reporting issue 5 - ey · welcome to issue 5 of reporting. economic forecasters may diverge on...

ReportingIt’s more than the numbers issue five | march 2013

How global companies are tackling the growing threat of water shortages

Runningout

Screen readable format

Under pressureWhy remuneration committees are being forced to change the

way they work

Valuable ideasHow companies assess

and report on thevalue of patents

march 2013 Reporting 2

Welcome to Issue 5 of Reporting.

Economic forecasters may diverge on percentage points regarding improvement to trade, growth and inflation, but they are

universally agreed that the end to this economic crisis and a return to ebullient growth is not in sight.

Continued market volatility makes financial reporting, and the underlying process of asset valuation, hugely challenging. With the many decisions and judgments corporates make as they finalize year-end accounts, how can stakeholders in capital markets, pressed for time as they are, make valid comparisons between investment opportunities and understand the intricacies and implications of the reporting principles used?

In a recent report by Professor Peter Pope of CASS Business School, supported by Ernst & Young, the research team examined asset impairment disclosures for PP&E, intangible assets and goodwill of 324 European companies as a means of studying the consistent application of IFRS. Overall, the

researchers found that the reporting for non-current non-financial assets is not uniform and varies by industry, country and the degree of discretion allowed and judgement needed by management.

At Ernst & Young, we have long held the view that a single global set of accounting standards is the cornerstone of transparency in global financial markets. Comparability through consistent application of reporting standards requires commitment from all parties — corporate reporters, the accountancy profession, the regulators who provide oversight, and the standard setters who review and address areas of application challenges or inconsistency.

What strikes me and my colleagues who work with leading global companies is how the matrix of communication with stakeholders has fundamentally shifted as a result of the economic turmoil in which we have all been embroiled for the last four years. I suggest there are two important changes.

First, investors, scarred by uncertainty and swings in capital markets, are increasingly taking a longer-term view. They recognize that market volatility is such that a snapshot of value at a given point in time is inadequate. So they look for evidence of long-term value creation and risk

management. They implicitly recognize that the short-term focus on asset valuation in today’s market is not the best harbinger of long-term value. On p5, you’ll find our article on valuing patents, a complex area for investment and reporting.

On the broader question of how companies report their environmental and social impact, Ernst & Young is an active supporter of the International Integrated Reporting Council (IIRC). The work the IIRC is undertaking toward developing a framework for integrated reporting will be an important step forward.

We believe that an integrated report should provide management and investors with real support to their investment decisions by providing insight on the organization’s strategy and actions and how they specifically relate to its ability to create and sustain value in the short, medium and long term.

Second, aspects of a business’s broader reputation have far more influence on market valuation. In the last few years, many organizations have suffered significant share price falls that were not due to profit warnings or financial restatements. Consumer and investor sentiment

ReportingWElCOmE

http://www.cass.city.ac.uk/

http://www.theiirc.org/

http://www.theiirc.org/

mailto:?Subject=Ernst and Young Capital Insights Q3 2012&body=http://www.capitalinsights.info/ci-pdf-editions/capital-insights-q1-2013-interactive.pdf


can be affected instantly by the pervasiveness of social media and global communications once a negative perception of business practices or ethics, or a disregard for social and environmental impacts on consumer protection, is formed.

So what do we take from this? Companies increasingly need to summarize their performance in a holistic and transparent way. Clearly, assessing an organization’s commercial performance is crucial, but a wider assessment of economic impact, including use of scarce resources (see p18) is also key.

For listed companies in competitive markets, management’s responsibilities are clearly stated; to provide investors with a return on their commitment. But if we extend the horizon beyond a six-month measurement of PE ratio or dividend cover, and incentivize the leaders of business accordingly (see p26), perhaps businesses can address a wider set of questions as they complete their year-end score card.

ChRiStian MoUillonChristian Mouillon is the Global Vice Chair of assurance at Ernst & Young

WElCOmE

ernst & Youngassurance | Tax | Transactions | advisory

about Ernst & Youngernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

Ernst & Young refers to the global organization of member firms of ernst & Young Global Limited, each of which is a separate legal entity. ernst & Young Global Limited, a uK company limited by guarantee, does not provide services to clients. for more information about our organization, please visit www.ey.com.

© 2013 eYGm Limited. all rights reserved.

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This publication contains information in summary form and is therefore intended for general guidance only. it is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither eYGm Limited nor any other member of the global ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

The views of third parties set out in this publication are not necessarily the views of the global ernst & Young organization or its member firms. Moreover, they should be seen in the context of the time they were made.

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contents

05how much is an idea worth?We look at the factors that affect the value of patents and the difficulty of putting a precise valuation on intellectual property

09Growing painscobus de swardt of Transparency International on the key findings of the corruption Perceptions index 2012

12the pollhighlights of a recent ernst & Young survey that looked at the evolving role of internal audit — and where it needs to improve

41lessons learned dealing with start-ups

26Executivereward

cove

r: G

etty

imag

es c

hris

tian

mou

illon

pho

togr

aph:

em

man

uel f

radi

n

tax and cloud computing

14

14 Cloud controlWe explain why the growth of cloud computing poses challenges for tax planners and regulators alike

18Running dryin the second of our series on systemic risks, we look at the growing threat posed by water shortages and how companies can tackle it

23Shifting perspectivesPolitical turmoil hasn’t lessened the attractiveness of the middle east to foreign investors, as a recent report reveals

26Remuneration in the spotlightGrowing shareholder influence is shaping changes to the way remuneration committees work. We investigate

30CFo and beyondWhy are cfOs increasingly being recruited as non-executive directors? We look at the key findings of a report on CFOs’ career paths

34the buy sidemaking investments in eastern europe can be challenging, but there is an upside

37the importance of insightWe examine best practice in disclosures in financial statements at year-end

415 things i’ve learneduli fricke of Triangle venture capital shares lessons from her successful career

43My wish listLou hughes of aBB on the changes he’d like to see in corporate reporting and governance

45 … and morerecent books and publications

CONTENTS

Reporting



How much is an idea worth?

Patents are big business, but assessing their worth, and then quantifying that value in financial statements,

is far from straightforward. Lawrie Holmes reports

“if it’s worth copying, it’s worth protecting” is a truism that helps to explain the continued rise in the number of patents filed every year around the world. as companies develop ever more innovative products and services, they naturally seek to protect them through patents, which give exclusive rights to exploit new products or processes for a maximum of 20 years.

Patents, as a means of protecting intellectual property, have long been an aspect of global businesses, particularly where research and development (r&D) investment is made in areas such as information technology, biotechnology and chemistry. Take the example of graphene,

the thinnest material ever created, which was pioneered at the uK’s university of manchester less than 10 years ago. The opportunities graphene offers in the iT, energy and medicine sectors have meant that thousands of patent applications have been registered for its use worldwide.

But patents — which are effectively the right to prevent others offering particular products or services — are a less effective means of protecting intellectual property with the current information technology available. There is also a question about the effectiveness of nationally based legal protection for businesses operating globally, which are looking to protect their products and services around the world.

