Exclusive - Prof Mervyn King: `CFOs critical for integrated thinking`
“My grandson Daniel, who calls me ‘judge’ like many other people, recently said ‘Judge, you are always in airplanes, you must have a big carbon footprint?’ He also asked me if I recycle all the paper I use. And that was coming from an eight-year-old!” Not only is Prof Mervyn King’s anecdote endearing, the former Supreme Court judge and global governance guru also makes a good point; even an eight-year-old knows that the world is changing. “It will be a disaster if companies don’t start thinking in an integrated way.”
Prof Mervyn King hardly needs introducing. His three reports on corporate governance - with a fourth in the offing - have not only set the standard in South Africa, but are considered reporting 'gospel' the world over. It's therefore no surprise that he currently chairs the International Integrated Reporting Council (IIRC) and is jetting all over the world advocating an integrated approach to governance. With his sights now also set on the public sector, CFO South Africa spoke to Prof King about best practices in corporate reporting, the crucial role of CFOs and the dangerously outdated ways that many boards and asset managers think.
"I would be mad to retire."
King is an eloquent thought-leader with an impressive CV, having chaired, commissioned and directed countless organisations and firms. He has also raked up various prestigious honorary positions, like being just one of seven honorary members of the Institute of Chartered Accountants of England and Wales (ICAEW) - "and I am not even an accountant, but a corporate lawyer." For good measure, he also has had various roles in cricket administration and has launched a walking trail in the middle of Johannesburg. Does he ever get anything wrong?
"If you think you can carry on with business as usual welcome to the age of stupidity!"
"Yes, I wasted a year of my life writing a thesis on the history of organ music in the Witwatersrand," says King, who finished school at 16 and his bachelor of arts at 19 years old. He developed a lasting love for the music of Wolfgang Amadeus Mozart at a young age. "I was young and impressionable and my biggest mistake was doing a major in the history of music, even though I really wanted to study law and become a lawyer. This was in 1957 and I have never played an instrument since."
Setting aside his musical ambitions, King went on to make a name for himself as a corporate lawyer and eventually as Nelson Mandela's 'favourite judge', although King maintains that was just a phrase the legendary former president used to put him at ease and get him to do things without remuneration. In the last two decades the professor has been making an ever-increasing impression on the audit and accounting profession across the globe, adapting the terms of engagement to the constantly changing needs of society.
"The current mega trends are population explosion, climate change and radical transparency," he explains. "Because of social media platforms like Facebook, Twitter and Instagram you can no longer hide a secret in the corporate closet. Another trend is the capital crisis, which is also still not resolved. With the EU being our main trading partner, South African CFOs need to be plugged into what's happening around the globe."
In dealing with those mega trends, chief financial officers and finance directors are crucial players, King says. "CFOs used to be seen as in charge of the financial accounting only, but the concept of value has changed completely. Because CFOs stand a little bit away from the team and are in a position to get input from other senior executives, they play a critical role in integrated thinking."
"I wasted a year of my life writing a thesis on the history of organ music in the Witwatersrand."
King says he was brought up with value meaning "the present value of discounted future cash flow", but that has changed radically. "Now value is about the way a company makes its money. What is the impact on the economy, on society and on the environment? If your firm has a bottom line of $100 million, but your impact on the latter two aspects is negative - then your company could be destroying value and not creating it. CFOs should be people who understand this new definition of value."
Not only has the CFO role changed, internal auditors are also in a different line of business these days, argues King. "In the past they were mostly compliance driven. Now it is about developing a risk-based plan for the firm in which mistakes in areas like technology need to be managed. Good internal auditing teams don't only consist of auditors anymore, but also of environmental professionals, water engineers and more specialists."
Integrated thinking explained
There is a starter's guide to integrated reporting available on the websites of the IIRC and the South African Institute of Chartered Accountants (SAICA), but King says the very nature of integrated thinking prevents the possibility of creating a more detailed template. "The IFRS accounting standard is very detailed and incomprehensible to the average reader. Directors spend a lot of time getting relevant information from that. That is why in integrated reports the business jargon needs to be translated into clear language. Nowadays, providers of capital are mostly pension funds, which means ordinary people in the street are important stakeholders. They need to be able to understand the reports. In those reports businesses need to show how critical sustainability issues are embedded into strategy and that value creation is maintained in a sustainable manner."
Where King's first report dealt with basic reporting standards and his second one with sustainability, the third one - in 2009 - was needed to emphasise the importance of integrated thinking, he says. "After King I, we realised that if we don't deal with sustainability as a business judging mechanism, we are headed for disaster. That lead to King II, but companies started reporting in two silos - financial and sustainability - that is why we published King III to rectify that. In some companies for the first time the head of sustainability, the head of internal audit and the CFO sit around the table together. Companies are using natural assets, finance, systems, human capital and social capital - it is all interconnected on the ground, but often not in reporting. That is why integrated thinking on an executive level is pivotal."
