Published: April 01, 2014
Everybody agrees that the current ‘corporate reporting’ model will have to change if it is to continue to be useful and usable by stakeholders, particularly if it is to meet their needs and the new regulations, especially European regulations. A more apt system would make the financial markets and the capital markets more efficient, but it would also restore investors’ rather shaken confidence. Transparency and comprehensiveness are needed. The societal responsibility dimension must be taken into account and integrated fully into financial reports. A trend towards a single, more forward-looking, integrated report (i.e., ‘one report’), which would cover all data, is emerging and gaining traction, ready to be imposed on us one day.
The financial crisis has shown up the lack of business guidelines, prudential standards, abuses and ways of getting round existing standards. The rules are sometimes there but unworkable, ineffective or even worse, unsupervised. The world of finance cannot exist without a set of robust accounting standards (e.g., IFRS) and financial reports that provide transparency, comparability and quality. An annual report is of no value unless it is complete and unique. Hunting through various reports for information is never a pleasant exercise for users. The approach used by annual reports has an uncanny similarity to an exercise which consists of ticking the boxes required for compliance. Surely form is prevailing over substance? Does this type of report present data concisely? Does it deliver the desired messages?
[[[PAGE]]]We rather think not. We need to devise the reporting vehicle of the future, different to and more comprehensive than the current patchwork of items piled one on top of the other with no real structure or operating framework. The idea is to present more ‘disclosures’, narrative elements or cross-referenced tables, to improve the clarity of MD&A (Management Disclosures & Analyses), to give further information on intangibles (too often overlooked) and to increase the proportion of non-financial detail by comparison to the financial items to which too much emphasis is often given. To achieve this, it would be best to have one single person in the driver’s seat to co-ordinate everything that is required. There is no dotted line joining up report items with each other to deliver a more comprehensive, coherent and better articulated story, or a story that is more forward-looking than backward- (or accounting-) looking. Even though the benefits of such a report exceed the costs, the costs are a discouraging obstacle, especially in the already burdensome context of compliance (EMIR, SEPA, etc). We are drifting slowly towards some sort of system of continuous reporting and perhaps we have already reached an acute stage of information inflation. In this context, treasurers and risk managers have a key role to play.
Over the years, the quantity of financial data has continually increased. The adoption of IFRS accounting standards has only fuelled this trend. Users of annual reports, in this age of the internet and total transparency, expect ever more comprehensive and more relevant information. In parallel with this tidal wave, we have found that financial information is being shaped in a certain way and that good practices are emerging. The leitmotiv has been absolute transparency, comprehensiveness and, most of all, comparability. We might think of IFRS 7 and 13, or of IAS 7, 13, 30 and 32 – there is no shortage of examples in international accounting standards. This is one of the consequences of globalisation, repeated financial crises and other reverberating scandals. Whether this more plentiful information is understood and used by investors is another matter, and a crucial question. However, this is no longer the time for arguing about whether these things should happen, but for following the rules for disclosing financial information. This clear trend of the future seems to have become unstoppable. At the same time, we also have to cater to national demands for reports for issuers or companies listed on different stock exchanges, in addition to their own national legal requirements. In Germany for example they have GAS 20 external reporting requirements supervised by FREP, and also reports supervised by BaFin.
In contrast, over several years an impetus has been developing in parallel to give more details that are not purely financial. Rating agencies do not base their assessment on financial figures or ratios alone. Non-financial information is gaining ground and is being assessed in ever more detail. So we need to ask ourselves what will go into the corporate reports of the future.
On 16 April 2013, the European Commission proposed the adoption of new external non-financial report measurements. It is considering requiring major corporations to disclose more non-financial data. Users and investors are demanding ever more non-financial information on corporate performance, particularly on environmental, social and governance aspects. Nobody can dispute that this demand is on the increase and that what is being demanded is covering an ever broader spectrum.
The most important source of ESG-type details is the sustainability/CSR (Corporate Social Responsibility) report and the annual report. As with financial information, if it is to be digested and used, it has to be comparable. Furthermore, investors are expecting that non-financial information should be better integrated into financial information. Readers of annual reports want to find KPIs (Key Performance Indicators) to measure and quantify what has now become an essential aspect. The ‘accountability’ mechanism must be an integral part of non-financial information. According to an international survey by the ACCA (Association of Chartered Certified Accountants – www.accaglobal.com), 67% of investors always use non-financial information, and 25% use it frequently. These are striking figures. At the same time, 78% agree that the current level of non-financial information disclosed is irrelevant or inadequate. This shows that the investor community has high expectations as regards ESG KPIs. The European Commission cannot leave people to do as they please in this matter.
