Mervyn King is a busy man. “Last week I was in Vienna, the week before in Spain, now I’m in London, next it will be Sydney and then I’m heading for Bangalore,” he says. This demand indicates the attention organisations and countries are paying to integrated reporting – and the fact that they are paying it such attention shows how successfully King and his colleagues at the International Integrated Reporting Council have been telling the world why it’s such a good (and necessary) idea.
A lawyer by training (he was the youngest judge ever to resign, at just 41), King then became a non-executive director (Ned) of a number of listed companies, which he says gave him an unusual perspective on organisations. “I had worked on corporate governance issues first as a lawyer and then as a Ned, and when you see the other side of the coin it often means you see things that make you think,” he says.
His involvement with the concept of integrated reporting came about after he was asked to develop corporate governance guidelines for South Africa in the period immediately after the end of apartheid. The only report of the kind that had come out before this was the UK’s Cadbury Report, which was published in December 1992.
“In 1992 we were going into our new democracy and the Institute of Directors and the large accountancy bodies wanted guidelines to help our people direct and manage companies because most of them hadn’t been in the mainstream economy before,” King says. “I agreed to do this, but I stipulated that we had to have a clean slate because we were a new nation being born. I brought in people from all sectors to sit on the panel, from the president of the Johannesburg Stock Exchange to representatives from the union of the textile industry.”
This broad panel produced the first King Report in 1994 and, King explains, it became known worldwide as an example of how to move from an “exclusive” to an “inclusive” corporate governance approach – an exclusive model, he adds, focuses entirely on shareholders, price and the bottom line even if this has an adverse impact on society or the environment.
“We said that the board needs to identify the key stakeholders in the business and understand their needs and the expectations of the company, and take this into account in making decisions in the best interest of the total value of the company,” he says. “The board must look at the positive and negative impacts of the organisation financially, socially and environmentally.”
The group put together to create the King Report never disbanded, which meant that King has been able to build on its collective experience to produce updated versions in 2002 and 2009.
The King report adopted the non-prescriptive “comply or explain” ethos now enshrined in the UK’s Corporate Governance Code (2010). The principle of inclusive reporting attracted praise around the world and in 2001 King was invited to chair the UN steering committee on corporate governance and to rewrite the governance and oversight provisions for the UN and the World Trade Organisation.
During the time King has spent working on corporate governance codes the situation around the world has shifted, making his principles of inclusive reporting ever more relevant.
“There’s no company today that doesn’t think about the expectations of its stakeholders,” King points out. “Shareholders are now the general public, through their pension funds and insurance companies, not a few wealthy families. It’s the duty of the people who manage these funds to ask whether the company they invest in will be around in the long term. Is it truly sustainable in a changing world?”
Whereas the people who directed companies used to think the world had limitless resources and an endless ability to absorb waste, everyone is now aware that this is not the case, he adds. The global population is expanding and natural assets are finite and diminishing. “Directors can no longer think they can carry on business as usual and that is why big companies are changing the ways they do business.”
At the same time, reporting has become far more complex since the days when the financials were the only things that organisations needed to report. This has led to increasing pressure for a model that enables reporting across a broad spectrum of functions.
“Towards the end of the 20th century, analysis of listed companies was showing that the market capitalisation was nowhere near the total book value according to traditional financial standards,” King explains. “As much as 80 per cent of an organisation’s value was not financial and we didn’t really know what it came from. We weren’t reporting on it and investors were uninformed.”
In addition, he points out that financial reports reflect a snapshot of the company’s finances at one time. “From that you can hardly make an informed assessment about the stability and sustainability of the company during global financial crises.”
Concerns about the inadequacy of existing reporting provisions led to a meeting held by the International Federation of Accountants (IFAC) in 2009. King addressed the meeting on the topic of integrated reporting and also included this new concept in the third King Report, published the same year.
The idea attracted attention and led to a meeting at St James’s Palace, hosted by Prince Charles. King and Sir Michael Peat, who was then the prince’s principal private secretary, invited luminaries including the chairs of the IASB, FASB and IFAC, the world chairs of the big four accountancy firms and the chairs of IOSCO, the World Bank and the World Business Council for Sustainable Development.
