Values, culture and the meaning of numbers and time were key themes of discussion at the annual conference of the International Integrated Reporting Council (IIRC) held in London on 6-7 December. The event was co-hosted with the International Corporate Governance Network (ICGN), helping the IIRC to boost its outreach to the investment community.
“We don’t talk about profit, we talk about value creation,” said IIRC Chair Judge Mervyn King as he set the tone for the event with his opening address. He highlighted new features of the King IV Code of Corporate Governance that was launched in South Africa in November. An important aim with King IV was to boost mindful governance versus mindless checklisting or a compliance driven approach that in some cases resulted from the long list of principles that featured in earlier versions of the Code. The new version with its “apply and explain” regime has a consolidated list of 16 basic principles or outcomes that define quality of governance.
King also made a plea for not getting stuck in financial figures, as opposed to focusing on broader corporate performance. His new book The Chief Value Officer (Greenleaf 2016) argues the case for the Chief Financial Officer (CFO) to become a Chief Value Officer. The role of the CFO cannot be reduced to overseeing the preparation of financial statements. Rather, it should be the role of being custodian of the values of the corporation. This also requires not getting stuck in data and senseless information. Don’t let knowledge get lost in information, is the motto. King was a well deserved recipient of the ICGN Lifetime Achievement Award given to him.
“Money is an incredible servant but a very poor master,” said Bertrand Badre, former CFO of the World Bank in his opening keynote. He gave a historical overview of loss of trust in the financial system following the global crisis of 2007 onwards. Questions remain about the role and profitability of banks, who are supposed to be utilities and key foundations of a stable system. Loss of trust in the system globally again underlined the importance of multilateralism and collaborative standards that are internationally recognized. Today the Financial Stability Board (FSB) continues to explore uncharted territory.
On 14 December 2016 the FSB Task Force on Climate-related Financial Disclosures (TCFD) published its recommendations for public comment. The Task Force was asked to propose voluntary, consistent climate-related financial disclosures that would be useful to investors, lenders, and insurance underwriters in understanding material risks. Providing core recommendations related to governance, strategy, risk management as well as metrics and targets, the Task Force recognizes the importance of organizational context. It noted governance and risk management context as key to appropriately understand the financial and operating results of an enterprise.
Bertrand Badre challenged participants to go back to basics and ask what finance is really all about. This set the scene for the first plenary session on “Aligning the capital market system for 21st Century needs” chaired by David Pitt-Watson of London Business School. When I interviewed Pitt-Watson in 2012 for the publication Making Investment Grade: The Future of Corporate Reporting (Deloitte et.al. 2012) he emphasized the impact of reporting requirements on listed companies in expecting them to account for themselves. The mere requirement and sense of being observed enhances behavioural change in the first place. Of course, he added, the more relevant and clear the information the company discloses, the more likely it is to gain the trust of investors.
One key reminder of the session was that trust is the lifeblood of the financial sector. And in the case of investment management, earning that trust today requires a new interpretation of fiduciary duty. It also requires rethinking the meaning of terms such as “value” and “wealth”, and re-examining current regulatory frameworks and standards that work against as opposed to in favour of long term decision-making.
Fiona Reynolds, Managing Director of the Principles for Responsible Investment (PRI) reported their current examination of the role of regulation and culture in the system. With its current membership representing 62 trillion US$ in assets under management (AuM), the PRI has had to ask some critical questions about the pace of progress in its 10th anniversary year. Its 2016 Practical Guide to ESG Integration for Equity Investing gives an overview of integration techniques, including traditional, fundamental strategies and quantitative, systemic strategies. The CFO of United Utilities argued the value of accounting in being quantitative first and foremost, which enables more easy comparison between companies. Important to note is that accounting as discipline was not just created to draw up financial statements. It was established as profession with the purpose of enabling accountability and stewardship.
In a session on C-suite perceptions on long-term value creation, it was mentioned that the annual report (AR) will exist as long as the regulator thinks it has to exist. The integrated report (IR) holds the prospect of a more authentic communication on the vision and direction of an enterprise. Communications agency Black Sun stressed the importance of the process, versus something like an AR that in some respects just becomes a filing cabinet. Jonathan Labrey, Chief Strategy Officer at the IIRC, argued that ARs just give you a databank, with P&L data out of context. In contrast, the IR starts with a discussion on business model and strategy, which only thereafter is followed by disclosure of data in as far as relevant.
On the relative merits of more qualitative versus more quantitative and financial metric approaches, Itau Unibanco Group Finance Director Alexsandro Lopes cautioned that the only precise figure on a balance sheet is the date. Some argued the case for using the term “pre-financial” as opposed to “non-financial” information, aware that in the longer run all relevant information translates into implications for corporate financial performance. Interserve Plc reported that its experience of experimenting with alternative or integrated P&L statements was one of getting stuck in technical details and losing sight of the bigger picture. When dealing with multicapital dynamics, the fact is that some things are simply not measurable.
