China’s new stance on sustainable growth challenges its leadership to manage resources better. Can integrated reporting help?
In the 2014 Government Report delivered on March 5, 2015 at the Third Session of the 12th National People's Congress, Premier of the State Council Li Keqiang noted that “China’s economic development has entered a new normal, meaning we must adopt a new attitude.” The content of Premier Li’s speech clearly identifies the contours of what “new normal” means: Economic growth that makes more judicious use of limited resources, and protecting the country’s vast natural capital from degradation while reducing negative impacts on the environment such as carbon emissions and air pollution.
“New normal” has strong social and governance dimensions as well. For China’s 1.3 billion people to have happy lives in a just society, reforms will be necessary. Corruption in the public sector, for example, will need to be eliminated to ensure that public servants are truly looking after the needs of the public, not simply their own. The idea of the “new normal” is so important to China that it will be the basis of the Party’s upcoming 13th Five-Year Plan, the official guideline for China’s national economic development.
The “new attitude” that will support China’s transition to sustainable development means revamping the six forms of capital that comprise its economic system: financial capital, natural capital, manufactured capital, human capital, social and relationship capital, and intellectual capital, including:
- Focusing on innovation and knowledge creation since the country can no longer rely upon low-cost, resource-intensive manufacturing jobs to provide employment opportunities and spur economic growth.
- Advancing national ecological security as the basis of economic development and social prosperity.
- Enhancing social and relationship capital among its people in order to, as Li put it, “improve our ability to communicate effectively with international audiences.”
Accomplishing this is a tall order. Under the leadership of General Secretary Xi Jinping, China’s government has made great strides in improving its own performance along these six types of capital. It has produced 7.7% GDP growth and created 13 million new jobs, resulting in higher average household incomes and increased food production. But the government cannot do it alone. The business community — beyond the big state-owned enterprises that are controlled by the government — has an equal responsibility in this area.
While Chinese executives are beginning to understand their role in the new normal, they need ideas and tools to help them develop a new attitude. Fortunately, an important one is now available to them. It is called “integrated reporting,” a new form of corporate disclosure to demonstrate and reinforce a new attitude.
What Is Integrated Reporting?
In the International IR Framework (IR Framework) developed by the International Integrated Reporting Council (IIRC), integrated reporting (IR) is defined as “a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of the external environment, lead to the creation of value over the short, medium, and long term.” At the core of the IR Framework are the six types of capital mentioned above.
The power of reporting in general is evident in how hard companies try to make sure they meet expected earnings targets. Sometimes they try too hard, employing tactics such as cutting costs that will hurt future performance, or even manipulating the reported numbers themselves to present a more favorable but less accurate portrait (even to the point of being fraudulent) of the company’s situation.
But where traditional financial reporting frequently overlooks assets and costs that are natural- or human-resource centered, integrated reporting seeks to capture intangible assets and hidden costs and assess their effects on both short- and long-term productivity. These can represent assets as diverse as the value of increasing employee skill sets by training (financial reporting considers training a cost rather than an investment, and so does not include ROI for training) or the less-than-obvious (and frequently subsidized) costs of different types of natural resource use — for example, impacts of logging, mining, or water use on the health and well-being of nearby communities, which are often the homes of company workers.
When a company reports on how it uses and impacts the six types of capital, it creates visibility that affects resource allocation decisions. Traditional financial reporting can be very effective in highlighting a company’s performance regarding financial and manufactured capital. Integrated reporting includes performance measures regarding the other four types of capital and how all six forms are related to each other.
How Can China Put IR to Work?
Through integrated reporting, Chinese companies will be better able to adapt to the new normal, supporting the government’s policies while improving their own performance. This information will be useful to the government, but it will also be useful for other important stakeholders, including investors, customers and employees.
For example, integrated reporting emphasizes the importance of intellectual capital and human capital in the value creation process and will challenge companies to develop ways of measuring how well they are using and contributing to these capitals. One approach would be to adapt the work of the U.S.-based Sustainability Accounting Standards Board to a Chinese context.
In addition, integrated reporting, supported by the appropriate government laws and regulations for creating a more sustainable economy, will enable the company, its investors and other stakeholders, and the government to determine if the company is supporting or inhibiting sustainable development in China.
The IR Framework also provides a mechanism for improving relationships with all of a company’s stakeholders, in large part by offering a more holistic understanding of material strategic issues that cut across the six capitals. For Chinese companies doing business internationally, integrated reporting will provide them with substantial credibility with their overseas employees, suppliers, customers, shareholders, and the governments of the countries where they are doing business. These companies will be setting a global standard for transparency and good business practices.
Although integrated reporting is still a new management practice, it is being increasingly adopted by companies all over the world. No Chinese company has yet issued an integrated report, but many are producing sustainability or corporate social responsibility reports, which are a step in that direction.
Finally, through integrated reporting, a company can shift its investor base to one that has more long-term investors — which, in turn, enables a company to make long-term investments to support a sustainable strategy. We believe that China, as a nation, will reap substantial benefits if all its companies are practicing integrated reporting. This includes the millions of small and medium-size enterprises, which account for some 70% of all the jobs in China.
Who Should Lead?
We don’t believe that government regulations should kick-start integrated reporting in China, although this will eventually be necessary. Instead, we recommend that some of China’s leading companies in a range of sectors work together to adapt the concept of integrated reporting and the IR Framework to a Chinese context.
To support this, the De Tao Group is working with the China Business Council on Sustainable Development (CBCSD) and PricewaterhouseCoopers to identify four to six companies that will be the “China Leadership Program on Integrated Reporting.” We launched this initiative at a recent seminar hosted by the CBSCD and intend to report on our progress over the next year.
Integrated reporting is still in its early stages, with only one country, South Africa, having made it a requirement of all listed companies. This is a tremendous opportunity for China. As the world’s second largest economy, the widespread of adoption of integrated reporting in China would demonstrate to a skeptical world that China really is serious about sustainable development. This would then challenge other large countries, such as the United States, to rise to the occasion as well. No country needs Integrated Reporting more than China because IR is one of the few management tools in existence that can effectively address the scale and scope of environmental degradation in China.
Is China ready to become an example for the world about how to promote and enjoy sustainable long-term prosperity? We think the time is right to show that it is.