The idea is not to add further reports but to select information more appropriately for more effective communication. In-house, ‘Integrated Thinking’ will monitor performance better by measuring and tracking internal qualitative value creation indicators. Externally, integrated reporting will help with better selection and structuring of data that investors find useful, to provide them with more concise information.
The objective is also to reconcile the differences in philosophical approach between continental Europe and the English-speaking world, or between the rules-based approach as against the ‘comply or explain’ approach or to produce a set of details and KPIs to provide only what is relevant to giving a true and fair view of the business. The consensus that needs to be found is somewhat like that which international accounting (IFRS) had to find to fit in with accounting systems based on historical cost. We need to give them more, and give it to them more quickly, with the assurance that it is quality information of true and fair value.
The IASB has also played a part in the IIRC’s work. The IASB’s review of the conceptual framework is one of the initiatives aimed at improving this reporting system (impairment, intangibles, off balance-sheet commitments, OCI, and others). There is a widespread desire to remove some of the complexity from financial information, along with its too backward-looking perspective; a desire to add further dimensions, particularly CSR. We could cite a few examples of non-financial KPIs: personnel turnover, customer satisfaction in service industries, a personnel satisfaction survey, the degree of maturity of internal controls, etc. To go back to the German GAS 20 example, this requires disclosure of the KPIs used in the business’ internal administration (financial and non-financial KPIs) for quantifying individual risks. This same rule also refers to reports on sustainability, on forecasts/expected developments, managing risks and opportunities and internal controls (CS/RMS), corporate governance, etc. There is therefore a positive convergence effect in which each of the stakeholders is asking for somewhat similar reports.
There is a series of crucial questions you need to ask yourself. For example, will the report explain how things are going? Will readers understand the business’ ability to generate value in the short and long terms? What progress has been made in implementing strategy and how does it align with risk management? What future developments are planned for reviewing the design of the business over time? To what extent could the ability to generate a return on investment be affected, and by what? What are the business’ strategic advantages and how are the assets controlled and managed? These are some examples of questions that are often not addressed in annual reports, in spite of their bulk. Companies are forgetting why they are reporting. A company’s real value is not revealed in the annual report. The idea of an integrated report is to combine the best of both worlds in a single report, giving a picture of performance while improving or refining each of the sections, without increasing the combined total volume. Some pioneering companies understand this and apply it: examples are Philips, Microsoft, HSBC, Novo Nordisk, EIB and Coca-Cola. The question is not about knowing whether to radically overhaul your reporting system or not, but when to do so. Some companies are simply opting for the wait-and-see solution, which consists of leaving European legislators to lay down requirements before making any move. Being proactive could however have benefits and lead to a competitive advantage over your peers. Standing out in the right way always has a beneficial effect.[[[PAGE]]]
This is a crucial question. However, we do not need more information, but better and more relevant information and a story, rather than just a simple snapshot of a financial position at 31 December of the year in question. Many people see ‘greenwashing’, a chance for the business to exaggerate its societal and environmental achievements, with no real intention of changing them. Would they just be a smokescreen? An investment yielding no return – no ROI? The trick is rather in making it easy for the readers of these reports to understand and digest them. NGOs are putting heavy pressure on businesses, particularly polluting businesses. These are new stakeholders. A majority of major corporations already use the GRI (Global Reporting Initiative) guidelines. These reports ought to be real management tools. In a world in constant and rapid change, it is crucial to demonstrate your value, your resilience and your ability to survive over time, while at the same time creating value. The Board of Directors must back the idea of an overhauled and (more) integrated report. The commitment of CEOs is essential for the success of such a project. The question is not whether we need to report differently, but instead when we should get down to do it and how. Are we going to wait for them to impose rules on this matter on us, or are we going to behave proactively? As an image, we might say that financial reporting is like looking into a rear-view mirror, while forgetting to look ahead at a road that is becoming ever more winding and dangerous. To conclude, I would like to quote this sentence by Nassim Nicholas Taleb, which is so true: “We are drivers looking through the rear-view mirror while convinced we are looking ahead”.
Note
[1] ‘Integrated Report’ (IR): The intention of IR is to promote a cohesive and efficient approach to corporate reporting, pulling together information from different sources and communicating all the different elements that have an impact on an organisation’s value creation potential. Opportunity to revisit financial reporting, processes and procedures, define clear roles and responsibilities, dependency on key personnel, loss of data and knowledge coordinate better reporting.
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