Integrated reporting – friend or foe?

FINANCIAL REPORTING in its current form fails to meet users’ needs, but integrated reporting is not the answer.

This was the message of a panel of investors, auditors and standard setters at a recent Financial Reporting Outlook conference hosted by Ernst & Young.

Integrated reporting is a relatively new initiative aimed to make annual reports more useful by linking disclosures, helping both investors and management examine key performance indicators and business risks.

The panel of experts debated the value of today’s annual reports, arguing that the concept of materiality is becoming less accurate as it grows in complexity.

Better Capital chairman Jon Moulton was most strident, saying: “Even train spotters of financial reporting don’t read more than halfway through companies’ narrative reports. They are written by the PR department.”

Moulton said basic accounts are more than sufficient in most cases, adding: “The art is to ensure these numbers show everything you need to know.”

Numbers or words?

This contradicts arguments for integrated reporting, which say numbers are nothing without qualitative information underpinning them. For example, a power station with fantastic profits would be less attractive if qualitative data showed pollution and safety laws were ignored.

For this reason, integrated reporting attempts to link different strands of disclosure: narrative; risk; and a long-term view of the company, to name but a few.

One of the biggest issues is the definition of materiality. Who are the stakeholders? Are they investors, or are they wider society? Without knowing this, it is difficult to establish what is material to integrated report users.

Failure to identify the stakeholders and what they want to know could be one reason some investors have been unmoved by the idea thus far.

The Global Reporting Initiative, a network-based organisation focused on sustainable and integrated reporting, is attempting to address this problem.

Around 50 major companies worldwide are part of a pilot scheme to integrate their annual reports, considering issues such as materiality and how to present a long-term view.

South Africa is also ahead of the game, requiring listed companies to produce integrated reports. This has resulted in weighty disclosures in many cases, but proponents claim increasing sophistication will cut the length of integrated reports.

Novo Nordisk is one high-profile success story. The healthcare provider has put in place a team of experts to constantly review its annual report, examining key performance indicators and conducting materiality assessments.

These measures plus negotiations with regulators have allowed Novo Nordisk to condense its annual report, but the process has clearly involved significant investment.

Integrated thinking

None more so than by management, which needs to be thinking in an integrated manner if it is to produce corresponding disclosures.

This is a major reason integrated reports might seem daunting to preparers and gimmicky to users. Really examining disclosure and how issues – which might never had been reported before – interconnect can be hugely time consuming.

While investors might see little relevance in knowing how much carbon a company produces per year, integrated reporting supporters claim green issues are just one aspect.

Bob Thust, Deloitte head of corporate responsibility, said integrating reporting can identify synergies and potential business savings, something investors might find more appealing.

Nestlé is one such example, and high-profile companies signed up to the GRI pilot scheme – including HSBC and Microsoft – indicate others are interested too.

Nevertheless, the Financial Reporting Outlook panel of experts seemed to give short shrift to the concept, saying there are other ways to improve annual reports.

Stakeholder doubts

Global standard setter Stephen Cooper said “there is a case for some disclosures being elsewhere”, and lists of subsidiaries or information on accounting methods could go online.

This approach has received support from those eager to cut weighty annual reports. But Peter Elwin, head of European pensions, valuation and accounting research at JP Morgan Cazenove, warned this could lead to disaggregation.

“The great thing about annual reports is that they’re coherent and in one place. If you split them, the worry is that senior management will delegate and stop reading the whole thing,” he continued.

Jean-Yves Jegourel, E&Y’s European professional practice director, said clients are interested in integrated and sustainable reporting, but three-quarters view it as a low priority compared with more pressing concerns.

For companies that do take the plunge, the problem of how to present integrated reports looms. The question of whether and how to provide assurance on some or all of the report is also unresolved.

As some investors and experts remain sceptical, the GRI pilot scheme could not come at a better time. If integrated reporting really is the future, it will take some powerful companies backing it to convince the wider market.

One of the front runners, Puma, has produced an environmental profit and loss account with the help of PwC. Audit partner Charles Bowman said this has sparked significant interest among other companies.

Preparers at least seem ready to give integrated reporting a shot. It remains to be seen whether their efforts will live up to expectations, and if investors will be happy with the results.