Integrate risk to balance the books

Companies are increasingly being urged to adopt integrated reporting, identifying business risks as well as opportunities, writes Rob Langston

The financial crisis of 2008 dragged the global economy to the brink of depression, but it also highlighted the need for businesses, large and small, to be aware of the risks they were exposed to.

Thankfully, the economy now seems to be in a much fitter state, with businesses across the country helping to fuel growth in the UK.

However, those lessons from the crisis remain keenly felt and have helped shape new approaches to company reporting. Greater numbers of firms are now analysing and setting out the risks with their business in efforts to keep investors informed of any potential issues before they arise.

“It’s an extraordinary fast-moving world where key trends are globalisation, urbanisation and digitisation,” says Charles Tilley, chief executive of the Chartered Institute of Management Accountants (CIMA). “The ability for an organisation to operate in that context and have a sustainable future is what investors are looking for.”

More recently, the move towards integrated reports, which advocates a more holistic approach to company reporting, has been promoted by investors and business themselves to improve the quality of information available to stakeholders.

The approach aims to encourage companies to better articulate their strategy and business model in the ever-changing marketplace, identifying key risks and opportunities.

By taking such an approach, it is hoped investors will understand businesses better and companies will be able to access lower cost capital, sorely needed in the post-crisis environment.

Although the concept has existed for a number of years, the International Integrated Reporting Framework was published in December after a three-month consultation last year that received more than 350 responses.

The framework has already drawn support from some of the largest brands and biggest names in corporate finance. However, Paul Druckman, chief executive of the International Integrated Reporting Council (IIRC), is keen to emphasise the process of integrated reporting.

“You have to differentiate between the reporting and the end product – the integrated report,” he explains. “Integrated reporting is very conscious reporting; it’s the outcome or output of integrated thinking. It’s an articulation of strategy risks and everything involved in running a business.

“If we talk about the integrated report at the end, what we’re talking about is a concise communication about value over time, but it’s not a compliance document, it’s a document that informs.”

A good quality integrated report reflects on the quality of management at the company

Colin Melvin, chief executive of Hermes Equity Ownership Services and chairman of the IIRC’s Pilot Programme Investor Network, adds: “It’s worth considering that it’s not a one-way causation. Companies that adopt an integrated approach to reporting tend to start adopting integrated thinking and vice versa.

“In our view a good quality integrated report reflects on the quality of management at the company.

“The point is that we recognise various drivers of performance, particularly from a long-term perspective, and we would like companies to report on material risks for their businesses, as well as the opportunities, outside of a narrow financial type of reporting.”

However, while integrated reporting and an increased focus on risk has become more prevalent among publicly listed companies, it is uncertain whether the approach will be adopted by private companies.

“It remains to be seen whether integrated reporting takes off voluntarily and/or is made mandatory in the UK,” says Kathryn Cearns, consultant at Herbert Smith Freehills. “And there is also a question about whether it would be an addition or alternative to the current legally required annual report.”

CIMA’s Mr Tilley agrees: “I think there will be an issue whether private companies have to provide an integrated report or strategic report, but like all these things, it comes down to what stakeholders need and what management need.

“The benefit of holistic comprehensive reporting when preparing a report for external stakeholders does drive management to think about the whole aspect of their business and all the elements of business model,” he says.

Mr Druckman, of the IIRC, says the greatest level of interest in integrated reporting has come from parts of Asia and South America, despite expectations that Europe would be the main driver of reporting.

Whether integrated reporting takes off or not, risk management is “very much on board agendas”, says Ms Cearns, adding: “It is good risk management that drives good risk disclosure.”

The approach to risk reporting is also likely to differ from sector to sector and from company to company, says Hermes’ Mr Melvin. “It’s obviously more beneficial for some companies than others,” he says. “Not every company faces material risks of these types or not to the same extent.”

Just as not all risks will be the same, he warns against the more risk-aware approach to reporting becoming standardised.

“We expect variety and welcome it because every company is different, with different pressures and circumstances,” Mr Melvin says. “The onus is on the investment community to bring to the analysis of this reporting their own quality and attention so they’re able to properly assess and challenge the logistics of business on quality of management.”

CASE STUDY 1

BUILDING A BETTER RAPPORT

Construction company Interserve joined the International Integrated Reporting Council’s (IIRC) pilot programme around 18 months ago and published its first integrated report in March this year, writes Ellie Duncan

Tim Haywood, group finance director and head of sustainability, says the company had been working towards integrated reporting long before then.

“It chimed very closely with what we were already doing with sustainability,” he says. “Our sustainability work was all about redefining how we value the results of our business. We’d spent a good couple of years in the business working out what it was that differentiated what we were doing and how we valued more than just the bottom line.”

He acknowledges the process to implement integrated reporting is ongoing. “The integrated report required us to think about how everything we did contributed to the achievements of the strategic objectives of the business.”

Another challenge Interserve faced in preparing to adopt the reporting framework was how to quantify the non-financial elements of the business; working out what data to capture and then how to assess it.

“I hope the work the IIRC and the pilot programme firms are doing is gradually getting the investor community to start appreciating how this is in the long-term interests of sustainable shareholder value,” Mr Hayward says.

The increased amount of governance and regulation in corporate reporting had not always made communication any simpler. “I expect with integrated reporting that the drive for conciseness and relevance will start to redress that balance,” he adds.

CASE STUDY 2

SHIFTING FOCUS TO EXPLAINING RISK

The International Integrated Reporting Council announced that retail goods multinational Unilever had joined its pilot programme in September 2012. Charles Nichols, Unilever’s group controller, says it began to imbed the principles of integrated reporting into its annual accounts for the first time last year.

“Integrated reporting provides a framework for explaining how we run our business to deliver the three elements of our vision: consistent growth, reduced environmental impact and positive social impact,” he says.

“The challenge is to shift the narrative from one which is narrowly focused on historic financial information to one that explains to our stakeholders and investors how the business creates value and the risks we’re managing as we do so.”

When asked what the response has been from stakeholders, Mr Nichols observes that the biggest differentiator for Unilever, as it seeks to attract graduate talent in emerging markets, is its sustainable living plan.

“That is actually strategically important because it means we have the talent we need to grow the business and also it is talent which is highly motivated to help us achieve our sustainable living goals,” he says.

Having spoken to other organisations about integrated reporting, Mr Nichols is aware of their concerns around the sensitivity of the information being disclosed and the reception from financial markets. Despite this, he believes that in time all businesses will converge on integrated reporting as their model for reporting.

He says: “We all face these challenges and the only way organisations are going to be able to deal with them is by showing leadership and by collaborating.”