Connecting financial and non-financial information
Veronica Poole
- 19 May 2022
Thinking in an integrated manner
Nowadays, the words ‘connectivity’ and ‘integration’ are regularly used in the context of corporate reporting, corporate governance, business strategy and standard-setting. ‘Integrated Thinking’ has also become an important term in business vocabulary. Integrated thinking involves integrating considerations of people, planet and prosperity (Brundtland’s three critical dimensions for sustainable development) into the core of the business — taking a holistic view of the factors that can create or erode value. Integrated thinking helps companies understand enterprise value and balance short- and long-term outcomes and consider its reliance on a wide range of resources. This understanding is business critical for companies to be able to create value sustainably over time.
The changing operating context is an integrated system
The context in which companies now operate has been transformed by climate change, nature loss, and social unrest, exacerbated by the global pandemic and geopolitics. These issues can impact businesses significantly. Digitally-enabled transparency has also increased awareness and changed societal expectations of how companies should be involved in addressing these issues. This, in turn, affects the business license to operate and ultimately a company’s enterprise value. Investors understand that companies with strong sustainability records can deliver superior financial returns and therefore increasingly seek out companies that integrate sustainability into the core of their business, or in other words, apply integrated thinking.
Embedding integrated thinking
Adopting integrated thinking often demands organizational change, business model transformation, and a cultural shift, it frequently involves multi-year programmes to build capacity, codify new organizational Key Performance Indicators (KPIs) and foster organizational transparency and accountability. Deloitte has developed a Roadmap that helps companies to progress on this journey.
At the centre is company purpose
The company’s ability to create long-term enterprise value is directly linked to how it aligns its purpose and values with the expectations of society. The purpose of business, in many respects, is being redefined as enterprises move to acknowledging the importance of delivering value to all stakeholders and recognising that the prosperity of society at large is a prerequisite for the success of a company.
Living the purpose
Companies must live their purpose – considerations of planet, people, and prosperity should be embedded into a company’s governance, strategy, risk management, and metrics and targets:
- Governance is the foundation for driving performance and delivering long-term success. Integrated thinking requires appropriate oversight and ownership and the board will therefore need to make sure the company’s purpose incorporates considerations of people, planet, and prosperity appropriately, that culture and values are aligned to that purpose, and that appropriate targets are set.
- Strategy should also be grounded in integrated thinking. The company’s strategic approach should consider the cost, availability, and limits on use of resources, business transformation and organisational change, and address potential trade-offs.
- Risk management requires a holistic approach, which ultimately means integration of sustainability risks in the overall Enterprise Risk Management process, subject to the same ownership, monitoring, control, and reporting to the board, as are in place for financial risks.
- Metrics and targets should be aligned with the strategy and the commitments made by the company. A review of systems, processes and controls will be needed to incorporate these broader KPIs into management accounting and reporting.
- Reporting is a critical part of integrated thinking; it should reflect the integrated approach and be authentic to how the business is run in order to inspire trust and enhance enterprise value.
Both micro and macro considerations
Integrated thinking is essential not only at an individual company level but should also be applied at an ecosystem level. Critically, we need connected thinking across jurisdictions.
- Director duties should encompass responsibility to consider sustainability including the company’s impact on stakeholders and the environment.
- Corporate Governance codes should establish clear expectations for boards to enhance their governance and controls over sustainability information to support their reporting on how they discharge their fiduciary duties and to set the right tone for behaviour change.
- Proportionality should be respected to achieve effective and practical measures across the range of companies that contribute to economic growth, from SMEs to the largest Public Interest Entities; this should enable the flow of information on sustainability risks and opportunities across value chains.
- Standard-setting, as a critical element of the capital markets ecosystem, should deliver consistent, comparable, and reliable information to support capital allocation decisions and support public policy objectives where these demand transparency on how companies comply with specific policies or on their broader impacts on society.
- Connectivity in standard-setting should enable information that connects disclosure about material sustainability matters to the information in the financial statements that shows how companies’ governance, strategy and risk management over these sustainability matters affect financial performance.
- Assurance, education, monitoring and enforcement would also benefit from an integrated approach.