ReportingINfOrmaTION: paTENTS



tRollS and tRadERSWhy china is pushing so fast to acquire patents is plain to see. There are huge financial rewards from taking out the right patents at the right time. as portfolio analysis and optimization tools continue to evolve, patent owners are becoming better equipped to make more informed and strategic commercial decisions about how they can maximize revenue from a sale or license of patents.

But these are not the only ways to generate revenue from owning patents. The activities of “patent trolls” — entities that own patents, not for innovative purposes, but to generate revenues from undertaking litigation against companies that have infringed those patents — are a fast-growing phenomenon. some argue that the actions of patent trolls close the gap between large and small developers, while others say they are the enemy of innovation. such is the perceived threat that, in 2008, a group of 11 high-tech companies (including ericsson, hewlett-Packard and Google) formed the allied security Trust, with the goal of identifying and obtaining key patents before they can fall into the hands of patent trolls.

One relatively new idea, which sheds light on the value of patents, is trading intellectual property through financial exchanges, such as IPXI, that let companies buy, sell and hedge patent rights, just like any other asset. The idea is to offer a patent or group of patents as “unit license rights” (uLrs),

EntER thE dRaGonJust how global the rise in patents is becoming can be seen in the rapid increase in patent applications by Chinese companies, reflecting China’s rapid growth as an economic superpower. figures released by the World intellectual Property Organization (WiPO) in December 2012 reveal that china has moved ahead of the us in the number of patents registered in its own market. China’s patent office had received more applications than any other country’s since 2011, three-quarters of them lodged by chinese companies. Looking at patents related to graphene alone, china has taken out 2,204 applications, compared with 1,754 from the us, 1,160 from south Korea and 54 from the uK.

Jay Pil choi, scientia Professor in the school of economics within the australian school of Business at the university of New south Wales, says the patent statistics reflect China’s ambitions in high-tech industries. “china aspires to reposition itself from a country of comparative advantage with low-tech, low-cost manufacturing,” he says, adding that it is almost certain that this trend will continue.

“The IIRC saysintellectual property issues are becoming increasingly important for investors in all types

of company”




which can be bought and sold like shares. “it’s a legitimate way to ensure return on investment,” says Nigel Jones, leader of healthcare at international law firm Linklaters. Founding members of IPXI include ford and Philips electronics, along with academic institutions in the us such as Northwestern university and the university of utah.

There is also an increasing trend around the world for organizations to build vast patent portfolios. aside from revenue generation, they can be used for defensive purposes. This is a particular feature of the pharmaceutical industry, where r&D investment is dependent on the ability to protect the outcome as patents.

Large electronics companies, including makers of semiconductors and circuits, are particularly keen to amass huge patent portfolios in order to protect themselves from patent suits, according to George chondrakis, a research fellow in management studies at the saïd Business school at the university of Oxford in the uK.

“This phenomenon has been often called the ‘patent races’,” he says. “in such areas, corporates do not really use the patents as monopoly instruments, but rather as bargaining chips; two firms know they both infringe each other’s technology, so they generate balancing payments based on the relative strength of their patent portfolios.”

MEaSURinG ValUEBut while companies with large patent portfolios have them regularly reviewed by experts, ultimately, the only real value is what another party is prepared to pay for them in a sale process. The best buyer is one in need, such as a start-up with few patents, which has to acquire a portfolio at short notice in order to stand up to litigation, or the threat of it.

The jurisdiction in which a patent is filed also has a huge bearing on its value, as the size of fines for patent infringement (which act as a deterrent to piracy) can vary widely. mathias Loqvist, a Partner and European Patent Attorney at Swedish firm awapatent, says that, despite the rise of china, the us will retain its strong position in the foreseeable future due to its litigation system, with potentially very high damages for patent infringement. “at present, the component bringing most value to a patent is whether it is granted in the us,” he says.

The benefits of a patent portfolio are not easy to quantify in financial statements, so how can a company be transparent about the value they may have created, but have yet to realize in revenues, and when that may occur? Treating patents for accounting purposes as intangible assets, based on historic costs, may not reflect commercial value.

Discussing the valuation of pharmaceutical patents in a speech in June 2012, international accounting standards Board chairman hans hoogervorst said: “intangible assets go unrecorded (or under-recorded) on the balance sheet. under strict conditions, ias 38 Intangible Assets allows for limited capitalization of development expenditures, but we know the standard is rudimentary because it is based on historical cost, which may not reflect the true value of the intangible asset.

“The fact is that it is simply very difficult to identify or measure intangible assets. high market-to-book ratios may provide indications of their existence and value. however, after the excesses of the dot.com bubble, there is understandable reluctance to record them on the balance sheet. although our accounting standards do not permit the recognition of internally generated goodwill, our standards do require companies to record the premium they pay in a business acquisition as goodwill.”

2,204The number of patent applications relating to graphene that have been lodged by Chinese companies




In industries where patents are significant, details of value are often found in the narrative report or management report, expressed in terms of investment in development, protection and direct and indirect revenue.

The WIPO has identified five factors that can determine the value of a patent:1. importance: breakthrough patents — those which

explore new areas of technology or are the first to find answers to longstanding problems — are the most valuable.

2. market size: the number of articles that are likely to be made and the cost of each article.

3. Term: how much of its maximum life of 20 years the patent has to run.

4. The amount of prior art: according to WiPO, prior art is “scientific and technical information that exists prior to the effective date of a patent application,” and includes items in the public domain such as technical publications, conference papers, marketing brochures, products, devices, processes and materials.

5. Significance: the product’s importance in a particular area.

tEllinG thE FUll StoRYBut it is in the push toward integrated reporting that economic value for intellectual property is more likely to be established. in its mission statement,

“How can acompany be transparent about the value they may have created, but have yet to realize

in revenues?”

the international integrated reporting council (iirc) says that intellectual property is one of the key factors that determine the value of an organization.

“an integrated report should tell the entire story of a business’s value creation,” says Juliet markham of the iirc. “intellectual property such as patents, copyrights, and software rights and licenses, are part of the intellectual capital, and therefore could be deemed material to an organization’s story of value creation.”

The iirc, which is due to publish an integrated reporting framework in December 2013 (following a consultation period that will run from april to July), says intellectual property issues are becoming increasingly important for investors in all types of company. “investors are calling for all businesses to report on topics that are material to value creation, and thus, omitting information on intellectual property would be detrimental to telling the true story of the business,” says markham.

The use of patents to protect a company’s intellectual property may have varying degrees of effectiveness around the world. But, as more consistent legal frameworks develop, and greater scope for harnessing the value of patents becomes available, there is likely to be an even greater surge from organizations the world over to develop patent portfolios and include an assessment of their value in performance reporting.




Com

ment

over the last few years, people across the world have begun to highlight corruption as the biggest social challenge of our time. The notion that ordinary citizens didn’t really care about corruption has been thoroughly dispelled. But we have not yet seen governments or businesses translating this incredible momentum for more openness and transparency into firm action.

This is particularly acute when we look at the world’s emerging growth markets. it is estimated that the Brics (Brazil, russia, india and china) have contributed up to 50% of global economic growth over the last decade. These fast-growing economies are increasingly attractive for businesses looking for new markets.

