Non-financial reporting sets a number of new challenges for IROs. Public companies now face questions about a broad range of issues that come under the heading of corporate (social) responsibility. New approaches have to be developed to help investors understand these issues - and to encourage them to do so.

Non-financial reporting: the challenge for IROs
Owners of two in every seven Exxon shares backed a resolution at the group’s 2005 annual meeting asking the board to explain how it will meet emission reduction targets in countries that have signed up to the Kyoto Protocol.

Despite the company’s aggressively sceptical stance on climate change, shareholders with 1.5 billion shares, worth more than $80bn, demanded an answer. This shows how far non-financial concerns have spread beyond the initial group of small ethical funds, and why IR professionals are taking these issues seriously.

In Europe, investors tend to engage, rather than confront, companies. But they are doing so in growing numbers and with an increasingly sharp focus on the risks to shareholder value.

In the UK, this will be accelerated by the requirement for quoted companies to address significant social, environmental and ethical issues in the new Operating and Financial Review (OFR) from 2006. Indeed, non-financial issues will become mainstream for 30 per cent of the world’s investors within five years.

Climate change is top of many investors’ agendas – Henderson Global Investors recently published the Carbon 100, analysing the emissions of carbon dioxide, by FTSE 100 firms. But public companies now face questions about a broad range of issues that come under the heading of Corporate Responsibility (CR) or Corporate Social Responsibility (CSR).

The issues tend to be viewed in relation to stakeholder groups such as employees, customers, suppliers and communities. As with any other aspect of company analysis, however, firms need to focus on the specific issues that matter to them. That might be human rights for an oil or mining company, mis-selling in financial services, or the treatment of farmers for the food industry.

New approaches are being developed to help investors understand these issues, and to encourage them to do so. In 2004, fund managers working with the UN Environment Programme (UNEP) sponsored a collection of sell-side analysts’ studies that identified the material sustainability issues in eight sectors.

For example, Dresdner Kleinwort Wasserstein (DrKW) warned that aviation emissions were likely to be included in the EU Emissions Trading Scheme, which would reduce airline and airport earnings.” A group of European institutions launched the Enhanced Analytics Initiative in 2004 to encourage sell-side analysts to cover “extra-financial issues.”

And they promise five per cent of their brokerage commissions to firms that provide good research in this area. Firms are assessed every six months; the latest winners include DrKW and UBS.

It is not easy to develop effective messages around these difficult issues. It is complicated by the fact that investors represent just one audience. NGOs, politicians, regulators, customers and suppliers may also be interested, while employees will also want to know what their company is doing.

Some firms have made the mistake of attempting to tell everything to everyone, resulting in unwieldy reports that tend to obscure, rather than enlighten. The likes of BT and Shell, who have been doing this for longer than most, have realised that more concise reporting is better for investors and others. They summarise information and support it with more extensive web-based material.

Long or short, companies still sometimes fail to provide useful information. Policy statements and broad objectives are fine but people want more. They want to know a company’s priorities, its dilemmas and difficulties, the targets it is aiming at and what progress it has made – in the most concrete and credible way possible.

Of course, it’s one thing to produce information; it may be a different matter to get investors to digest it. Mainstream analysts in high-energy sectors are increasingly engaged on climate change. Elsewhere, SRI analysts will provide the main audience.

But it will be possible to grab the attention of others on broader corporate responsibility issues, as long as the impacts on earnings or shareholder value can be demonstrated, if not accurately quantified.

Getting the message across here may be easier with collective meetings where several companies from different sectors can present. Individual firms can also look to their advisers to organise sessions on CR with groups of investors.

Analysts will not be interested in a vague presentation about values and principles. They will take notice of a firm with a clear story to tell, that can identify the important issues, show that it is addressing them seriously and how this will make a difference to investors.

Roger Cowe is a director of Context, a corporate responsibility consultancy

Do non-financial issues matter?
Four key players in the investment community explain why they care about non-financial information – and what they want from your firm.

Anita Skipper
Head of corporate governance,
Morley Fund Management
Non-financial information is becoming more important; it gives us a fuller understanding of a company as a whole. Increasingly, we are integrating governance, social and environmental issues into our analysis.

