
Key Questions About a New Framework
BSR is an active participant in both the GRI and the IIRC (BSR CEO Aron Cramer is an IIRC member), and we believe integrated reporting is moving disclosure in a positive direction, embedding sustainability into company strategy and decision-making. It has the potential to clearly show how companies are creating long-term value.
Over the next few months, we will work with member companies to test the integrated reporting principles and shape the resulting framework. In our view, there are four key debates to consider:
Which comes first, integrated thinking or integrated reporting? The primary challenge in integrated reporting is to articulate the connections between financial and non-financial performance. This cannot be achieved by simply inserting a four-page CSR spread in a traditional annual report, or by adding a set of sustainability metrics to financial data. Rather, it requires business leaders to better understand how financial performance and sustainability performance are linked to make decisions about governance, strategy, and management based on that understanding.
But the integrated reporting approach presupposes a level of maturity in integrated thinking that may be present in a relatively small set of leadership companies. Will quality integrated reporting remain a niche practice of a handful of sustainability leaders? Or can the integrated reporting process and the IIRC’s framework help inspire greater integrated thinking, and generate a broader uptake of the reporting model?
Who determines materiality? The IIRC is currently prioritizing investors as a key audience for integrated reports because they have a particular need for better information about risks and opportunities associated with non-financial data. As the discussion paper notes, only a “small percentage of market value is now explained by physical and financial assets—down to only 19 percent in 2009 from 83 percent in 1975.” Additionally, making sustainability information more relevant to investors has the potential to shift their current short-term focus toward longer-term performance.
The IIRC framework is based on the premise that a wider range of issues are material to investors than is currently reflected in annual reports. However, by defining investors as the primary audience (and therefore making relevance to that group the determining factor in what gets covered), the IIRC's framework may mean companies overlook important sustainability issues. That could undermine a founding premise of sustainability reporting: that material issues should be defined by a range of stakeholders. Will the development of an integrated reporting framework mean that “materiality” continues to be one word with two different meanings, one for investor reports, and one for broader sustainability disclosures? Or will investors’ concerns increasingly take into account stakeholder interests, as the IIRC framework suggests, since stakeholder relationships enhance companies’ ability to create value?
How much focus should be on the future? Despite some forward-looking statements and information about strategic focus, both annual and sustainability reports focus mostly on the past. The IIRC proposes that integrated reports include a greater focus on the future, with a “Future Outlook” section covering where the company is going, how it will get there, and what barriers it will face.
If this happens, it will certainly provoke some challenging analysis among business managers—especially since sustainability trends such as climate change, resource scarcity, and rapid socioeconomic change are all increasing the uncertainties that businesses face. Will companies be able to identify potential future opportunities, challenges, and uncertainties? Will they able to identify lower-probability risks that could have extreme consequences to their business?
How will accountability for reporting change? Today, the approach companies take to sustainability reports varies widely: Some are led by communications functions, others by CSR managers, and still others by small, cross-department teams.
If companies adopt the integrated report as their primary approach, executive oversight, especially by the CFO, will become the norm. The IIRC also assumes that the CFO will measure and manage the value of all forms of capital—human, financial, social, and ecological. The implication is that sustainability considerations would become embedded in the business-planning process (back to that “integrated thinking” requirement), and that the CFO would play an increasingly important role in areas such as scenario planning and valuing stakeholder relationships. Are CFOs prepared to take a greater role in valuing sustainability issues, especially in those areas such as ecosystem services that previously were “uncosted”? Will business leaders be able to demonstrate the relationships between key performance indicators and sustainability issues that cannot be fully quantified, such as the quality of stakeholder relationships?
Where We Go From Here
Despite the momentum behind integrated reporting, it is too early to know where we will be in 10 years. Whether integrated reporting becomes the norm will depend on whether governments mandate some form of the practice. One scenario may be that the integrated report becomes a concise, strategic document that links business sustainability, long-term objectives, and performance at a high level for an investor audience, while GRI-based sustainability reports are placed online, allowing a range of users to dig into the data that concern them most.
But we do know that in order to make progress, companies need to put the IIRC’s vision into practice, experimenting, making mistakes, working through problems, and ultimately sharing their insights.
We encourage you and your colleagues to review the discussion paper and provide comments to dpresponses@theiirc.org or online, by Friday December 14, 2011. BSR is seeking to work with companies during the pilot phase of integrated reporting to experiment with the format. Interested companies should contact Dunstan Allison Hope or Virginia Terry.
Let’s talk about how BSR can help you to transform your business and achieve your sustainability goals.