Cobus de Swardt of Transparency international explains why rapid growth in emerging markets brings with it a responsibility to tackle corruption

Growingpains

PRoFilEcobus de swardt is managing Director of Transparency international (Ti), the global civil society organization leading the fight against corruption, which has recently published its

Corruption Perceptions Index 2012. Through more than 100 chapters worldwide and an international secretariat in Berlin, it raises awareness of the damaging effects of corruption and works with partners in government, business and civil society to develop and implement effective ways to tackle it.

ReportingCOmmENT: COBuS dE SwardT

http://www.transparency.org/cpi2012/results



Transparency international’s (Ti’s) Corruption Perceptions Index 2012 contains a clear message for governments trying to control such high-growth economies: with growth comes an even greater responsibility to battle corruption.

in fact, some of the world’s fastest-growing economies — specifically, Brazil, Russia, China and india — are woeful underperformers in Ti’s annual corruption perceptions list. Our ranking of 176 countries shows Brazil ranked 69th, china 80th, india 94th and russia 133rd. furthermore, each of these countries had at least one massive corruption scandal in 2012, and all are planning major investments that are big corruption risks, covering construction, energy and infrastructure projects. russia and Brazil, for example, are both preparing to host the Olympic Games.

unless persistent corruption is addressed, it will continue to present high risks for foreign investors and for emerging economies, which could see their growth stunted by failure to confront problems such as bribery.

The lack of progress in the Bric countries is definitely a cause for concern. However, if we look at the enforcement of foreign bribery legislation in many of the established G20 economies, they have also performed very poorly over the last few years. This is emphatically not just a problem for emerging markets.

however, the Brics have very fast-growing economies, and where there is fast growth, if corruption isn’t controlled, it also spreads much faster. Take Brazil, for example. its rapid growth has been accompanied by many corruption scandals, and several ministers have lost their jobs. fast growth often brings greater opportunity for corruption — if you don’t have anti-corruption systems in place beforehand. similarly, good anti-corruption systems can help to drive sustainable growth.

The Bric economies realize the consequences of failing to act. They are now fully aware that economic growth will be hampered by failing to tackle corruption. for that reason, in 2011, we saw china criminalizing foreign bribery to the standards set out by the Organisation for economic co-operation and Development, because the Government realizes that, without this, its long-term economic growth will be threatened. The General secretary of the chinese Communist Party, Xi Jinping, has warned senior leaders to be vigilant about the spread of corruption.

These issues need to be tackled globally, as businesses from the world’s large industrialized countries are also failing to do enough to report on a country-by-country basis what they pay for concessions to the government. unfortunately, the new players from the emerging markets are now doing the same. Openness on taxes paid is still, by and large, well below what it should be.

avenues do exist to improve behavior, and the G20 process — bringing big business and governments together in the major economies — creates a channel to tackle the problem. The good news is that we’re not in the position we were in 15 years ago, when we didn’t have an international legal framework. We now have that, in the form of the united Nations convention against corruption.

The world has changed a lot. The challenge now is to bring about rigorous enforcement and monitoring, the critical tools in the fight against corruption.

We must not go back to a situation where governments or businesses seek to hide secret deals and off-budget payments. Over the coming decade, we will be living in a world where there will be much greater access to information and public accountability, whether governments and businesses like it or not. That is what people will demand, and the quicker businesses and governments adapt to this demand for public accountability, the better.

“Where there isfast growth, if corruption isn’t controlled, it also spreads

much faster”


http://www.transparency.org.uk/



as a leading supporter of Transparency International’s corruption measurement tools, including its Corruption Perceptions Index, Ernst & Young has a keen appreciation for how TI’s research is used by companies as they develop their approach to managing bribery and corruption risk. Our own research, including our 2012 Global Fraud Survey, confirms that international firms continue to intensify their efforts to manage these risks as they seek additional revenues in rapid-growth markets.

With a number of countries adopting new anti-corruption legislation in recent years, and international cooperation increasing among enforcement agencies, the conduct of companies operating in rapid-growth markets is under unprecedented scrutiny. Enforcement by the uS department of Justice and Securities and Exchange Commission remains robust. Germany remains the most active enforcer

in Europe, though uK enforcement may be on an upswing under new Serious fraud Office director david Green. The uS and uK authorities have both issued practical guidance with respect to how companies should expect the anti-corruption laws to be enforced, and the uK is poised to adopt a deferred prosecution agreement model that could be similar to that used in the uS to resolve enforcement actions.

while TI highlights the substantial work that is left to do by some governments, it is important to note that there is cause for cautious optimism in many countries. although new anti-corruption laws have not always been accompanied by strong enforcement, grass-roots political pressure for better governance, combined with competition among countries for foreign direct investment,

can provide powerful incentives for governments to improve transparency and strengthen their commitment to the rule of law.

For companies doing business in these jurisdictions, it is important for senior management to have a nuanced appreciation for both the local commercial culture and the applicable regulations, whether local, national or international. Rigorous risk assessments must be conducted and refreshed regularly. with anti-corruption policies and procedures tailored to the specific business and geography, supported by appropriately resourced compliance and internal audit functions, companies should be confident that there is a place for integrity in their effort to grow beyond.

To read Ernst & Young’s 2012 Global Fraud Survey, Growing Beyond: a place for integrity, go to ey.com/globalfraudsurvey2012

Viewpoint

managing corruption riskdavid Stulb, Global leader, Fraud investigations & dispute Services, Ernst & Young

“ Rigorous risk assessments must be conducted and refreshed regularly”


http://ey.com/globalfraudsurvey2012



a rECENT ErNST & YOuNG SurvEY SuGGESTS ThaT INTErNal audIT fuNCTIONS NEEd TO aCT NOw TO drIvE BuSINESS ImpaCT — Or rISK BEING lEfT BEhINd

The poll

in 2012, ernst & Young commissioned forbes insights to conduct a global survey about the evolving role of internal audit. in the survey, 75% of respondents believe strong risk management has a positive impact on their long-term earnings performance. and yet, 80% of respondents acknowledge that their internal audit function has room for improvement.

What sort of impact has strong organizational risk management had on your long-term earnings performance?

how pressing is your need to improve your internal audit function?

3% 2%

33%

42%

10%

10%

somewhat positivestrongly negative

strongly positivesomewhat negative

No impact at allDon’t know

We need to make improvements within the next 12–24 monthsDon’t know

We need to make improvements within the next 12 monthsWe do not need to make improvements at this time

We need to make improvements, but not within the next 24 months

1%

28%17%

12%

42%

Reporting INSIGhT: ThE pOll



Conducting real-time risk assessmentsimproving the risk assessment process is the number one priority of chief audit executives and stakeholders alike. Identifying risks that are truly significant to the business is the first step to effective risk management and monitoring.

Today’s internal audit functions are focused on enterprise-wide risk coverage, leadership engagement and direct linkage to strategy to increase the relevance of the risk assessment. in addition, most leading organizations are incorporating a quantitative component. Data-driven analytics can produce more focused stakeholder discussions, help to frame facilitated workshops and drive the scope of internal audit reviews.

