The new balance sheet: Life beyond profits

Some Indian businesses are turning their annual reports into integrated reports. Here’s what it’s all about

It’s that time of the year when annual reports of corporate entities start streaming out. Profits will be dissected, share prices will rise or tumble, and catchphrases like value and growth will be thrown around. But what about purpose? What about the larger social and ecological footprint of a company?

Caught up in a season of fourth quarter results, it is worth remembering the words of Mervyn King, a celebrated academic and a former judge of the Supreme Court of South Africa. “Quarterly reporting drives short-term thinking . . . (and) short-term capitalism has failed," he said. “When you lose trust and confidence in the company, value is destroyed very quickly."

King is the father of a radical new way of reporting a corporate entity’s performance—in fact his approach came to be termed as “King Reports" (in the 1990s). And a small number of Indian businesses are turning their annual reports into integrated reports, jumping on board a progressive vision which first took root among companies listed on the Johannesburg Stock Exchange (JSE).

Essentially, the heart of the idea behind an integrated report is this: mere financial reporting is no longer enough. Measuring an organization’s growth purely in terms of economic and financial value creation is a siloed and obsolete world view. Tata Steel Ltd was one of the earliest integrated report adopters in India, with its first integrated report in 2015-16. In 2017, the firm’s report was declared as “Asia’s Best Integrated Report" by the Asia Sustainability Reporting Awards.

Businesses, after all, need to make money and register profits to sustain. So, what is the connection between financial growth and impacting socio-environmental change, if at all? Or is it a hyped up esoteric concept to move large organizations to do good and for society-at-large to feel better?

Take an industry example—insurance, for instance, which is a key part of any financial system. Globally, insurance companies manage over $30 trillion in assets, act as important guardians of wealth, and, in a lot of ways, fuel economic growth. The recent special report by the Intergovernmental Panel on Climate Change states that the estimated net present value of damages from a 2°C of warming is expected to be around $64 trillion by 2100. This may be just a small indication of what the future may hold. You possibly cannot be the sufferer from and an investor in the same businesses!

Globally, asset managers are recognizing that financial returns and impact outcomes can go together and are increasingly embracing sustainable investing as a business building approach. Larry Fink, chairman and chief executive officer (CEO) of BlackRock Inc., the largest money-management firm in the world, in a letter to the CEOs of S&P 500 companies and large European organizations had stated: “One reason for investors’ short-term horizons is that companies have not sufficiently educated them about the ecosystems they are operating in, what their competitive threats are, and how technology and other innovations are impacting their businesses."

According to the World Investment Report 2018, about 50% of the funds in developed economies such as Europe and Australia factor in environment, social and governance practices for sound investment. In Asia, merely one per cent of the funds do so. To facilitate such decision-making, organizations need to put in place reporting frameworks that investors and other stakeholders can draw upon.

The story so far

While mere financial reporting has been the norm for decades, rising concerns from internal and external stakeholders needed to be addressed. Governments, local bodies and independent organizations put in place various frameworks and standards. As a result, social responsibility and sustainability reporting has seen a significant expansion over the last 20 years.

In India, the Companies Act, 2013, requires companies to formulate a corporate social responsibility policy and incur at least a certain percentage of their profits as expenditure on social activities. The business responsibility report (BRR) became a mandatory requirement for the top 100 listed entities, and then was subsequently extended to 500 firms in 2015. In addition, there are a number of voluntary and non-voluntary reporting initiatives that companies are undertaking to reach out to their stakeholders —Global Reporting Initiative (GRI) standards, UN Global Compact guidelines, UN’s Sustainable Development Goals, and so on.

With a slew of guidelines and commitments that companies have suddenly begun to claim they are attached to, how does an average shareholder or consumer demand transparency and accountability?

And therein lies the key to the push behind integrated reporting (IR). Though not intended to replace any existing reporting frameworks, as the name suggests, the annual integrated report does purport to answer the big question of price of progress through “One Report".

IR has gained sizeable acceptance since the inception of the Integrated Reporting Council (IIRC), a global coalition of regulators, investors, accounting professionals, companies, and non-governmental organizations. It was launched in 2013 as a global framework and as a more holistic form of reporting the value that businesses create. The IR model provides a great approach that adds five additional capitals to the traditional financial capital—natural capital, social capital, human capital, manufactured capital, and intellectual capital. Conscious consideration to the impact of these capitals on the business, society, and environment requires integrated thinking. And greater clarity of inter-linkages of business processes helps address larger challenges by demonstrating the place of each capital in strategic decision-making.

To that extent, IR is not an end, but a means to an end since it is an outcome of integrated thinking and sound management approach.

