The game-changing model of US criminal justice, “the broken windows theory”, dictates that if you take care of the small problems you can prevent the big problems from occurring in the first place. The theory is that when a window is broken and someone fixes it, it is a sign that disorder will not be tolerated. But when a broken window is not fixed it “is a signal that no-one cares, and so breaking more windows costs nothing”. The theory is informing the work of the US Securities and Exchange Commission (SEC) and the related discipline of behavioural economics is also being explored by the International Organization of Securities Commissions (IOSCO).
This philosophical shift in the focus of capital market regulators towards encouraging good behaviour and best practice, as well as being the guardians of market culture in an era of complex interconnected economies, is important. It is consistent with another regulatory development: the spread of Stewardship Codes, which recognise that investors share responsibilities with management for the effective stewardship of the business and place real value on high quality dialogue between boards and providers of financial capital.
These developments are enabling the other major innovation taking place across the world: the evolution of corporate reporting towards a more integrated and inclusive system. Integrated, because silos lead to gaps and inefficiencies that today’s fast paced and interconnected markets will not tolerate and will price accordingly. Inclusive, because long-term financial performance depends on the efficient and productive management of resources not currently measured by traditional accounting methodologies – human, intellectual, social and relationship, and natural “capitals”.
Despite some tangible progress, especially in the field of environmental and risk accounting, traditional financial reporting must do more to open its doors further to the measurement and management of these multiple resources to enhance the confidence of investors so that the best becomes the norm – and the norm becomes reporting that is concise, cohesive and complete. Integrated Reporting is no longer a punt: it is the guarantor of the future relevance of corporate reporting and is the umbilical cord that connects a business to capital market decision-making, economic progress and social wellbeing.
Integrated Reporting is part of the solution to today’s economic, capital market and corporate reporting challenges, but it is not a silver bullet. It fixes the “broken windows” in the corporate reporting system, but more far reaching changes are required to ensure Integrated Reporting brings benefits not just to the business pioneers, but to all market participants.
It is why we will continue to advocate for three economic governance shifts that we believe are essential to creating a more secure, stable and successful global economy. Each of these shifts is underpinned by practical and actionable recommendations. One, an economic system shift from a financial capital market system to an inclusive capital market system, recognising that a financial capital market system is insufficient to guard against the multi-faceted and interconnected risks of the future. Two, a capital markets system shift from short-termism to sustainable capital markets, with incentives that encourage and reward long-term decision-making. And, three, a corporate reporting system shift from silo reporting to Integrated Reporting, the mainstream adoption of which will contribute towards financial stability and sustainable development.
We have shown over the last three years that an integrated and inclusive corporate reporting system can deliver practical benefits to businesses and investors. It is time to extend these principles to strengthen the quality of economic and corporate governance, and spread the rewards of Integrated Reporting to all.