Which of the following do you consider to be the key elements of the internal audit risk assessment process? Select your top three

for a copy of the full report, please email [email protected].

47%

40%

45%

34%

28%

19%

14%

enterprise-wide coverage

active participation bybusiness unit management

Linkage to company strategyand key initiatives

active participation byexecutive management

input from other riskmanagement functions

active participationby external audit

50%40%30%20%10%0%

formal facilitated workshops tovalidate and prioritize key risks

Reporting INSIGhT: ThE pOll

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Cloudcontrol

The recent prevalence of cloud computing has given many multinationals a boost, enabling significant cost savings and opening new revenue streams,

but the implications for taxation (especially in the cross-border context) are complex and uncertain. This background poses a challenge for companies,

tax planners and regulators alike. Vince Heaney examines the key issues

it can take time for laws to catch up with new business models, and cloud computing is a classic example of this. cloud computing is an approach to shared infrastructure in which large pools of iT systems — which may include servers and other equipment located in multiple countries — are linked to provide various iT services and content. as far as the user is concerned, all that matters is that the resources they wish to purchase or access are available over the internet or through another form of network-enabled technology.

The benefits of cloud computing are clear. using software and services in the cloud effectively abolishes the need for a business to have its own

iT infrastructure, and the number of companies recognizing the potential for cost savings and the ability to avoid expensive upfront investment is growing. according to Fighting to close the gap: Ernst & Young’s 2012 Global Information Security Survey, 59% of organizations currently use or plan to use cloud computing services, up from 44% in 2011 and just 30% in 2010.

many companies, however, appear to overlook the accompanying tax implications, especially when operating in a global or multijurisdictional environment. Because, while cloud computing is often borderless, tax regulations and compliance requirements are not.

ReportingINfOrmaTION: ClOud COmpuTING

http://www.ey.com/Publication/vwLUAssets/Fighting_to_close_the_gap:_2012_Global_Information_Security_Survey/$FILE/2012_Global_Information_Security_Survey___Fighting_to_close_the_gap.pdf





“a key issue for tax purposes is whether cloud arrangements create a taxable presence, and therefore a liability to pay direct or indirect taxes based upon where the company’s people are, where the content resides and where the assets are located,” explains channing flynn, ernst & Young’s Global Tax Technology sector Leader. “additional issues of concern include the withholding tax implications and the myriad indirect tax applications to cloud arrangements.”

cloud services are often provided by interrelated data centers in different locations, which means that both the cloud service provider (csP) and the cloud user may be subject to tax regulations in all the countries through which the cloud network passes the user’s information. The rules governing what constitutes a taxable presence differ across jurisdictions. in some countries, the mere presence of a computer server is likely to be enough to trigger a tax liability, but many follow guidelines set out by the Organisation for economic co-operation and Development (OecD), which set out additional factors that determine whether a company may be liable to pay tax in a particular jurisdiction.

tYPES oF REVEnUETo compound the issues, cloud computing covers a range of services and offerings, and the way in which the revenue is credited has significant implications for tax liability.

“Companies need to blend their commercial and legal view of their business with their

tax view”Channing Flynn, Ernst & Young

INfOrmaTION: ClOud COmpuTING

from the perspective of a csP, there are two broad types of service. The first involves providing content in a cloud-enabled environment; for example, allowing customers to download films, music or periodicals. The second involves providing services — typically, computing software, infrastructure or platforms.

The way in which revenue is characterized is a key factor in determining tax liability. if a customer accesses content in one country but the csP is in another, when payment is made, does that

constitute a license, rent, a royalty or a purchase of a service? in Japan, for example, if a user pays for content through the cloud, the payment could be characterized as a royalty, which creates a withholding tax liability.

“in Japan, individual consumers frequently do not withhold tax on certain transactions made abroad, while corporate consumers are required to do so under otherwise equally applicable law,” says flynn. “But from a company’s perspective, there is the uncertainty that the government may try to collect all the tax their customers should have withheld.”

Liability for indirect taxes such as vaT and GsT is even more complex. a core issue is to determine at what point in the value chain the indirect tax should be applied. many countries have “place of supply” rules that govern the incidence of indirect tax. under these rules, for business-to-business services, the buyer’s jurisdiction applies, while for business-to-consumer services it is the supplier’s jurisdiction that is important.

Reporting



however, a csP may provide a service from a number of different locations simultaneously, and a multinational buyer might be accessing that service from several offices in different countries. Determining place of supply becomes extremely difficult, and the buyer could be liable for taxes in multiple jurisdictions, depending on where the service was consumed and the tax regulations that apply in each of those jurisdictions.

Transfer pricing is another important consideration in establishing where in the supply chain value resides, and hence how each jurisdiction’s profits are determined. Once again, many countries follow

OecD guidelines, although these are not binding and regulations vary across jurisdictions.

StRUGGlinG to kEEP PaCEcloud computing business models are evolving more rapidly than tax authorities can formulate guidance, leaving companies facing considerable uncertainty.

“many of the core principles underlying the tax system are out of date,” acknowledges John Whiting, Tax Policy Director at the chartered institute of Taxation in the uK. “The tax authorities are beginning to realize that the challenge is how

key questions… for the CFo and company boards to consider:• Are tax considerations such as global

withholding tax on cross-border payments, indirect taxation, and the creation of a taxable nexus, factored into your IT department’s business decision about cloud computing?

• Have you adequately considered taxable presence and the related compliance issues in the selection of your CSP, and are they clearly documented in your agreement? are the filing and tax responsibilities clearly identified among the parties?

• How will you monitor ongoing tax risk and ensure the necessary information on cross-border transactions is recorded for tax reporting?

• How will the relationship with your CSP adapt to changing tax statutory and regulatory requirements?

… for cloud service providers:• Is your tax strategy aligned with your

business model and flexible enough to change as required?

• Where do you have a taxable presence?• what are the revenue characterization and

sourcing rules for each jurisdiction in which you operate?

• Are you aware of all potential domestic and global incentives to supplement CSP expansion plans?

• What level of independent assurance are you willing to offer your customers?

to adapt systems that were designed to deal with physically delivered goods and services to a new era where goods and services can be rerouted at the touch of a button.”

in the meantime, the experts agree that too few companies take the cloud’s tax implications into account before embarking on a cloud-based iT strategy. “The extent to which companies take the tax considerations of a shift to cloud computing into account may partly reflect their awareness of the importance of gaining specialist tax advice on strategic decisions,” says Dr. Paul Booth, Technical and Development manager at the iT faculty of the


Reporting



institute of chartered accountants in england and Wales. “While it is a generalization, company size may play a part; larger businesses often have better access to good tax advice than small companies, which may be tempted to view the cloud simply as the latest technology that could save them money.”

flynn agrees that start-up and mid-market cloud providers, as well as cloud users, may have insufficient management resources available to deal with the tax issues raised by the cloud. however, he notes that the larger, well-established csPs do generally have the necessary infrastructure and knowledge.

