Re-aligning the capital markets for today’s needs

In December 2016, the IIRC’s official conference, in partnership with the International Corporate Governance Network (ICGN), brought together 400 people from over 30 countries around the world. Following our introductory conference article in last month’s newsletter, here we report on the key messages, issues and debates arising from Plenary One, which focused on ‘Aligning the capital market system for 21^st Century needs’.

Plenary One’s assembled panel set out to answer and discuss several weighty questions: What can key players in the capital markets system do to achieve the right outcomes for longer-term growth? What roles should investors, corporates and governments take to ensure the capital market works as intended? What’s not working now, and what outcomes are we aiming for?

Kicking off proceedings, David Pitt-Watson, Co-Chair of UNEPFI, outlined the scale of the challenge involved in trying to align the capital market system to present needs. This challenge, he suggested, lies in the fact that there are such contrary forces at work in the world. On the one hand, we have the two major global agreements of recent years, the UN Sustainable Development Goals and the Paris Agreement which, he said, “seek to eliminate poverty…and ensure that we have an environment that is sustainable for the long term.” On the other, we have the election reckonings of 2016 which have delivered Brexit in the UK and President Trump in the US. Around the world, governments and institutions are also grappling with major issues, such as “how we’re going to pay pensions and fund the health [of] older people.”

A question of trust

In the UK, Pitt-Watson observed, Theresa May has declared she wants “an economy that works for everyone, not just the privileged few.” But, he remarked, “for people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employers, and the wider public.”

Asked if people can trust the capital markets, Jane Diplock, Director at Singapore Exchange Limited, replied “the answer has to be no…the lifeblood of the financial sector is trust, and once that is broken it is extremely difficult to get it back again.”

Jack Ehnes, CEO of California State Teachers’ Retirement System (CalSTRS), said that trust is all about a perceived “alignment of interest”, which is why 75% of Americans say they distrust their insurance agent and their banker, while the technology sector tops the Edelman Trust Barometer every year. Describing the sustained pressure from customers to divest, invest and engage with the issues that matter, Ehnes explained that CalSTRS’s high levels of trust (80%) among its 900,000 members stem from the fact that its business decisions are clearly aligned to their interests. “If [you] can’t say that as a business,” he remarked, “that’s what [breeds] distrust.”

The long-term agenda

According to Fiona Reynolds, Managing Director of PRI, “the long-term sustainability agenda is the answer that everybody is looking for.” But we need to look at “beneficiary interest in an expanded way” – to look beyond quarterly returns to a system that people can retire into, that supports health, wellbeing and the environment. Furthermore, through long-term investment models, companies can begin to show they are performing a fiduciary duty. Everyday people, she explained, “do save for the long-term, do think about the long-term”, and they need structures that support their long-term interests. This, it was agreed, is a major change required in the capital markets if we are to meet the needs of the 21^st Century.

In supporting of the shift towards long-term value creation, however, Russ Houlden, CFO at United Utilities, said we need to “readdress the narrative” around corporations. Widely perceived to be a problem, corporates, he remarked, “are the key participants in the capital market system”, and “without corporates, there is no value creation.” In order to make the process of value creation more sustainable, Holden suggested that “the one simple thing [corporates] could do, is to get on board with integrated thinking and Integrated Reporting as the way to tell their story.”

Jane Diplock echoed this view, saying that Integrated Reporting represented an effort “to put trust back into corporations…by [helping them to be] very transparent,” while Houlden added that if “all the corporates just said, ‘Okay, we’ll do Integrated Reporting,’ in five years’ time we’d be in a much better space.”

Flexible and consistent

To achieve this acceleration towards Integrated Reporting, and in this way ‘readdress the narrative’ around corporates, it was suggested that Fund Managers need to start requesting to see integrated reports; to create a sense of expectation and demand around disclosure through integration: “Do you have one,” one panellist asked a hypothetical corporate client, “and if not, when are you are going to bring me one?”

Certain issues, however, still need to be resolved as corporate disclosure evolves. As panellists discussed, one of the great strengths of Integrated Reporting is its flexibility, which enables companies to “tell their own story”. But, as Houlden observed, “the flipside of that is it’s almost the total opposite of accounting, where you follow IFRS…and if everybody just tells their own story, investors will [struggle] to compare.” What’s needed is for “asset owners to get together, and help all of us by defining those few non-financial measures – whether they be environmental, social or governance-related – that they would like companies to publish on a consistent basis.”

Other recommendations from the panel to help support the transition to Integrated Reporting, and thereby drive change in the capital market, included the following points:

• Integrated reports must remain concise and totally focused on materiality
• Investors have to push on the issues of meaningful, material disclosure
• Around the world, stock exchanges need to get on board with Integrated Reporting, following the example of the Sustainable Stock Exchange Initiative
• Governments, as key participants in the capital market system, need to carry out independent impact assessments before voting on new laws and regulations

More jurisdictions, following the example of South Africa and Singapore, should mandate integrated and sustainability reporting for listed companies.

This article was kindly contributed by Stratton Craig: www.strattoncraig.co.uk.