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When I met with BIS in 2012 to give my thoughts on the Strategic Report I asked how it would be policed? How could we be sure that companies would pursue the spirit as well as the letter of the new legislation – in other words, go beyond mere compliance to where the real benefits to investors would lie? ‘The investment community will do it’, was the answer I was given by Government. I challenged this preconception. Already by then six years of FutureValue’s evaluation of the quality of strategic value in corporate reporting had shown little if any difference in the overall standard of narratives. The Stewardship Code would serve as encouragement, I was told.
Now, in 2018 and six years further on, the quality of UK corporate reporting has still shown limited signs of any general advancement. FutureValue’s rigorous annual evaluation of Strategic Reports indicates relatively little change in the overall standard, counter to the understandable claims made by the FRC of wholesale improvement . It has taken the actions of one investor, albeit the largest in the world, to make a difference. An annual personal letter from CEO and Founder of BlackRock, Laurence D [Larry] Fink, to the CEOs of all companies in which BlackRock is invested, is gradually having an impact. And there are, as Mr Fink points out, far more BlackRock investees than one might imagine by virtue of all of the BlackRock index funds that require a holding by the investor. This year’s letter, received by invested CEOs this week, raises the bar even further.
In his two previous annual letters Mr Fink asked CEO’s to communicate to shareholders their strategy frameworks for long-term value creation and to show how they have adapted those strategies to major changes in the global environment. This year he is setting out his belief that companies should show how they are responding to broader societal challenges. He asks CEOs to show how their company is making a positive contribution to society as well as delivering financial performance. In addition to addressing their social purpose he wants Boards to be ready and able to describe their strategy for the long-term so that engagement with shareholders can be ongoing and much more productive. He also wants Boards to describe the process for overseeing their company’s strategy. And, should anyone be in doubt, Mr Fink is demanding year-round engagement with investees, not just once a year at AGMs. He is gearing up stewardship teams at BlackRock to enable this.
The Annual Report will inevitably remain a mainstay of the means of engagement. It provides the platform for Boards to demonstrate to all its stakeholders, not just to shareholders, the logic of their long-term thinking and, through the company’s performance, the effectiveness of the application of that thinking. Mr Fink’s demands will, however, have specific ramifications for UK listed companies and their Strategic Reports.
‘Purpose’ is a relatively new concept for a good deal of companies, many of which struggle to define why they exist. Mr Fink is effectively upping the ante. He is asking them to define their existence in terms of social, and not just economic purpose. This will be the key to a more integrated report. Some companies get it already. For example, Lloyds Banking Group defines its purpose as “helping Britain prosper” – a set of words that explicitly addresses most, and tacitly all, of its stakeholders. Equally, Unilever, presents a succinct social purpose: “to make sustainable living commonplace’” – a form of words that goes far beyond considering mere financial performance. Both companies live their purpose. Even so, both Mr Horta-Osorio and Mr Polman may still need to read their personal letters from Mr Fink. There is more to Mr Fink’s demands this year than just social purpose.
Mr Fink also expects Boards to be able to describe their strategy for long-term growth, and not just rely on someone else to articulate it for them in the Annual Report and investor presentations. To do this effectively will require Board members to understand intrinsically and communicate clearly what drives the profitability in their business, and what will produce expected growth. FutureValue maintains that the starting point both for that understanding and its communication will be the company’s business model, at the foundation of its strategy framework. Simple clear exposition of the business model will enable Boards to share the logic of their strategy and strategic thinking with shareholders and stakeholders at large. It should be the centrepiece of the strategic report. For the majority of companies and their Boards there is much work still to be done here.
Mr Fink also recognises that strategy process is a critical success factor. He stipulates that BlackRock expects Boards not just to describe the strategy for long-term growth, but to be able also to describe their process for overseeing their strategy’s implementation. It is a key point that we have always maintained at FutureValue. Too much emphasis is put on strategy content in corporate reporting and not enough on strategy processes. Mr Fink is unambiguous about his expectations: “Just as we seek deeper conversation between companies and shareholders, we also ask that directors assume deeper involvement with a firm’s long-term strategy.”
For US listed companies where BlackRock is a shareholder Mr Fink’s demands will feel like a seismic shift. US Boards will feel the impact that much more keenly because they have no associated Strategic Report, let alone a non-financial reporting, requirement. For UK listed companies Mr Fink is pushing to some small degree at a door that is slightly ajar – opened by the EU Non-financial Reporting Directive and its incorporation into UK reporting law; there is of course already the prerequisite of the Strategic Report. Even so, this will still amount to a step change here in the UK. As Mr Fink sums up: “A company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process.”
Reporting will be the key and the means by which companies, their Boards and their CEOs will engage and be judged. Well done, Mr Fink! We applaud you. We hope that your stewardship teams will walk softly and carry a big stick.