A roadmap for long-term value creation in the capital markets

Richard Howitt – CEO, International Integrated Reporting Council

Let me suggest a new take on the debate about shifting to long-termism – something investors are often portrayed as having little interest in.

It is true that there is a natural tendency to review outcomes frequently and base investment decisions on recent history and events. It is only natural that emotions affect the way we think and act and it is hard to get emotional about the future – about things that we are not yet fully feeling the impact of yet.

Some, of course, are deliberately short-sighted. As the head of global structured products at the Royal Bank of Scotland said in February 2004: “We are investment bankers. We don’t care what happens in five years.” The date of this quotation stands out when you consider that the Royal Bank of Scotland was bailed out by the UK taxpayer precisely four years and eight months later.

It is only natural, therefore, that these mindsets have been challenged over recent years. There is a growing school of thought that, for the success of our capital market system, it has to change. The likes of Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board, are focussing global attention on what Carney calls the ‘tragedy of horizons’, which is defined as market failure that arises from not taking into account today known future risks – in this case, he was talking about climate change. This analysis strikes a chord with integrated reporting, which Carney has identified as a tool for communicating future risks and opportunity.

Future accountancy

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures is a crucial signal that senior market leaders are increasingly recognising the importance of accounting for the future and I have pledged the International Integrated Reporting Council (IIRC) support for its recommendations and the action this garners in capital markets around the world.

Other partners that are doing important work in this space include Focusing Capital on the Long Term and the Coalition for Inclusive Capitalism. Both organisations are introducing evidence, ideas and innovative steps forward to ensure we refocus our capital market systems on the long term. While these and many more movements are flourishing, they are not yet embedded and that is the challenge for the next five years.

As CEO of the IIRC, I have the honour of leading the global coalition of individuals and organisations that seek to integrate this quest for long-term value creation, not simply into corporate reporting, but also into reform of capital markets.

Any investor worth their salt knows that past performance is no guarantee of future success. Increasingly that means that investors are looking beyond naturally backward looking financial statements to information about strategy, the business model, and the resources and relationships that they rely on to create value over time. Integrated reporting has been created to provide investors with the information they need to make more effective capital allocation decisions and facilitate better long-term investment returns.

It is a two-way street, however, so moves by investors within the growing networks associated with the IIRC to make investment decisions for the long term must be backed up by accurate, dependable information from businesses. This challenge lies with the board and through good corporate governance.

Since the financial crisis, the need for boards to build trust in their businesses and demonstrate their contribution towards long-term economic stability has become a high priority. Integrated reporting is an indispensable part of achieving this.

Integrated reporting itself is an evolution of corporate reporting, with a focus on conciseness, strategic relevance and future orientation. As well as improving the quality of information contained in the final report, integrated reporting makes the reporting process itself more productive, resulting in tangible benefits.

Integrated reporting requires and brings about integrated thinking, enabling a better understanding of the factors that materially affect an organisation’s ability to create value over time. It can lead to behavioural changes and improvement in performance throughout an organisation.

Enhanced dialogue

Integrated reporting is now the reporting framework of choice for major businesses in Japan. The Japanese government signposted to companies to adopt integrated reporting as part of its corporate governance reforms and as a means of enhancing the dialogue between companies and investors.

Japan’s business leaders increasingly appreciate the contribution that integrated reporting can make towards achieving greater financial stability and a focus on long-term investment. This perhaps comes more naturally to the Japanese – of the 4,000 businesses globally that can boast a history of 200 years or more, more than half of them are Japanese.

The same focus on the future can be said of South Africa, where we welcomed the publication of its new corporate governance code, King IV, in November 2016. It is the first outcomes-based governance code in the world and modelled on the International <IR> Framework. Corporate reporting is an essential and inseparable part of corporate governance – it is the outcome of a corporate governance process – grounded in the purpose, values and activities of the business and reflecting on behaviour throughout the business, from the board and management team downwards.

General Electric in the United States, Generali in Italy, Itaú Unibanco of Brazil, and New Zealand Post, are just some of the 1,000-plus companies worldwide who have chosen to apply the <IR> framework.

An increasing body of evidence from the five-year take-up of integrated reporting demonstrates that an integrated and inclusive corporate governance system delivers practical benefits to both businesses and investors, including improved share price performance.

The corporate governance reforms announced by the UK Prime Minister, Theresa May, are an important opportunity to bring similar benefits to the UK markets. Inclusive and integrated governance, where silos are diminished and management prioritises communication with stakeholders, attracts long-term investors, improves risk management and cuts the cost of capital.

Long-term perspective

The change in thinking and behaviour away from unrelenting short-term factors towards the longer term horizon is key to the work of the IIRC. As Lars Sørensen, CEO of the pharmaceutical giant Novo Nordisk, which has adopted integrated reporting, said: “The business of business is business – but with a long-term perspective.”

Integrated reporting is today practised by businesses in more than 30 economies, a testament to the universal applicability of the concept and its usefulness for embedding an integrated approach.

How our capital markets system creates and distributes wealth and resources is a critical question that must be addressed with urgency. Our contribution is the International <IR> Framework. Integrated reporting is fundamental to the governance of institutions and economies in the 21st century and I am committed to working tirelessly to ensure more and more businesses across the world benefit through its adoption.

I encourage you to start the journey towards integrated reporting in your business and look forward to engaging with you.

About the Author:

Richard Howitt is Chief Executive Officer of the International Integrated Reporting Council. For five years prior to becoming CEO of the IIRC, he acted as a voluntary IIRC Ambassador, promoting Integrated Reporting within the policy and business communities. He took over from the previous CEO Paul Druckman. He was Member of the European Parliament for the Labour Party for the East of England between 1994 and 2016