A changing world
King knows his statistics, like the fact that one eighth of the world goes to bed hungry each night and that the world will have two billion more inhabitants than its current 7,5 billion by 2035. "If you think you can carry on with business as usual welcome to the age of stupidity! Large, multinational companies like Unilever understand that they will be out of business if they don't change. That is why they are now driving at zero waste, by introducing recyclable packaging, making sure consumers use less water and energy and by forcing their suppliers to produce differently."
Partly because executives are usually younger, King feels they tend to be ahead of their boards when it comes to integrated thinking. So while he says that 'the integrated thinking Bastille has been stormed' and 'the revolution is over', non-executive Board members still have some catching up to do. "The board's mindset has to change. They are still spending 80% of the time on management accounts, but other agenda items are needed, like IT governance. Security has also become critical in any IT environment. Cyber breaches are accelerating and there is the new Protection of Information Act. Do you have a response officer to deal with those issues? That should be the board's concern."
Even stakeholder relations, sometimes still seen as a fluffy topic, needs to be given high priority. Corporate Shareholder Relationship Officers (CSROs) should talk to stakeholders and feed information about their needs, interests and expectations to management and the board should be informed through the audit committee, King explains. The doyen of corporate governance also notes that the new concept of 'value' is not embedded yet with many older non-executives. "Young people are more concerned about the global environmental crisis than the global financial crisis. The cream of the crop at universities are people who don't want to work for companies that exacerbate the crisis. Most executives understand that, but there is often a tension with the boards. I think integrated thinking is winning though."
Investment advisors and administrators are another group that has some serious catching up to do, says King. "Responsible investment is on the rise, but there are still a lot of asset managers focusing on the short term and then pulling out the money. If you do an actuarial calculation in a pension fund you realise that, although you need to do payouts now, most of your payouts will be in the future. The problem is that the asset managers still get rewarded, bonus-wise, in a way that is focused on the short term. That needs to change. Investments need to be focused on an enhanced bottom line, including social and environmental aspects. It is not happening enough and that is an issue. Stakeholder expectations are greater than ever before. Businesses cannot make money anymore at the expense of human rights, for example."
So who's getting it right?
Besides Unilever, King often uses Coca-Cola as an example of well-developed integrated thinking. In South Africa he is impressed with SABMiller, which is working with the World Wildlife Fund around water issues. "Another one is Nedbank's former CFO Mike Brown - now CEO - who has been a big driver of integrated thinking. I have a lot of frustration, not only in South Africa but globally, with people that still think on a short-term profit basis."
"The Coca-Cola Company is a great example of how things should change," says King. "They realised 'if we don't conserve water, we don't have a business' and introduced four key themes - reduce, recycle, recover and reuse - with the aim not to waste any water by 2020. I was at the company's Hellenic Bottling in Istanbul earlier this year, one of the biggest bottling plants in the world, and they have already accomplished 80% of water saving. That is quite astounding. Imagine being Head of Internal Audit of that plant. If you would just capture financial numbers, you would not add any value. You need to start developing informed controls over a wide purview of issues such as strategy, sustainability, technology and treasury."
The allegation that Coca-Cola causes obesity was another great test for the firm, says King. "The company is over 128 years old and for 126 years they have been concentrating on marketing their product, which was the greatest brand in the world until Apple came along. Since May 2013 they have started to focus on the impact of the output by offering low- or no-calorie beverage options in every market, providing transparent nutrition information, helping get people moving by supporting physical activity programs in every country where they do business and by refraining from advertising to children under 12. This is a great example of integrated thinking - taking account of the outcomes of your output."
"I have a lot of frustration, not only in South Africa but globally, with people that still think on a short-term profit basis."
Most people of his age (68) are taking it a bit easier than King, but he flat-bats the question of retirement with disdain. "People ask me all the time if I will retire, but if I retire, I will die I get phone calls every day from everywhere in the world, from here to Timbuktu, to come and speak. On a corporate level we are now in the marketing phase of integrated thinking, but I also want to start focusing on the public sector. Governments are starting to think on an integrated basis."
In the past few years King has addressed the global bosses of the big accountancy firms, the global accountancy and audit bodies and the World Bank and he received a Gold Service Award for his "worldwide contribution to the accountancy profession" from the International Federation of Accountants (IFAC) in 2012. No wonder that King claims he is "at the pinnacle" of his career at the moment, as chairman of the IIRC and chairman emeritus of the Global Reporting Initiative (GRI). "The accountancy profession can save the planet. If integrated thinking becomes common, we can have a sustainable planet by the end of the century. The IIRC is really making a difference in the world at the moment and, as its chairman. I would be mad to retire."