The United Nations has put global reporting by companies on sustainability among its proposed key outcomes for the Rio+ 20 summit in June. The “zero draft” policy agenda that negotiators will consider, calls for “a global policy framework requiring all listed and large private companies to consider sustainability issues and to integrate sustainability information within the reporting cycle.”
This is a welcome move. Corporate reporting is all too often narrowly limited to financial information. But in our increasingly complex world, a company’s finances represent just the tip of the iceberg. Below the surface lurk risks that could cause leaks in the most seemingly successful business’s operations, reputation or bottom line. The oil spill in the Gulf of Mexico involving BP and recent issues regarding factory conditions at a Chinese supplier for Apple are cases in point.
Many of the growing sustainability risks companies face, such as changing consumer preferences, climate change, and water, food and natural resource insecurity, do not feature clearly in companies’ financial reports. This oversight gives investors and companies an incomplete picture – both of the risks they face, and the opportunities they may be missing.
Today’s financial accounting standards are outdated. They emerged after the 1929 US stock market crash, in an era when ecosystems and natural resources were in abundance and manufactured and human capitals limited. Today the opposite is true, and natural capital needs to be reflected in a company’s balance sheet.
While corporate sustainability reporting accomplishes this to some extent, such reports are voluntary. They generally do a poor job connecting the dots to financial performance and risk. Further muddying the picture, both financial and sustainability reporting tend to be backward looking, fragmented and short-term.
So what’s the answer?
Fortunately, an alternative, known as integrated reporting, is gathering momentum. As its name suggests, this approach seeks to bring together financial, environmental, social and governance information in a single, comprehensive and authoritative reporting format. Sixty companies around the world are currently road-testing such a reporting framework created by the International Integrated Reporting Council (IIRC).
The IIRC is a coalition of businesses, regulators, securities exchanges and not-for-profit groups, including the World Resources Institute. Crucially, it also includes participants from the world of financial reporting such as the International Accounting Standards Board, US Financial Accounting Standards Board, International Organization of Securities Commissions, and the “big four” accounting firms.
IIRC’s work comes at a time when investors and stock exchanges (as well as UN policymakers) are pressing for more complete information from companies, especially on sustainability issues. In 2010, the Johannesburg Stock Exchange made it compulsory for all listed companies to produce an annual integrated report or to explain why it was not doing so. In the United States, the Securities and Exchange Commission has published guidance on what public companies should disclose to investors on risks related to climate change.
Meanwhile, a few corporate pioneers are already experimenting with integrated reporting, including some sustainability information and metrics in their annual financial reports. Examples include Philips, Novo Nordisk, American Electric Power, Pfizer, Astra Zeneca and United Technologies Corporation.
What does integrated reporting mean for companies?
The IIRC defines five guiding principles for preparing integrated reports which it argues should:
- Convey a company’s strategic focus
- Provide information that “connects the dots” across all types of risk they face from financial to environmental and social
- Describe the company’s future “orientation” or business path
- Be responsive and inclusive to stakeholders and their concerns
- Contain concise, reliable and material information.
While taking such a path will require a shift in thinking and culture for companies, those who embrace integrated reporting will likely reap significant benefits. By gaining a more complete picture of the challenges they face, companies will be able to make better decisions, reduce risk and build a more sustainable long-term future.
Where might all this lead?
Imagine that it is 2020 and integrated reports have supplanted corporate annual financial reports as the go-to place for investors seeking information on corporate risk. These reports connect the dots on how corporations draw on six sources of capital: natural, manufactured, social, intellectual, human and financial.
Acting on this intelligence, corporate CEOs and CFOs are prioritizing strategies that keep their companies competitive in a resource constrained and crowded world. For example, they are investing in clean energy, procuring raw materials sustainably and offering green products as a rule rather than exception. Fiduciary duty has been expanded from financial capital to include stewardship of the other five sources of capital that underpin corporate performance.
In today’s world, limited transparency around corporate sustainability risks can lead to investments that are bad for the environment and for investors’ bottom lines.
In tomorrow’s world, companies that embrace integrated reporting can look forward to navigating much safer (and cleaner) waters when it comes to avoiding reputational or operational icebergs.