By Ellie Winninghoff

Corporate giants American Electric Power, United Technology Corp., Southwest Airlines and PepsiCo are among the growing number of companies that have merged their separate financial and sustainability reports into a single "integrated report."

"It helps us break down this concept of financial reporting and non-financial reporting," says Ceres president Mindy Lubber, who spoke in a virtual broadcast sponsored by the Association of Chartered Certified Accountants in August. "If a company is in the agricultural sector, is it going to have enough water to grow these crops? That's not non-financial; that's financial, and we have got to merge these concepts of financial and non-financial because they can and do have interlocking implications."

Environmental, social and governance (ESG) data has become its own separate silo, much like the rest of the data collected by the investment industry. Non-financial information isn't limited to ESG data; it also includes things like intellectual property and knowledge, organizational relationships, reputation, brand and other intangibles.

A study by NYU Stern Business School accounting guru Baruch Lev is one of many that shows balance sheet items (including traditional bricks and mortar, as well as financial capital) represent less than 20% of a company's book value.

"We are trying to deal with problems of the 21st century with 20th century systems, and in this case, reporting systems," says Paul Druckman, CEO of the International Integrated Reporting Committee (IIRC.)  

According to Druckman, integrated reporting is not simply about ESG reporting or financial statements reporting. Rather, it's about connecting the dots between a company's strategy and the relationships it creates with and between the different types of capital--financial, manufactured, human, intellectual, natural and social. In this sense, integrated reporting is holistic, and it is as much about integrated or holistic thinking and strategy as it is about reporting. Ultimately, the hope is that integrated reporting will be forward-looking rather than backward looking.

"[Integrated reporting] is not the evolution of sustainability reporting," Druckman says. "It's the evolution of corporate reporting."

This is the final segment of a three-part series about accounting for sustainability. Part one (http://www.fa-mag.com/green/news/8124-accounting-for-sustainability.html) traced the trajectory of the Global Reporting Initiative, or GRI, a hyper-Democratic, multi-stakeholder-based consensus-seeking global institution that has developed and continues to refine frameworks and guidelines for environmental, social and governance (ESG) reporting.

Part two (http://www.fa-mag.com/component/content/article/14-features/8448-seeking-assurance.html) discussed some of the tricky issues related to verification/assurance by accounting firms and others of the information contained in corporate sustainability reports.

Part three describes the early stages of a global effort to create integrated reports. But first a little background.

Royal Endeavor
As discussed in part one, the GRI story harks back to the Exxon Valdez oil spill in Prince William Sound in l989. Socially responsible investment pioneer Joan Bavaria, founder of the Boston-based Trillium Asset Management, pulled together a coalition of leading environmental activists and social investors. Christened the Coalition for Environmentally Responsible Economies (later re-branded Ceres), the idea was to ask companies to go beyond the letter of the American law to practice what she called an "environmental ethic."

By early 1998, Ceres became what then-president and GRI-co-founder Bob Massie, now a Democratic candidate for Senate in Massachusetts, calls the "honest broker and custodian of an experiment." Five years later, the GRI, as that experiment came to be called, became an independent entity in Amsterdam. Today the GRI's guidelines for disclosure of ESG data, which have been adopted by more than 2,000 companies worldwide, continue to evolve.

Meanwhile, Britain's Prince Charles has long been interested in sustainability--an interest he has shared with his former personal private secretary, Sir Michael Peat, a former partner as well as grand-scion of one of the founding partners of KPMG. In 2006, the prince launched his Accounting for Sustainability Project, or A4S as it's called. Led by Michael Peat, the idea was to work with businesses, investors, the public sector, accounting bodies, NGOs and academics to determine how to "embed" sustainability into the DNA of how companies manage themselves.

A corollary project of A4S, which was called Connected Reporting, involved developing a framework for companies to connect the dots between various ESG factors and financial issues. Led by Paul Druckman, a former accounting software entrepreneur and now CEO of the IIRC, that framework has subsequently been used by companies such as BASF, Aviva Investors, HSBC and Allianz. (The IIRC was formed as a collaboration between A4S, the GRI and the International Federation of Accountants.)

But these weren't the only people looking to connect the dots. Harvard Business School professor Robert G. Eccles had written books on the need to improve financial reporting. And while he knew about GRI and counted Bob Massie as a friend, he considered stakeholder reporting to be entirely different from his area of concern--reporting to shareholders.