Given the complexity of the issues, corporate tax managers should be more involved in the decision to switch to new technology like the cloud. “my message to cfOs and boards is to be very clear about how you define your business commercially,” says flynn, who believes companies need to think carefully about the type of services they are providing, and from where. “The opacity of this area means that companies need to blend their commercial and legal view of their business with their tax view.”

59%of organizations currently use or plan to use cloud computing services — up from 44% in 2011 and 30% in 2010


While the cloud represents an opportunity for users to achieve considerable cost savings, indirect and direct taxation has the potential to erode those gains. meanwhile, from a provider’s viewpoint, many cloud services are not high-margin products, making tax a potentially significant financial factor.

“Tax implications should not be paramount in deciding whether to implement a cloud iT strategy,” concludes alex Postma, ernst & Young’s international Tax services Leader, “but they should be highly prominent in how to execute that strategy.”

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Water lies at the heart of the global economy. The majority of the raw materials that businesses depend on require water for one reason or another. however, a gap already exists between supply and demand. The uN estimates that two-thirds of the world will face water “stress” situations by 2025. We are already experiencing the effects of water scarcity; only last year, the us suffered its worst drought in 50 years, and it sent commodity prices skyrocketing.

aside from the effects of global warming, increased exploitation of water resources across the world has led to significant degradation of ecosystems. a report entitled Assessing Water Risk, published in 2011 by WWf Germany and KfW Bankengruppe (a German Government-owned development bank), says: “as well as being an issue

for environmentalists, over-exploitation of water has economic risk implications for businesses. Their needs for water and the ways in which they use, dispose and operate their facilities will be increasingly under the spotlight and open to the scrutiny of society, communities, governments, media and, increasingly, investors.”

Running dryAs demand for water begins to outpace supply, water risk is becoming a greater challenge for global companies. In the second of our series on systemic risks, Lawrie Holmes examines the issues and looks at how businesses are tackling them

The aral sea, which lay between Kazakhstan and uzbekistan, was formerly the fourth largest lake in the world. it has been shrinking since the 1960s, and by 2007 it had declined to just 10% of its original size

INSIGhT: SYSTEmIC rISK

“More than a quarter of the profits of the world’s biggest companies would be wiped out if

water was priced to reflect its availability”Richard Mattison, trucost

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http://awsassets.panda.org/downloads/deg_wwf_water_risk_final.pdf

http://awsassets.panda.org/downloads/deg_wwf_water_risk_final.pdf



dEGREES oF RiSkas a result, businesses, especially those with a high demand for water (such as food and drink companies), are increasingly seeking to define the degree of risk that water shortage creates within a broader risk spectrum. in order to do this, they are looking at how their operations would be affected by short- or long-term water shortages and tracing water inputs, flows and outputs throughout their operations. some are also analyzing water usage and other environmental impacts all along the supply chain, as well as considering the impact of water price increases on their operations. a few are even producing water management plans for each operational center.

A fully fledged water strategy (see panel, opposite, for an example) will often have a number of steps, such as improving water performance, accounting for water management through a framework that considers risk and opportunity, and engaging with other businesses, government agencies, non-governmental organizations and community groups.

coca-cola enterprises is one notable company that has taken steps to address the issue of water risk. “We have strong energy and water management programs in place in all of our manufacturing plants. Over the past few years, we have undertaken source Water vulnerability assessments at our facilities and, working with local communities, have implemented source Water Protection plans for each site,”

SaB Miller’s four-point planin 2009, global beer producer saB miller became the first company in any sector to publish a corporate water footprint. according to head of sustainability andy Wales, its approach to water risk is four-pronged, starting with the supply chain.

“Our procurement business has people who lead the execution of sustainable development through the supply chain,” Wales explains. Taking 2008 as a base, the company is planning to reduce the water used in its breweries per liter of beer by 25% by 2015. “Those targets are driven down to brewery-level targets in every part of the business, and then to the packaging hall, the brewing hall and so on.”

second, employee awareness of water risk was raised as part of a major campaign in 2010 called “Ten Priorities. One future.”

The company then created an independently verified sustainability assessment matrix of 10 priorities. “On water usage, it’s broken down

into: what is your water efficiency? What is your waste water level? What are you doing to understand water risk in the supply chain through water footprinting? What kind of partnerships have you built to protect your water risk, and to work with communities on water? so you get a weighted score for your water performance,” says Wales, adding that two of the nine KPis in saB miller’s annual report are water-and carbon-related.

“it’s an effective internal benchmarking system, because our companies compare themselves to each other,” he continues. “if you have a responsibility in that part of the business and you don’t hit your goal, it’s likely you won’t get part of your bonus.”

finally, regional and corporate accountability committees review performance on water-related issues. “it rolls up every six months to a board committee who look at the elevated issues that come out of that,” Wales explains.


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“mapping such risks can be challenging for a diversified investor,” says Bunny Nooryani, a spokesperson for NBim, “but it is fundamental in ensuring the long-term security and success of our investments.” consequently, NBim expects companies to report on how they manage water-related risks. This includes disclosing metrics that show their exposure to water-related risks and opportunities, and that measure the performance of their water management strategies. “This type of information is important for investors,” explains Nooryani.

An integrated report may be able to fill this information gap by giving stakeholders, including investors, transparency about non-financial information and actions a company has taken that create value. Better management of water usage, for example, can provide future financial value for a business, as reducing its use can have a cost benefit and can minimize the risk of future price rises. such action will also create an externality for that business in reducing its demand on the global water supply.

in its 2011 report on water risk, NBim assessed 447 companies in a number of industries: mining and industrial metals; electricity and multi-utilities; water utilities; pharmaceutical; food and beverage; and forestry and paper. it found that 58% reported on water-related risks in their operations, while 53% of the businesses implemented action plans to manage these risks — both figures up one percentage point on the previous year. But less than a fifth of the companies reported on water management in the supply chain.

14.6%The amount by which Coca-Cola Enterprises has reduced its water use ratio in its facilities in Great Britain and France in the past six years

US$30bThe amount that Saudi arabia has spent on desalination plants — some of the largest in the world

says John Brock, chairman and ceO, coca-cola enterprises. “using metering technologies, a monitoring and targeting system, and the commitment of our employees, we have been able to reduce our water use ratio — the amount of water we use to make one liter of product — by 14.6% since 2007. as a result, our facilities in Great Britain and France are some of the most water-efficient coca-cola production plants in the world.”

multinational mining corporation rio Tinto has also developed a number of programs to help reduce water usage, including a target of a 6% reduction in freshwater used per tonne of product between 2008 and 2013. it also sets a water standard that prescribes the minimum expectations for each operation when managing water, and delivers a water risk review that helps an operation to assess risks and opportunities.