Not only did everyone accept the invitation, but they agreed within an hour that the future lay in integrated reporting, King says.
He was surprised by the speed, but not by the verdict. For him, the clearest image of the need for integrated reporting is that of two cartoon men: one sitting on a stool with a single financial reporting leg, wobbling dangerously; the other sitting securely on a stool supported by the three legs of financial, environmental and social reporting.
However, agreement is one thing; identifying how to implement integrated reporting in practice and changing the ways organisations think and act about sustainability is another.
For a start, King says, organisations need to change the way they communicate. “For about 80 years we’ve been reporting in IFRS-speak, but consumers, labour and society generally don’t understand it,” King says. “We’ve been communicating in incomprehensible language, and new safeguards established to protect us after scandals such as Enron have just made it more complex.” When sustainability reporting was established, it just meant that organisations produced two reports, “both incomprehensible to the average stakeholder”, he says.
This matters because, King argues, the way in which companies report influences the way they behave. The size and complexity of most annual reports also ensures that even the directors rarely read them cover to cover.
This is why the International Integrated Reporting Council (IRRC), chaired by King, has released a framework laying out the principles of integrated reporting and guidelines on how to put it into practice. The council has been working with large organisations around the world to run pilot studies implementing its principles and learning from their experiences.
“The collective mind of the board has to understand all the points in the report and work as one mind,” King says. “The report has to be clear, concise and understandable. To be accountable you have to be understandable.”
The new framework isn’t mandatory, but King says that major asset owners around the world are supportive, while countries are writing up codes to incorporate integrated reporting.
But frameworks and guidelines are only as good as the people who implement them. The twin pressures of investor concern and the danger of bad publicity when something goes wrong can prompt even reluctant executives to pay attention, but internal audit will be crucial to making it work.
“Internal audit is the glue in modern governance and the right arm of the non-executive board,” King says. “Internal audit could also stand for ‘independent assurance’. When I started my career, internal auditors were seen as the people in the back room who ticked boxes. Not any more. Now they are critical to corporate governance and to controls that manage the way the company makes its money.”
No strategy is any good if it’s not controlled, he warns – and the only person who really knows whether a company’s strategy is controlled is the head of internal audit (HIA). The HIA is then responsible for ensuring that the internal audit team is adequately resourced.
“External auditors look mainly at the financials, which is understandable, but internal auditors look at everything across the company. The internal audit team therefore needs to be better resourced than the external audit team because its remit is far broader,” King reasons.
It also needs to be independent, with a communication route straight to the board. It’s important that internal audit can criticise the executive without fear, King says, and this usually happens only if internal auditors report to the audit committee, not the board.
HIAs should also attend strategy meetings. “They need to be able to say ‘No, you can’t implement this strategy because it can’t be controlled’ or ‘I can’t control this with existing resources’,” he adds.
King points out that the only proof that what is written in a board pack is accurate is the independent assurance throughout the year. “Internal audit develops a risk-based internal audit plan that dovetails with the risk-based external audit plan. Putting this into action for integrated reporting may require more specialist resources in the internal audit team – for example, you may need an environmental lawyer,” King explains.
“We’re moving on from the days when internal audit was drawn from a pool of accountants and we now need to draw people in from a far broader range of backgrounds.”
Directors’ duties haven’t changed significantly despite changes to corporate governance standards. However, their roles have become far more complex, partly because of emerging risks in areas such as social media. King says that this means directors need a strong internal audit function more than ever.
“I would never be a non-executive of a company that didn’t have an excellent internal audit department. I’d be mad to take on the risk,” he says. “I would always want to meet the HIA at a company that asked me to be a Ned as part of my due diligence. It’s critical.”
So what is the next step for King and for integrated reporting? “Oh, there will be more developments and we’ll probably issue version two of the framework at some point,” he says. “The King Report committee still meets every quarter as it has done since 1992 so we will probably revise this further too. Continuity of knowledge is vital, even if individual members move on.”
And does he enjoy the constant travel? “I really feel I’m making a difference and what more can a person want than that?” he asks. “Making a difference to the quality of reporting, and ensuring that businesses are sustainable, has been my vision since 2000 and I’m seeing it happen.”
This article was first published in Audit & Risk March/April 2014.