The remedy, Eccles, believed, was a single integrated report targeting both shareholders and stakeholders. "They had to be pulled together," he says, "because ESG issues were becoming increasingly important for shareholder value and for essentially the legitimacy of corporations."

Eccles discussed his idea with others, and learned that Philips Corp., the Dutch electronics and health care company, had been publishing integrated reports for three years. And that United Technologies, the Hartford, Conn.-based industrial conglomerate, was the first company in the Dow Jones Industrial Average to publish one. And that Natura, a Brazilian cosmetics and fragrance firm, was also doing it.

"There was no way that [these three companies] knew about each other," Eccles says. "They were in different countries, different industries. Nobody had written a book. And all of them had done it for the same reason--sustainability.

"When an idea's time has come, " he continues, "it pops up in different places at the same time."

Integrating Ideas
Eccles, along with former Grant Thornton partner Michael Krzus, began researching their book, One Report: Integrated Reporting for a Sustainable Strategy, which was published in March 2010.

The books posits that financial reporting is out of date not only because the financials don't account for intangibles like intellectual property, reputation, brand, or the value of a company's organizational relationships, but also because complexity and excessive detail obscure transparency.

Beyond this, there is a bigger question about the role of corporations in society and their impact on natural capital and communities where they operate. In the IT industry, for example, entire forests are being destroyed in Colombia because the minerals required to manufacture cell phones and computer screens are there.

"It's very costly," says Nelmara Arbex, COO of the GRI. "We are digging deeper and deeper. But because the price of minerals goes up, they just continue to do it. The context where business operates is getting more complex right now."

In this light, it's hard to argue that corporations should not be accountable to stakeholders. "A corporation does not create value in a vacuum," says Krzus. "It relies on society and natural resources to create value."

Breaking Down Silos
But while accountability is a great first step, it's not enough by itself.

"Just telling you that [a company] uses 400 million hectares of aquifer water is meaningless unless you know that ten of their 20 plants are in water-stressed areas," says Eric Hespenheide, Deloitte & Touche LLP's global leader of sustainability and climate change, audit and enterprise risk services. "[Integrated reporting] is driving toward understanding the context in which [a company] is using natural capital, human capital, manufactured capital and financial capital to drive those results."

Ultimately, though, integrated reporting is about integrated thinking.

"It's really about a culture change," says Krzus, who points out that integrated reporting is about breaking down silos that impede communication whether it's between operations and finance, or finance and marketing, within the sustainability group, or between senior executives. "It's really more about change management than it is about integrated reporting.

"We should not emphasize the report as the end result," he adds. "The question is how does a company integrate ESG factors into how they run their businesses so that it goes into the very core of their decision making."

That's exactly what happened at American Electric Power, which published its second integrated report in 2010.

"It ended up helping to break down silos," says Sandy Nessing, AEP's director of sustainability and ESH strategy and design. "People began to see how things were interconnected--something somebody else was doing could help what they were doing. Or, maybe we could do something different together."

At AEP, Nessing says, the facilities managers were the first out of the gate. A LEED consultant was hired to describe a more holistic approach to energy use, water consumption, workplace environment and the like. "You could see the proverbial light bulb go off for every employee around the table," she recalls. "'Wow!'" she says they said. "'We've been wanting to do this for a long time.'"

The result: Since 2007, the company has reduced its own electricity consumption by 17%.

"That means we can sell that power back into the market," she says.

Broader Acceptance
In January, the Johannesburg Stock Exchange became the first stock exchange in the world to mandate integrated reporting. And the movement for integrated reporting continues to gather momentum. The IIRC has committed to developing an international framework for reporting, and its working group last month released a discussion paper for public comment, available at its website (http://www.theiirc.org). It has also invited companies to participate in a pilot program, and Microsoft and Prudential are among the first out of the gate.

"It's important for companies to develop sustainably over the long term," says Eccles from Harvard. "It's a giant collective problem, and it's global scale. To solve it, it requires standards-setters, companies, investors, analysts, and accounting firms.

"And if it all gets done," he continues, "this will be as important a social convention as required accounting standards and reporting."

A former investment banker and veteran financial reporter, Ellie Winninghoff is a writer and consultant. Her work about responsible and impact investing can be found at:  www.DoGoodCapitalist.com. She can be contacted at: Ellie.Winninghoff [at] gmail.com.