UndER PRESSUREJust how far companies will go to address these issues may depend on the amount of pressure they come under from organizations such as the Norges Bank investment fund (NBim), which manages the Norwegian Pension fund — Global. The fund assesses the water risk of companies in its portfolio, many of which rely on water as an input or output factor in their operations and supply chains.


a desalination plant in Dubai, uae

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Spain’s water crisisspain, the most arid country in the european union (eu), faces serious challenges in water resources management. it has one of the largest water footprints in the world — about 2,000m³/capita/year, according to the Water footprint Network. When there are problems with supply, the results can be calamitous; in 2008, the country’s second city, Barcelona, had to import water by ship to combat a drought.

spain’s demand for water, measured in liters per inhabitant per day, is well above nearby countries such as Portugal and france, as well as all large eu members except romania, says milo Jones, visiting Professor at the ie Business school in madrid. That’s because of the agricultural industry’s heavy use of irrigation, which accounts for about 80% of the country’s water consumption. Jones says the natural solution to water scarcity in spain would be more efficient pricing of it as an asset, but adds that raising the price of water would have an adverse effect on the competitiveness of spanish fruit and vegetables in the export market.

The european commission has warned the spanish Government that it could withdraw funding invested in desalination plants, as they have been underused. This is because the water used by

irrigators is highly subsidized, and as such, the commission says madrid is failing to implement eu Water framework Directive requirements that call for environmental costs to be reflected in the price of water.

Because spain has a powerful horticultural lobby, it is almost impossible to achieve sound water and agricultural policies without their collaboration, according to ramón Llamas, Director of the fmB Water Observatory at complutense university in madrid. “it is necessary to look for win-win solutions,” he writes in the book Water, agriculture and the environment in spain: can We square the circle?, published in 2012. “farmers have to increase their economic productivity, and also ensure that farming practices become less polluting and compatible with natural ecosystems. The former can be achieved with relative ease, thanks to continuing advances in agricultural technology. achieving the second objective does not seem so easy.”

Jones adds: “in southern spain, some agricultural firms are using technologies like sealed greenhouses. Overall, however, most water-saving measures are capital-intensive, and capital is in quite short supply in spain these days.”

it’s this area that NBim wants to see more companies becoming involved in, and it is pushing for more such reporting. “companies need to evaluate water-related risks in their supply chains, not merely in their own operations,” says Nooryani. “They need to improve reporting on quantitative targets for water consumption and water-related risks, and they need to standardize reporting in this area.” in 2012, NBim teamed up with Dutch pension fund service provider PGGm to hold talks with mining and power companies in china and india. The dialogues aimed to improve the companies’ reporting on and management of water-related risks.

ManaGinG WatER RiSkThere are many things companies can do to manage water risk, according to claudia ringler, Deputy Division Director at the environment and Production Technology Division of the international food Policy research institute (ifPri). “companies can often construct cooling or other facilities using closed cycle mechanisms and water treatment facilities, to reduce both dependence on water resources and the environmental impacts of operations,” she says.

Desalination plants offer access to an alternative source of water in places with an extremely dry climate, such as the Gulf states. harnek shoker, head of meNa energy and infrastructure Projects at law firm Freshfields Bruckhaus Deringer, says Saudi arabia alone has spent more than us$30b over the


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past 80 years on some of the largest desalination plants in the world. however, the process usually leads to the creation of waste, which is dumped into the sea, having a huge environmental impact, says shoker. “Desalination plants are also expensive to build, operate and maintain,” he adds.

thE ValUE oF WatEROne of the biggest reasons given for overuse of water is a false valuation often put on the resource, which is subsidized in most parts of the world — even where it is considered scarce. “more than a quarter of the profits of the world’s biggest companies would be wiped out if water was priced to reflect its availability,” says Dr. Richard Mattison, chief executive of Trucost, an environmental research group.

This concern is amplified in places where demand for water is at its highest and availability is low. for example, the “Dry 11” of the 31 regions of mainland china create 52% of the country’s industrial output and 40% of its agricultural products, according to Trucost.

as a result, some companies are exploring the value of water beyond the purchase or procurement price, in recognition that water may at some point be less readily available. a realistic option might be

to change the way it is priced. “in so-called mature water economies, where the scarcity value of water has increased, governments impose demand-side management instruments, such as water prices,” says ifPri’s ringler. “markets in tradable water rights have been seen in australia, california and chile, but they remain rare.”

as more countries adopt similar models, costs are only going to increase — which presents another risk for businesses that rely on water. however, tools such as an integrated report could mitigate these risks and help create value for a company by forcing them to consider the future implications of water shortages and factor them into decision-making immediately. That’s one more reason for companies to take water risks very seriously indeed.

To read the ernst & Young report Preparing for water scarcity, go to ey.com/waterscarcity

“Companies need to evaluate water-related risks in their

supply chains”Bunny nooryani, nBiM

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http://www.ey.com/Publication/vwLUAssets/Preparing_for_water_scarcity_-_Business_awareness_on_water_issues/%24FILE/Preparing_for_water_scarcity.pdf



From the deserts of Libya to the oil wells of iraq via the skyscrapers of Dubai, the middle east is a vast and diverse region. in economic terms, many still think of it solely in terms of oil, and it’s true that six middle eastern countries control 44% of the world’s crude oil supplies. But other sectors are growing fast as well, and the region now accounts for 10% of emerging market GDP, despite having only 6.7% of the population.

Despite the events of the arab spring, in 2011, the number of foreign direct investment (fDi) projects in the middle east rose by 7.8% on 2010, and their value by 2.2%. clearly, there is still confidence in the region’s attractiveness as an investment destination. a recent report (Shifting perspectives: Ernst & Young’s 2012 attractiveness survey — Middle East) reveals that business leaders are also optimistic: three-quarters of respondents to the survey believe the attractiveness of the middle east will continue to improve.

The region has many of the qualities companies look for in an fDi destination: solid fundamentals, strong demographics and government willingness to improve the already concrete growth prospects. The region has a large population, which is also one of the youngest and wealthiest in the world. vast natural resources and increasing oil prices have created substantial budget surpluses among oil exporters, which have helped governments to increase their spending on infrastructure projects and drive their diversification efforts.

as a result, the image of the middle east has changed; its economy can now offer growth in many other sectors as well as oil.

Shifting perspectivesDespite political turmoil, the Middle East remains an attractive destination for foreign investors, as a recent report reveals

mist in Dubai, October 2012. for a few days every year, the temperature begins to drop overnight and the humidity that has built up over the previous day meets cooler air, forming a rolling fog that envelops the city.

INfOrmaTION: ThE mIddlE EaST

10%The middle East’s share of emerging market Gdp

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http://www.ey.com/Publication/vwLUAssets/Shifting_perspectives_Middle_East_2012/$FILE/Shifting_perspectives_Middle_East_2012.pdf





Overall, investors remain positive about the middle east, but still see some areas for improvement. respondents to the survey highlight a rigid regulatory environment, lack of technological readiness and the limitations in research and innovation capacity as key challenges:• middle eastern countries have a mediocre rank on the level of protection, transparency and disclosure that foreign investors require, while Transparency international’s Corruption Perception Index 2012 gives many middle eastern countries an unfavorable ranking.• The region suffers from limited access to the latest technologies. however, according to the Global Information Technology Report 2012 from the World economic forum (Wef), most of the Gcc countries rank well ahead of other emerging markets on Wef’s index of network readiness.• many countries in the region, including Qatar, saudi arabia and the uae, hold a low rating on the Global Innovation Index 2012.

it is also notable that there are differences in the perceived attractiveness of countries in the middle east for fDi. The relatively stable Gulf cooperation council (Gcc) countries, such as Qatar, saudi arabia and the united arab emirates (uae) remain fDi favorites, while investors are more cautious about non-Gcc nations, such as egypt and Libya.

