Issue: December 2011 / February 2012


Such good intentions

They don’t necessarily make for good corporate communications. Integrated reporting mustn’t allow companies to convey the impression of performance, sustainability and governance being hunky-dory when they aren’t; particularly not with ESG now to the fore.

There’s a process to be nipped in the bud right at the start of King III implementation. It concerns the manner in which environmental, social and governance (ESG) factors are “integrated” into companies’ annual financial reports, a principle enthusiastically propounded by King. Between the theory of King and the practice by companies, the practice can undermine the theory of helping stakeholders better to understand the company.

Companies look good when they claim to have complied with King. But the bells and whistles they produce as evidence, in glossy reports that become increasingly voluminous, might be so self-selected as to mislead by obfuscation. This happens when the comprehension of financial disclosures is overshadowed by mountains of ESG information intertwined with marketing spin.

Okay, so King is a voluntary code. And although compliance is a JSE listings requirement, finer points can easily be sidestepped. Devils in the detail are supposed to be scrutinised by stakeholder engagement, also propounded by King. But what engagement unearths rarely reaches the public domain, to the extent that engagement happens at all. By and large, stakeholders are an acquiescent bunch.

This will change, at least in so far as shareholders are concerned. Take ‘shareholders’ to mean primarily financial institutions in whose names the shares are frequently registered on behalf of such beneficial owners as pension funds. Institutions are bound as signatories to the Code for Responsible Investing in SA (CRISA) which, although also voluntary, commits them from February to “incorporate sustainability considerations” and demonstrate their “acceptance of ownership responsibilities” in investment arrangements (TT Sept-Nov).

Not voluntary is the revised Regulation 28 of the Pension Funds Act. Amongst other things, it obliges trustees to “give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance nature”.

Placing such emphasis on fund trustees effectively places an onus on certain service providers they select. The trustees must provide the ESG mandates to their investment managers who rely on company reports; consultants will need to advise accordingly, and the oversight for compliance then goes back to the trustees. Thus is the circle between King, CRISA and Reg 28 completed.

Integrated annual reports, the investor’s basic research and reference tool, are the starting point for “stakeholders to make a more informed assessment of the economic value of the company”, as King puts it; for institutional investors to “incorporate sustainability considerations including ESG into (their) investment analysis and investment activities”, as CRISA puts it; and for pension funds, as a fiduciary duty, to “adopt a responsible investment approach” which includes ESG considerations “across all assets and categories of assets (to) promote the interests of a fund in a stable and transparent environment”, as Reg 28 puts it.

King wants communications with stakeholders to use “clear and simple language” in setting out “all relevant facts, both positive and negative”. They must be structured for target markets “to understand the implications of the communication”. Now evaluate these worthy objectives against the way they’re applied.

A usefully bad example is the 2011 annual report of media group Avusa. It’s selected for a number of reasons (one being that this writer has a certain familiarity with its operations). Mainly, it’s because the chief executive officer states that this is the group’s first comprehensive integrated report, compiled against the requirements of King III and the Global Reporting Initiative: “This level of disclosure – arguably a first in our industry – underscores our commitment to full and meaningful reporting to our stakeholders”.

Now take a look at the report’s 147 pages. Ah yes, the King requirements for an independent chairman and non-executive directors, the audit and remuneration committees etc are all properly in place. There are reams of disclosure about corporate values, success factors and awards too. Very nice.

Look further for “all the relevant facts”, especially the negatives after the positives have hit the reader between the eyes. Where are the forward-looking statements that foreshadowed a trading update, a month after the company’s annual general meeting, that headline earnings were to be down by at least 20%?

Or an indication of tensions that led to the resignations of three directors at the meeting itself, followed shortly afterwards by the departure of the chief executive? Not very nice for shareholders who’d be hoping that Avusa’s share price will hold if the takeover bid by private-equity firm Capitau doesn’t eventuate.

Then explore a few specifics:

  • The profit improvement is boasted but not explained. Stripping out the five months of contribution from Retail Solutions, acquired for R800m in November 2010, the profit turns to loss. Readers of the report are expected to work this out for themselves;
  • Segmental reporting makes it impossible to assess the profit trends of key newspaper titles. For instance, there’s proud mention of The Times “having recorded its maiden full-year profit” but stakeholders are left to guess whether this was assisted by subsidisation from the Sunday Times. Similarly, while BDFM (the joint venture owning Business Day and Financial Mail) had “returned to profitability”, its results are agglomerated with 83%-owned I-Net Bridge;
  • There’s an assurance that measures in place “were adequate to address all significant financial risks facing the business”, but nothing on non-financial risks;
  • The remuneration policy could, in the eyes of stakeholders including employees, be contentious. It doesn’t explain why executive bonuses are no longer capped, or why they become payable “if financial performance of 75% is achieved”. Neither is there explanation of what’s meant by “financial performance”, why 75% is considered satisfactory, or how come the chief executive had a fixed-term performance contract to end-March 2013 enabling him to depart with a golden handshake of over R20m. Without known performance criteria, it’s unknown whether bonuses are based on organic growth (weak) or the contribution from acquisitions (Retail Solutions).

So the purportedly groundbreaking effort of Avusa is hardly a model for integrated reporting to follow, but certainly it’s a model of the need for stakeholder engagement. King III, CRISA and Reg 28 beckon. In combination, they’ll test companies, institutional investors and pension fund trustees alike.