A traditional financial report doesn’t necessarily tell you about a company’s culture, its research and development, its brands, how it treats its employees and its customers.

We want to know as much as possible about these issues because they can be just as important to the future health of a company.

In terms of the types of information we look for, it depends on the type of business. If it’s an oil company, and they’re not reporting on their environmental performance, you know there’s something wrong. With a financial company, it may be something different. If something’s missing, we want to know why it isn’t there. It leads you to thinking: “What else are they not telling us?”

There’s been a big increase in the volume of non-financial information. But it’s a bit all over the place. The [UK] Operating and Financial Review should help companies report more systematically.

Paul Lee
Associate director,
Hermes Pensions Management
Hermes is owned by, and the principal fund manager for, the BT Pension Scheme. Thus, we have an investment time-horizon of some 20 years.

Over that sort of period, many issues that are not of concern for short-term trading will have real financial impacts. For example, a company that exploits its customers, or its suppliers, may prosper in the short-term, but it will not be a sustainable business.

The company that fails to manage environmental and other risks may save money for a few years but it is only storing up trouble for the future.

That is why we take an interest in issues that are covered by so-called “non-financial reporting” - because these issues are not “non-financial”, they are just “not yet financial.”

We want “non-financial reporting” that is tailored specifically to each individual company. We favour companies living up to the over-arching aim of the Operating and Financial Review – to report on the company “through the eyes of the board.”

We want directors to discuss the issues that will drive value in their business over the long term.

Reto Ringger
Chief executive,
Sustainable Asset Management
There are several trends that have led to the growth of sustainable investing.First, there is increasing evidence that sustainable investing pays off.

Second, traditional ways of evaluating companies’ financial performance are becoming less reliable. Painful corporate scandals such as Enron or WorldCom have confirmed the need for new risk management and valuation techniques.

Third, regulatory initiatives are fostering sustainability among institutional investors. Increasingly, issues such as corporate governance and climate change are becoming part of criteria for assessing corporate reputation and risk.

At the moment, we see three types of sustainable investor. There are those who see sustainability as a way of outperforming the market. For this group, non-financial information must directly affect shareholder value.

Another type of investor is pursuing a value-based, or ethical, approach. They want non-financial information that reflects their ethical values; they are not as interested in materiality.

Lastly, there is the type of investor who has been obliged to consider SRI because of regulatory or public pressure. This investor wants ease of access and availability to SRI information.

Down the road, the biggest challenges are in the availability of corporate data, quantifying sustainability criteria and understanding the materiality of non-financial data.

Dr Raj Thamotheram
Chair, Steering Committee, Enhanced Analytics Initiative, and senior adviser, Universities Superannuation Scheme
The sell-side has, in the past, been notably absent in the debate about extra-financial reporting. That has encouraged management to focus in an unbalanced way on short-term financial performance. As a result, taking long-term investment decisions has been made more difficult. But things are changing and one important reason for this is the Enhanced Analytics Initiative (EAI).

Dissatisfied with the amount of commentary on narrow financial metrics, a group of fund managers and asset owners has moved beyond complaining about broker analysis to articulating what they are willing to pay for.

The underlying vision behind EAI is one of broker analysts commenting on any material extra-financial issues relevant to the firm or sector they are covering.

The basis of the EAI is that members agree to allocate a minimum of five per cent of their brokerage commissions to sell-side researchers who are effective at analysing material extra-financial issues and intangibles. This equates to more than 8m for the year 2005.

The strength of this initiative is that it provides the sell-side with a commercial incentive to produce innovative research that captures corporate performance on extra-financial issues including corporate governance, employment standards, intellectual capital management, remuneration, climate change and public health.

Lessons from the pioneers
Firms that take non-financial issues seriously share their secrets...

Deborah Ancell
Corporate responsibility manager, British Airways
“BA has produced environmental reports since 1990. Our 2005 edition is our sixth full environmental and social report. We use our internal staff newspaper and intranet to inform employees about the content of the report, while our main external communication tool is our web site (www.ba.com).