Materiality
A fragmented approach to standards and regulation is challenging. It leads to the lack of comparability, promotes compliance mentality, increases complexity and costs for companies and ultimately results in reduced transparency. To create a coherent, comprehensive and interoperable corporate reporting system, and thus avoid fragmentation, we should look at the concept that lies at the heart of corporate reporting — materiality. Materiality is the filter that helps us determine what sustainability information should be disclosed to serve the needs of capital markets and what information could satisfy broader objectives. The ‘Group of 5’ of the leading sustainability standard-setters and framework providers view materiality as nested and dynamic.
Dynamic materiality recognises that whilst a company may have many positive and negative impacts on people, planet and social prosperity, a subset of those impacts can, in turn, positively or negatively affect the company’s business model and therefore create or erode its enterprise value and financial returns to providers of financial capital.
- Big lens includes all sustainability matters that reflect a company’s positive or negative contribution to sustainable development and matters that could inform assessments and decisions by a wide range of users.
- Middle lens includes those sustainability matters that influence enterprise value, that is those matters that affect a company’s ability to generate financial returns to providers of financial capital.
- Small lens represents those sustainability matters that influence enterprise value, but which are already accounted for and disclosed in the financial statements.
Thinking about materiality through these lenses highlights how a comprehensive system of corporate reporting standards can be built. It is often referred to as a building block approach.
Building blocks
The establishment of the International Sustainability Standards Board (ISSB) by the IFRS Foundation has made a significant step towards building a comprehensive system for the disclosure of sustainability matters relevant to enterprise value.
If the ISSB standards are implemented consistently around the globe, they should facilitate consistent and comparable reporting by companies across jurisdictions, which will help us make informed capital allocation decisions and direct capital to long-term, resilient, and sustainable enterprise. Further blocks (‘top ups’) can be designed to meet specific public policy priorities at jurisdiction level or reporting on impacts relevant to broader stakeholders.
Interconnected reporting standards
The ISSB is uniquely positioned to address the needs of capital markets because of the structural connectivity achieved through the IFRS Foundation. It follows then that the International Accounting Standards Board (IASB) and ISSB will need to work together to evolve common concepts and reporting principles that facilitate connected reporting. The IASB and ISSB will need to develop something similar to an integrated reporting framework. This can be an evolution of the existing <IR> framework and IASB management commentary (see IFRS news release).
Intangibles
Connectivity in standard setting should lead to connected thinking about specific accounting issues, such as intangibles. Many intangible assets don’t readily meet the definition of assets in the financial reporting conceptual framework (because of the inability to demonstrate control) and so they are not recognised on balance sheets. However, identifying them and understanding how they are managed, enhanced, and maintained is fundamental to understanding the value of a business today. Another example is accounting and disclosure in respect of climate change. The ISSB exposure draft on climate disclosure considers impacts of climate change on financial statements. In my view, this is an opportunity for the IASB to consider possible enhancements to IFRS, for example relating to the disclosure of estimation uncertainty in the notes to the financial statements.
Proposed blueprint for connectivity
Connectivity in standard setting should lead to connected thinking about specific accounting issues, such as intangibles. Many intangible assets don’t readily meet the definition of assets in the financial reporting conceptual framework (because of the inability to demonstrate control) and so they are not recognised on balance sheets. However, identifying them and understanding how they are managed, enhanced, and maintained is fundamental to understanding the value of a business today. Another example is accounting and disclosure in respect of climate change. The ISSB exposure draft on climate disclosure considers impacts of climate change on financial statements. In my view, this is an opportunity for the IASB to consider possible enhancements to IFRS, for example relating to the disclosure of estimation uncertainty in the notes to the financial statements.
Conclusion
I’m a great believer in integrated thinking at both individual company level and at the corporate reporting ecosystem level. Integrated thinking moves us forward at a greater pace, which is exactly what we need in order to make progress in sustainable development, progress in achieving the UN’s Sustainable Development Goals and to give us a fighting chance to mitigate the risks of climate change.
The video of the event and the presentations are available here
Videos of each presentation and associated downloads are available on the portal here
Subscribe to join the Good Governance Community here and be informed of our next events
Subscribe to join the ESG Exchange here or contact us here for more information