Middle East fact fileCountries surveyed: Bahrain, egypt, iraq, Jordan, Kuwait, Lebanon, Libya, Oman, Palestine, Qatar, saudi arabia, united arab emiratesPopulation: 177.2 million people as of september 2012Median age: 25 (making it one of the youngest populations in the world)GdP growth rate: 3.5% in 2011Share of global Fdi projects: 6.8%


a WatChFUl attitUdEAlthough investors remain confident about the middle east, they express some hesitation for the short term. The immediate investment plans of many foreign companies appear to be affected, not only by the uncertain outlook globally, but also by the recent political turmoil in some countries.

When asked about the way they plan to invest in the middle east, 30% of the respondents chose “joint venture” or “alliance” as the most likely.

This helps foreign companies gain leverage from the local connections of their partners, and, most importantly, share and mitigate the potential risks in the region. Only 7% are planning acquisitions and just 4% are considering greenfield investments in the middle east.

all in all, these results suggest that business leaders are playing it safe and investing in improving established operations in the region.

To read Shifting perspectives: Ernst & Young’s 2012 attractiveness survey — Middle East, go to ey.com/mas

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http://www3.weforum.org/docs/Global_IT_Report_2012.pdf

http://www.ey.com/GL/en/Issues/Business-environment/2012-Middle-East-attractiveness-survey-FDI-dynamic-and-emerging



There is a diverse array of reporting challenges and opportunities associated with investing in the middle East, which go beyond the media focus on political risk and volatility.

Corporate reporting standards are less developed than in other regions, with a particular issue relating to shareholding structures. most corporate acquisitions in the middle East are not formal buyouts, but involve the purchase of a minority interest.

However, the usual instruments to protect investor returns — different classes of shares and preference shares — are not commonly available. This can make transactions more complicated and may involve setting up structures offshore to the investee countries, even within the region.

There are few additional listing requirements for companies looking to expand into the region;

companies that are listed on a stock exchange in the uS or Europe will not find the requirements in the middle East particularly onerous. Indeed, when it comes to the dubai International financial Centre or Saudi Arabia’s Capital market Authority, the standards are similar to most other capital market authorities. There has been significant progress in the last five years in reforming and upgrading standards, and these are now far advanced on the old listing requirements, which were generally run by each individual country’s stock exchange.

Perhaps the biggest challenge in terms of legal structures is how much equity foreign investors can own; many countries have caps on foreign ownership. But some, such as Saudi Arabia, are considering changes, including allowing direct foreign ownership to large institutional investors.

One obstacle that foreign investors do encounter is that corporate valuations in the middle East are out of sync with much of the rest of the world — a reflection of the massive liquidity that has flooded into the region in the past 10 years. The middle East (with a few exceptions) managed to escape the worse of the 2008 financial crisis, thanks to oil revenues. But this has had the effect of raising asset prices, putting off potential buyers.

The key challenge that companies encounter in the middle East is generally to do with the business culture, rather than onerous rules and regulations. Tax is a clear example of this. In Bahrain and the uaE, there is no corporate tax at all, and taxation rates tend to be low in other countries. However, transparency levels and investor protection rights are more opaque than in other jurisdictions.

Viewpoint

challenges and opportunitiesimran ali, assurance leader, Ernst & Young Middle East and north africa


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in the spotlightRemuneration

Growing shareholder influence is forcing remuneration committees to be more transparent, and to ensure that executive pay drives

long-term sustainable value. James Gavin reports

From the dodd-Frank act to the “shareholder spring,” remuneration risk has been thrust to the top of the corporate governance agenda. Newspaper headlines repeatedly highlight the seemingly vast discrepancies between corporate performance and levels of executive pay.

The wider atmosphere of shareholder dissatisfaction with apparently disproportionate executive salary rises is causing companies to give much more serious thought, not just to how they are compensating senior management, but also to whether the corporate processes that inform such decisions need to change.

The financial crisis brought this situation to a head. regulators around the world are demanding change, and increased transparency in particular, and investors are also signaling that change is needed.

They would like to see pay being more closely linked to performance, and executives being incentivized to drive long-term value creation, rather than taking unnecessary risks to earn personal bonuses and other benefits. This stance was illustrated in the new guidelines that the association of British insurers issued in November 2012, which called for companies to ensure that their remuneration plans are linked to long-term performance, and that they are clear and transparent.

all this means that the workings of the remuneration committee (known in the us as the compensation committee) are coming under more scrutiny than ever before. until recently, executive remuneration had not been high on many investors’ agendas. Now, however, many are contending that remuneration committees haven’t lived up to their responsibilities,

INSIGhT: rEmuNEraTION

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nor have they been properly held to account. in europe, North america and asia, these committees are having to adapt to an environment where shareholders (often via proxy advisory firms) are being expected to be more actively involved as part of the “say on pay” trend (see panel, p29).

according to irv Becker, the us-based National Practice Leader for executive compensation at hay Group, financial firms have traditionally granted their remuneration committees significant discretion in setting pay, but institutional shareholders are now pushing them toward formula-driven approaches. even so, says Becker, “the regulators are saying: ‘We like the discretion, so don’t go too far toward a formula.’”

thE nEEd FoR tRanSPaREnCYas institutional shareholders have become more active with regard to executive reward, companies have come under pressure to communicate their remuneration arrangements in more detail.

“We typically advise remuneration committees to communicate with shareholders regularly, and to be as transparent as possible — particularly before changes to remuneration policies are proposed,” says Giles capon, uK lead for ernst & Young’s uK Performance & reward practice. “early and proactive discussions are crucial. if investors better understand the correlation between the remuneration structure and the business strategy, they will be more


supportive — particularly where the committee demonstrates that the remuneration arrangement supports long-term growth and value creation.

“it’s worth adding, though, that shareholders have limited time, so it is essential to convey the rationale behind the remuneration structure, and its relevance to the company’s strategy, as clearly and simply as possible.”

lonGER-tERM hoRizonSWhile remuneration committees have to respond to shareholder concerns actively, they must also confront a market where target-setting has become much more complicated. setting goals and trying to match them with appropriate compensation can be difficult to get right.

The setting of executive pay is both an art and a science. “most organizations still just use a combination of financial measures, which are likely to include short-term measures such as cash flow and earnings per share,” says Don Lindner, executive compensation Practice Leader for WorldatWork, a non-profit human resources association.

however, too much focus on short-term measures, or, indeed, shareholder return generated over the short term, at the expense of longer-term measures of performance, is unlikely to be in the best interests of shareholders themselves. it is perceived that such a system could be open to abuse; executives might be tempted to cut costs, underinvest or enter into speculative mergers to encourage short-term share price increases in order to earn a better remuneration package, or focus on short-term targets at the expense of the long-term sustainability of the business.

regulators are therefore asking for more long-term horizons for rewards, but setting appropriate and meaningful goals over longer time periods can be particularly challenging in many sectors.