“Aviation is a major contributor to global warming. The industry is responsible for two per cent of CO2 emissions and about 3.5 per cent of total man-made global warming. It is important that we address
our impact on climate change and have been working hard to do this in a number of ways.

"We have improved our fuel efficiency by 27 per cent since 1990 and we are the only airline participating in the UK Government’s trial emissions trading scheme.

"We understand the need for the aviation sector to be included in the next phase of the EU emissions-trading scheme from 2008 and we are taking a leading role.

“Another key issue is oxides of nitrogen emissions, which affect local air quality. We are working with various stakeholders to understand the sources of these emissions at Heathrow - most of which are from road transport.

“Aircraft noise is also a CSR issue; we are concerned by the impact of our operations around the airports where we operate. We work with local communities - especially Heathrow - to mitigate the effect of these impacts.

“As well as environmental information, we’ve also included customer service as part of our corporate responsibility reporting. Some people say this shouldn’t be part of CR reporting, but we think it’s a key part of the way we interact with the public. Last year, 35 million people chose to fly with us. Valuing our customers also means taking health issues into account, including deep vein thrombosis, the threat of pandemic flu and onboard food safety.

“Our CSR report is mostly read by CR specialists and NGOs. But there is an increasing amount of interest amongst the financial community and we are making efforts to explain the issues to them. From an economic point of view, climate change is the most important issue.”

SABMiller
Alan Knight
Head of corporate responsibility
“As a beer company, our main CSR issues are alcohol, water use, climate change, employment policy, packaging, and community relations. In terms of communications, we have our annual CSR report, now in its eighth year, and we hold various stakeholder forums.

“We recently produced a video about our CSR programs in Botswana. The film shows how our subsidiary KBL has started seven CSR initiatives, including water, packaging and solid waste reduction, a project to buy locally wherever possible, a fund to help young entrepreneurs, and an HIV/AIDS program for KBL’s employees (one in three Botswanans have contracted the virus).

“We are dealing with these issues across the 40 countries in which we operate. Reducing our water use is a priority (last year we managed a one per cent cut overall), as is supporting and educating local farmers and suppliers. HIV/AIDS is another big issue. Up to 25 million people are infected in Africa, and the virus is a growing concern in Asia and Eastern Europe.

"In commercial terms, HIV/AIDS poses a significant risk to our ability to run our business and to sustain our sales growth.

“The Botswana film is available on our website. It’s nine minutes long and quite in-depth. It gives a better vision of what we’re doing because the programs are endorsed by real people on the ground.

"The film, made by Cantos, is shot in a deliberately plain documentary style. It’s not like a traditional corporate video. It’s important that it has an authentic feel because people are suspicious about companies trumpeting their CSR programmes.

“The problem with expensive CSR communications is that it leaves you open to the accusation that you are spending more money talking about what you’re doing, than doing something about it. I think it’s justifiable to spend £10,000 publicising a £10bn company.

"I don’t think it’s justifiable to spend £10,000 publicising £10,000-worth of social investment. It’s got
to be proportionate to your CSR spending.

“We are looking at better ways of collecting CSR-related data. We currently use site visits and questionnaires but we know the latter have their limits. They can be a drag to complete and often don’t get to the ‘soul’ of the work.”

British American Tobacco
David Betteridge,
Head of media

“This is year number four for our social report. For the first three years, we have had a launch event where we’ve presented the report. This year, we thought we would try something different. We wanted to try to bring the subject alive.

"The social report is a big document – 42.5 megabytes if you want to print it – and though it’s online and people can pick and choose what they want to look at, it’s very detailed. We give information on 35 countries where BAT operates and the report runs to more than 170 pages.

“We came up with the idea of interviewing our chief executive, Paul Adams. Cantos, the online video communications firm, asked Paul a lot of the questions we normally get from journalists at newspapers such as the Guardian or the Financial Times about our CSR activities.

"People are often quite cynical about a tobacco company doing CSR. So there’s no point doing an interview like this unless the questions are credible. We’ve done enough interviews to know what people are going to ask.

"One question, for example, is: ‘Some claim you’re involved in CSR just so you can resist tighter regulation. Do you agree?’ That’s a pretty authentic question.

