​Sustainability

Investors and other stakeholders clearly recognize that an organization's value is no longer created solely within its walls and they're pushing organizations for better disclosures on how value is created.

A generation ago, most of the corporate value in the S&P 500 was in tangible assets – 80 percent in 1975, with intangible assets comprising less than 20 percent of market capitalization. Today, that ratio has been inverted – nearly 80 percent of corporate value is found in intangible assets. This change reflects the transition from a manufacturing-based economy to one that is service/knowledge-based, something that accounting standards and traditional metrics have not kept pace with and, as a result, soft assets, such as expertise, synergies, innovation or customer base have not been well measured.

Investors and other stakeholders clearly recognize that an organization's value is no longer created solely within its walls. Organizations have numerous value drivers, many of them intangible, and the value of an organization can be affected, both positively and negatively, by events and processes that occur outside the organization and outside its local geography. For example, changes in an organization's environment, such as demographic changes, resource or energy limitations, new technological developments and other factors, can dramatically change its business model – either disrupting or enhancing it – thereby changing the value of the organization.

Because of this, stakeholders want to understand where and how the organization's value is created, and they're pushing organizations for better disclosures of non-financial information. Organizations are feeling that pressure, which has resulted in a dramatic increase in the number of companies reporting on their sustainability performance.

In 2013, 72 percent of the S&P 500 companies reported on environmental, social, and governance (ESG) performance, up from just 53 percent (and 57 percent of Fortune 500 companies) that did so a year earlier. Organizations that reported on sustainability saw positive effects on their reputation and valuation compared to organizations that did not report their ESG performance, and those that reported using the Global Reporting Initiative (GRI) framework enjoyed the greatest benefits.

Ultimately, what shareholders would like is for organizations to provide an Integrated Report <IR>. Many organizations have started providing a sustainability report as the first step on their journey towards integrated reporting. Typically, it takes a few years to refine sustainability reporting; initially, companies disclose information on matters about which they have available data or can report positive results. In the second or third year, they have refined their concept of materiality and determined what is important to their stakeholders and their business, which often means moving from more obvious sustainability indicators to those that are most relevant to their organization.

For their part, investors and other stakeholders have also become sophisticated in their understanding of sustainability disclosures. They know the indicators that are relevant and will question organizations that do not report on those indicators. Organizations whose reporting of non-financial information is considered to be inadequate may find themselves with low ESG scores compared to their peers, and may possibly be targeted through social media.

Despite its name, integrated reporting isn't just a reporting exercise. Because integrated reporting identifies and measures all of the attributes that create value for the organization, it helps organizations to manage their business in a more holistic way, enabling management to utilize all of the various financial and non-financial capitals more effectively.

In June 2014, the Natural Capital Coalition (NCC) announced that the World Business Council for Sustainability (WBCSD) and the International Union for Conservation of Nature (UCN) will develop a Natural Capital Protocol to provide a standardized global methodology to help organizations understand their impacts and dependence on natural assets including ecosystem services. This initiative will solidify the business case for sustainability and integrated reporting.

Globally, regulators appear to be slowly moving towards integrated reporting. In South Africa, publicly listed companies are required to comply with the King III Report, which deals with integrated reporting; they must either comply with or explain why they have chosen not to apply the principles. Most listed companies in South Africa do produce integrated reports. Brazil requires listed entities to produce either a sustainability report or an integrated report to disclose non-financial information. Malaysia is considering including an integrated reporting requirement in its accounting standards, but it is not yet compulsory.

The International Integrated Reporting Council (IIRC) has announced initiatives designed to add value to integrated reports. Currently, auditing standards can be applied to some sections of an integrated report, but there is no formalized assurance standard specifically for integrated reporting. As a first step towards developing a formal standard, the IIRC has released a discussion paper on the assurance of integrated reports. In November 2014, the IIRC launched an <IR> Technology Initiative to determine how technology can be used to facilitate the production, related management processes, and assurance of an integrated report. The project's objective is to "evaluate how technology is currently used to facilitate corporate reporting and related management processes, how technology might enhance integrated thinking, how software can capture narrative elements of reporting, and how technology can facilitate the audit & assurance of an integrated report."

Boards of directors are increasingly playing a role in integrated reporting. Initially, many boards were uncertain of the oversight they should apply to integrated reporting and what should be included. Today they have greater clarity around their role since the IIRC framework sets out a structure for an integrated report, including the principles underlying the report and the various content elements to be covered in the report. Although the IIRC framework is voluntary, it has been adopted by many organizations that provide integrated reports and it appears to be the preferred standard of most investors.


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