Two core concepts, therefore, in IR are “integrated thinking" and “value creation"—both can be interpreted by organizations differently and adapted to suit the needs of individual organizations. Businesses perceive this subjective yardstick as both a boon and a curse. Early expounders of integrated reporting such as Robert G. Eccles and Michael P. Krzus have also suggested the use of internet to provide integrated reporting in ways that a paper-based report cannot—providing stakeholders an opportunity to sift through information that is of particular interest to them, and analyse financial as well as non-financial information, as users seem fit.

Where India stands

Recent studies have shown India as one of the top countries for reporting environment and social responsibility information in the annual financial reports of companies. Yet, only a handful have been able to publish what can truly be called an integrated report.

A few companies made a nascent attempt by adding a couple of pages that listed scattered information around the six capitals, missing by a mile what the report should actually be. This is because most companies don’t realize the significant difference between installing solar panels and planting trees to show reduction in carbon footprint and proactively recognizing and seeking business opportunities in a low-carbon world. To that extent, the integrated report is not a sustainability or corporate social responsibility (CSR) report attached to the financial report.

In a circular issued on 6 February 2017, Securities and Exchange Board of India (Sebi) had recommended that “integrated reporting may be adopted on a voluntary basis from the fiscal year 2017-18 by (the) top 500 companies which are required to prepare BRR". That year, around 30 firms in India published their integrated reports.

At the close of the second fiscal year of Sebi’s circular, more organizations are now contemplating the adoption of IR. The transition journey, however, is fraught with more questions than answers: Is there any value addition? How is it different? We already publish the BRR, we already have a sustainability report, so why should we do this? And so on.

How to go about it?

In South Africa and Brazil, IR is mandatory. Regulators and policymakers in the UK, the Netherlands, Australia, Spain, Singapore, Japan, and the US are promoting and giving a huge impetus to IR. The IIRC database shows that 20% of FTSE 100 companies in the UK refer to, or are influenced by, the International IR Framework.

So what part does regulation play? Studies from South Africa, the first country to mandate IR, have clearly indicated mandatory compliance as the primary driver towards IR. Most UK FTSE 100 companies moved towards IR driven by regulation. The IIRC, however, warns that the “compliance only" mindset usually results in the real social benefits of business benefits being missed.

That being said, studies in South Africa, where overtime IR has matured, also suggest that early adopters have gained significant benefits from IR through effective decision-making and enhanced reputation.

The IR process is far from generic. It is anything but a one-fit-for-all framework and firms can truly take from it as they see fit. So, where do organizations begin? The following by and large covers the process, though not necessarily in that order, depending on the level of IR process the company is at.

■Take time to build a team (with internal and external support) and ensure “buy-in" especially from top leadership. Good governance is the driver and always filter down.

■ Don’t develop the business and value-creation models in a hurry. When doing so begin by looking at micro aspects, while keeping in mind long-term vision.

■ Build on what you have done before.

■ Identify your internal and external stakeholder groups to determine the material issues and risks that your organization faces.

■ Start with fewer clear numbers across the six capitals and build it over time.

■ Continually check with the linking to business objectives and ensure process alignment.

■ Collect data on the identified material aspects and set clear timelines for data collection.

■ Try and tell clear stories of how you create value over time.

■ Build the report

■ Overtime, embed integrated thinking into the business (this will be highly beneficial not only to the process but also to the organization).

The abstract concept of integrated thinking in tangible terms implies bringing together all the resources that an organization depends on as well as the ones it impacts. That requires developing processes, tools and systems. This year, India enters the sixth year of CSR compliance. Though Indian business spent close to 55,000 crore on development projects over the past five years, to a substantial number of stakeholders the larger picture is still a blur.

Two main components in IR are a business model and sustainability initiatives. While all businesses have a strong business model, the fact that a much smaller per cent report on or document their sustainability initiatives is a gap that needs to be filled. If available, the information is too scattered to make any difference.

Most organizations miss that IR is a process and the integrated report is the outcome. An understanding of what constitutes value is another barrier to implementing the IR framework. To expect all organizations endeavouring to report on value creation to clearly identify all of their “increases, decreases or transformations of the capitals caused by the organization’s business activities and outputs" demands complete disclosure of not just value creation, but also the value destruction that firms cause. This is one of the primary reasons why so few companies bother to report on the six capitals.

Despite the seemingly sluggish adoption of the IR framework, the integrated report is that common language with the power to articulate the value creation story and make it comprehensible to investors as well as the other stakeholders. The India story on that front is only just beginning.

The author is a director, non-financial reporting at AICL Communications Ltd.