“The interview is about nine minutes long and is aimed at anyone with an interest in CSR - analysts, CSR professionals, journalists. The feedback we’ve had from analysts so far has been positive - many of them have said they never looked at the report but they’ve watched the video [online].

"If you don’t want to look at the video, there’s a transcript of the conversation as well. But the video is good because it’s human and people can get an idea of Paul Adams’ body language as he answers the questions, which is important.

“There’s also lot of CSR information on our website. We speak at a lot of conferences and there’s a lot of employee communications. We send out overviews of the social report to many different stakeholders. This year we’re emphasising our harm reduction initiatives, including our trials of smokeless tobacco.

“A number of outside authorities have praised our social reporting. In November last year, the UN Environment Programme placed BAT fourth in its ranking of 50 top social reporters. We’ve also been commended by PricewaterhouseCoopers, the ACCA, and Business in the Community (BITC).

“Sometimes people question the value of CSR. The payback you get is over the longer term. Our chairman Jan du Plessis has said some of the biggest value in CSR is internal. There is a new vigour and openness around the group.”

BT
Alison Garner,
head of corporate responsibility communications
“The main corporate responsibility risks to our business include off-shoring, privacy and climate change, which is fairly key for us. Our management is aware of our impact on the environment. Like many major service providers, floods and other bad weather can have an effect on our business.

"However, we are able to contribute positively too, as many of our products and services have a positive environmental impact by reducing the need to travel.

“Much of CSR external reporting is very dry, so we try to do different things. As well as our social report, we have a web site that communicates our CSR issues in different ways. The social report covers key areas and data for people who are looking for more information.

"Alongside that, we publish items of general interest such as our independently-written “Hot Topics” section and video case studies of BT staff talking about issues such as health and safety and flexible working. It’s a way of humanising these issues.

"Our “Better Business Game” allows people to step into the shoes of a fictitious CEO and make business decisions relating to corporate responsibility. It demonstrates how managers have to balance doing the right thing with making profits. We’re also just completing a board game version of this due to demand from business schools who use the game at CSR conferences.

“BT published its first environmental report in 1992. Since 2001, we have also produced a full social and environmental report. To be honest, it used to be a real struggle to collate the material. We didn’t know what we should put in there and what we shouldn’t.

"Internally, people didn’t always realise the importance of “non-financial” information. There was a lot of relevant information stored in various places across what is a very large company, so it was sometimes difficult to get hold of the right information for publishing. We would have lots of different people producing different things in different styles.

“Now everyone has a much clearer idea of what’s required, and the whole thing is formatted in the same way. Every aspect of the report has an “owner” in each part of the business, so there are clear lines of accountability.”

Jargon buster
ETS: The EU’s Emissions Trading Scheme. Launched in January
2005, it places a cap on the amount of carbon that firms can emit without buying a permit from a firm that falls short of its own limit. It thus creates a market in carbon emissions.

SRI: Short for “Socially Responsible Investment”. SRI funds are proliferating across Europe and beyond.

NGO: stands for non-governmental organisation. A private, voluntary, non-for-profit body, such as a charity.

Sustainability: in 1987, the World Commission on Environment and Development defined sustainability as meeting “the needs of the present without compromising the ability of future generations to meet their own needs.”

Triple-bottom-line: criteria for measuring success that encompasses social and environmental as well as financial performance.

Dow Jones Sustainability Index: Tracks the financial performance of firms that meet a set of sustainable business criteria.

FTSE 4 good: A financial performance tracker comprising firms that meet “globally recognised corporate responsibility standards.”

Sin stocks: Holdings in firms that some people consider to be morally questionable. Can include alcohol, tobacco and online gambling.

OFR: Operating and Financial Review. A new disclosure requirement for UK companies, obliging them to state their impact on the environment and society.

Corporate citizenship: a term describing the extent to which a company considers its responsible involvement in the community.

CRE: Corporate Responsibility Exchange. An online depository for non-financial information run by the London Stock Exchange.

EAI: Enhanced Analytics Initiative. A consortium of European asset managers that devote five per cent of their commission to investment banks that provide the best research on non-financial issues.