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Integrated reporting, which combines financial and sustainability information, is starting to appear more on companies’ agendas. Although this is a step in the right direction, integrated reporting should not be the final objective, but rather a means of meaningful reporting, say financial analyst Johan van der Lugt and engagement specialist Daniëlle Essink.
The two separate streams of information companies currently provide, i.e. sustainability data in a Corporate Social Report and financial information in an annual report, need to be integrated into one comprehensive, meaningful report, say Daniëlle Essink, engagement specialist at Robeco, and Johan van der Lugt, a financial analyst in the Global Equity team. ‘In most cases, a Corporate Social Report does not speak the language of financial analysts, whereas an annual report only provides financial data,’ says Essink. ‘At Robeco, sustainability specialists and financial analysts increasingly work together when analyzing the risks and opportunities of companies’ business models, as the two types of information are not isolated but impact each other. We need companies to provide information that integrates the two, showing their interlinkages.’
There are companies that sign the UN Global Compact, disclose a dataset on sustainability metrics, appoint a Sustainability specialist in the Investor Relations department, and that’s it. This is just the starting point, says Van der Lugt. ‘Companies need to make sustainability information available to investors in a transparent, comparable and accessible manner. It should reflect integrated thinking. With this, I mean linking traditional sustainability data to the company’s strategy and its financial outcome.’
‘As investors and users of financial and sustainability reports we would welcome a higher degree of standardization and integration of the various metrics,’ he continues. ‘Reports need to contain quantitative information on material sustainability issues. If sustainability issues are indeed material to a company – meaning that they have a significant impact on their long-term competitiveness and profitability –there is no reason why this information should not be disclosed in their annual report.’
‘Integrated reporting needs to be a reflection of integrated thinking’
In addition to including material sustainability information, the reports should also show how the company has arrived at defining the factors that are material to them. ‘Thinking and reporting about materiality should be a dynamic process,’ says Van der Lugt. ‘As investors we want to understand the relative importance of material factors over time.’
‘When companies do look at material factors, they tend to focus only on risks,’ Essink adds. ‘As a result, they miss out on the opportunities sustainability integration can also provide. Investors like companies to establish how they can seize opportunities to enhance long-term returns. A good example is Hewlett-Packard, which differentiates itself by helping its customers to get by with fewer and more energy-efficient printers. This is where sustainability and business meet.’
‘Determining the materiality of sustainability factors is just the first step,’ Van der Lugt agrees. ‘Companies should have a view on how they can create value by investing in the six different forms of capital as identified by the International Integrated Reporting Council, i.e. intellectual capital, customer capital, human capital, environmental, social and financial capital, and how this effects their financials such as growth (revenue), profitability (costs), capital efficiency and their risk profile. If a company doesn't sufficiently invest in its value creation capital, the sustainability of its profitability is at stake. For investors it is important to understand to what extent a company is in control of these issues. At Robeco we discuss these topics whenever we meet with companies and their management. We like to be in a constant dialogue with them about this.’
‘It is important for investors like us to determine whether a company has merely fallen into an integrated reporting trap (when the publication of an integrated report itself becomes the final objective, typically steered by the management team and corporate center) or whether sustainability thinking truly cascades down into the organization,’ Van der Lugt continues. ‘The latter means that sustainability becomes part of a balanced scorecard or KPI setting and is linked to a company's ultimate financial targets (for example, a Return on Equity in excess of 15%).’
‘Investors do not want polished stories, but prefer a balanced view and integration with KPIs and value creation. We feel that more work needs to be done in terms of bridging the materiality factors and their link to the different forms of capital on the one hand, and a company’s key financial targets (embedded in the long-term incentive plan) on the other. This is what we want to talk about with companies.’
‘In this respect, we do see a risk of overshooting in standardization,’ Essink adds. ‘One size does not fit all. Although we do want to see some form of comparability between reports, they have to remain relevant for the company concerned. Integrated reporting should therefore not be the final objective, but a means of meaningful reporting.’
Van der Lugt and Essink do see that sustainability is increasingly being integrated into business operations. ‘Leading companies are moving from a model in which sustainability is managed as a separate function towards embracing sustainability as a key factor in running a successful business,’ Van der Lugt states. ‘Companies that are more advanced in terms of reporting on the different forms of capital and their material impact are in our opinion better placed to generate sustainable Returns on Equity than their less advanced industry peers.’
‘South Africa is a pioneer, having adopted integrated reporting back in 2010 on a comply-or-explain basis,’ Essink knows. ‘Furthermore, Europe is clearly in the lead, whereas US companies typically lag far behind other regions, especially when it comes to including material sustainability information in their annual reports. This might be attributed to heavily standardized SEC-filing requirements. These offer little room for companies to adapt their annual reports to accommodate sustainability data.’
‘In an ideal world I would be out of a job in a few years’ time,’ Essink concludes, ‘as companies and financial analysts will cover sustainability topics naturally. The next step now will be to have more strategic, integrated discussions between companies and sustainability specialists. Companies can help advance this by integrating their sustainability efforts into their strategy and business model and vice versa.’