But some surprising lessons are being learned about measuring the seemingly unmeasurable. SAP described ways in which it links human and intellectual capital performance (including related IP) with financial performance metrics, among others tracing revenue from new products as percentage of new order value. Eisai Company from Japan mentioned how skepticism regarding corporate governance quality leaves as much as a third of listed Japanese companies trading at a market value below their book value. This contrasts with companies such as SAP that has had a Price to Book Value (P/BV) ratio in 2016 of often well over 3.50.
A session on corporate governance and ESG in long term investing hosted by MSCI Inc illustrated the fact that aspects of Governance (G) are better defined, more consolidated and more easily linked with better financial performance in ESG investment analysis. As a result, noted MSCI Global Head of ESG Research Linda-Eiling Lee, “G” aspects are today more factored into mainstream investment analysis than “E” and “S” aspects. This complicates research to demonstrate superior performance of ESG-rated stocks, in as far as all equities already have governance criteria applied in their weighting. It signals the complications of attribution, seeking to map cause and effect relations in making the business case for an ESG approach. Looking at the time dimension, Will Oulton of First Estate Investments and co-author of Taking the Long View by the Cambridge Investment Leaders Group (ILG), indicated that based on typical market cycles they consider 5-7 years as “long-term”. The ILG surveys investors to track how the investment management culture is evolving. It is an evolution in which some prefer to speak of a movement towards “sensible investment”. Rather than existing, “alternative” terms such as “(socially) responsible” investment, this is meant to signal a new understanding of what constitutes quality of management and governance.
A plenary session on investor views showed different perspectives on what constitutes effective stewardship and different levels of activism in ownership or asset management. Stewardship can take many forms, of which active voting is only one. The process of engagement with investee companies can be invaluable, among others in bringing Investor Relations and Sustainability departments to the same table. Michelle Edkins, Global Head of Investment Stewardship at BlackRock stressed the importance for asset managers to explain to clients how ESG information is actually used.
Again the shortcomings of numbers cropped up. No accounting figure is absolute and plenty of subjective managerial estimates are involved in corporate financial as well as investment decision-making. Coming up with future estimates, estimating the ability of a company to generate certain cash flows in future, cannot be seen as a mechanistic exercise. The need to put numbers in appropriate context was also evident from a closing keynote address by Sir Win Bischoff, Chair of the UK Financial Reporting Council, who spoke of the importance of a healthy corporate culture, with supportive values and quality in leadership. With this comes the expectation of improved reporting on culture, enabling the better application and assessment of stewardship.
Discussions also showed uncertainty about the role of new information and communication technologies (ICTs), including artificial intelligence, in enabling sustainable investment. This was also the theme of a Responsible Investor webinar on which I was panelist in September, entitled “Can FinTech and AI solve the ESG data puzzle?”. Does an increase in more passive investment strategies, electronic trading and indexed funds by definition lead to a dominance of market short-termism? Is the share just casino chip, an up/down directional bet? This was asked by Saker Nusseibeh, CEO of Hermes Fund Managers.
Acknowledging that appropriate time frames are different for different industry sectors, the FSB Task Force in its latest recommendations noted that many organizations conduct operational and financial planning over a 1-2 year time frame and strategic and capital planning over a 2-5 year time frame. It encouraged climate reporters to consider appropriate longer term time frames within their industry context, considering the life of their assets and the profile of the climate-related risks they face. Michel Prada, Chair of the IFRS Foundation Trustees that oversees the International Acounting Standards Board (IASB), argued that he doesn’t necessarily see an inherent tension between short term and long term considerations in decision-making. When you run a marathon, you need regular time updates even while you are certainly intent on running the full marathon.
Marathon is what came to mind in discussion of the international corporate reporting infrastructure. Many called for convergence between different reporting standards. New IIRC CEO Richard Hewitt told the story of a driving instructor who gave him an invaluable lesson many years ago: Do not be fixated by the dashboard indicators right in front of you… look at the road ahead and watch where you are going. He has full confidence in the Corporate Reporting Dialogue initiated by the IIRC and other reporting standard setters. Transparency International Chair Huguette Labelle highlighted two outputs of the Dialogue to date, namely the Reporting Landscape Map and Common Principles of Materiality Document published in 2016. Both documents are very introductory and only scratch the surface. Clearly there is room for plenty more dialogue in years to come. This includes dialogue to bridge the gaps between different professional cultures of the different standard setter networks involved.
* I attended the ICGN-IIRC Conference as representative of BSD Consulting, headquartered in Zurich, which was announced in early 2016 as the IIRC’s first global certified <IR> Training Partner. Information on the IIRC Training Partners and <IR> Training Programme can be found on the IIRC website.