“‘Say on pay’hasn’t actually reduced executive

compensation”don lindner, WorldatWork

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“some industries, such as retail, have had to move to six-month goal-setting,” says Lindner. “During these volatile times, it’s difficult to set goals even just 12 months in advance.”

according to hermann stern, ceO of swiss-based financial research firm Obermatt, which produces executive pay indices, the risk of “black swans” — unpredictable but defining events — makes it a struggle for companies to set long-term targets they can stick to. “This need not be a major problem,” he points out, “if remuneration committees operate within a corporate culture where targets are flexible and where they adapt quickly to new circumstances.”

some prominent companies’ remuneration committees have already opted for longer-term pay horizons. BhP Billiton, the anglo-australian resources giant, has an executive incentive plan that measures performance at the end of a five-year period. It believes that measuring performance over five years better aligns executives’ and shareholders’ interests.

“in addition to setting longer timescales to determine reward, there is a growing expectation that companies establish performance metrics that are tailored to specific strategic business objectives, rather than generic share price or earnings performance,” says andy ryser, a member


of ernst & Young’s us executive compensation Leadership Team. “This trend has been noted in the global companies we deal with, where metrics such as balance of geo-specific revenue and geo-specific

market share are combined with more traditional performance measures.”

inCREaSEd RESPonSiBilitiESfor remuneration committees in general, increased scrutiny on pay has prompted a substantial increase in their workload, with more time devoted to ensuring that their plans appropriately award pay for performance. “We used to have four meetings a year, each lasting an hour and a half,” says Lindner, who, as an executive compensation consultant, serves as a delegate on the compensation committees of both public and private company boards. “Today there are between 8 and 10, and they run for between two hours and half a day.”

These changes transcend borders. Na Boon chong, who manages part of aon hewitt’s human resources consulting business in southeast asia, says that in the more advanced Asian markets the larger firms, which are more attuned to global markets, tend to be more rigorous in setting performance measures and rewards. “These firms’ remuneration committees are meeting eight or nine times a year, similar to their Western counterparts,” he says. “But at the lower end, companies are more insulated from global standards and might only meet once or twice a year.”

“Increased scrutiny on payhas prompted a substantial increase in the remuneration committee’s workload”

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The Dodd-frank act has raised the bar for the compensation committee, says Becker, resulting in its workload moving closer to the audit committee’s. “There’s a bigger time commitment now, and it’s much more technical than it used to be. it’s effectively more geared around the performance of the business.

“That means the quality of the individuals you need on the compensation committee is very different. They need to understand the technical aspects of compensation, which has only grown more complicated in the last few years.”

ultimately, the success of the evolution of remuneration committees will be judged on results. “in the us, we’ve had ‘say on pay,’ either voluntary or mandatory, for four years,” notes Lindner. “it might be helping to establish a better connection between pay and performance for some companies, and it has also opened up dialogue between companies and shareholders. But it hasn’t actually reduced executive compensation.”

Shareholder revolutionIn the uS, the dodd-frank wall Street reform and Consumer Protection Act, signed into law in 2010, requires companies listed in the uS to hold shareholder votes on the compensation of top executives at least every three years. Though these “say on pay” votes are advisory and non-binding, they have nonetheless exerted a decisive impact on the compensation committee.

The more rigorous scrutiny of remuneration committees triggered by “say on pay” has particularly hit the handful of companies where excessive pay packages have contrasted most starkly with corporate underperformance. This is still a tiny minority, though. The International Corporate Governance Network notes that only six companies in the Fortune 500 failed “say on pay” votes in 2011, less than 2% of the total.

The “say on pay” approach will become more critical in the uK with the advent of the binding shareholder vote on proposed executive remuneration policy for fiscal years ending after October 2013.

In Australia, the “two strikes” rule applies. If 25% of shareholders vote against a company’s remuneration report at two consecutive annual general meetings, the entire board may have to stand for re-election within three months.

In the Netherlands, Sweden, Norway and denmark, “say on pay” votes are legally mandated. Switzerland, Germany and Canada allow voluntary adoption of “say on pay,” without making it a legal requirement, although Switzerland is moving toward a compulsory system.


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INSIGhT: ThE CfO’S CarEEr paTh

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CFOand beyond

A recent Ernst & Young report, CFO and beyond1 looks at the growing demand for CFOs to serve as non-executive directors in addition to their job as finance leader. We examine the key findings of the survey and look at how CFOs can maximize their chances of winning a place on the board

CFos are in unprecedented demand for non-executive directorships on corporate boards. among the 800 finance leaders surveyed for Ernst & Young’s recent report, CFO and beyond: the possibilities and pathways outside finance, 79% agree that cfOs are more in demand than ever for board-level roles because of their financial expertise. a similar proportion think that the cfO’s skills and experience make them highly transferable into roles outside finance.

research conducted for CFO and beyond found that, over the past decade, there has been a significant increase in the proportion of board

members from a finance background. For example, in 2002, just 8% of board members at 347 of the world’s largest companies were either serving or former cfOs. a decade later, that share has climbed to 14%. This shift is even more evident on the audit committee. in 2002, just 19% of audit committee chairmen were either serving or former cfOs. But by 2012, the proportion had risen to 41%.

knoWlEdGE and ExPERtiSEThere are three main reasons why finance leaders are becoming more commonplace on corporate boards. The first is the macroeconomic environment.

1 CFO and beyond; the possibilities and pathways outside finance, ernst & Young, 2012

http://www.ey.com/GL/en/Issues/Managing-finance/CFO-and-beyond---Possibilities-and-pathways-outside-finance

http://www.ey.com/Publication/vwLUAssets/CFO_and_beyond_-_The_possibilities_and_pathways_outside_finance_-_2012/$FILE/CFO%20and%20beyond%20-%20The%20possibilities%20and%20pathways%20outside%20finance%20-%202012.pdf

http://www.ey.com/Publication/vwLUAssets/CFO_and_beyond_-_The_possibilities_and_pathways_outside_finance_-_2012/$FILE/CFO%20and%20beyond%20-%20The%20possibilities%20and%20pathways%20outside%20finance%20-%202012.pdf




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With growth trajectories continuing to diverge between developed and rapid-growth markets, financial markets still highly volatile and banks facing acute funding pressures, serving and former cfOs have the knowledge and expertise that companies need to navigate a complex economic context and help them make the right strategic decisions.

a second factor is the changing nature of the finance leadership role. Over the past decade, CFOs have assumed a much broader, more strategic set of responsibilities, and this has significantly increased the contribution that they are able to make to non-executive positions. The core technical and finance skills that once dominated the role are now just one part of the knowledge and experience that finance leaders must possess. as a result, boards and nomination committees increasingly see cfOs as playing a much wider role than only being an expert in financial reporting and finance.

regulatory factors have also had an impact. for example, public companies listed in the us must disclose whether they have at least one “financial expert” independent of management on their audit committees. if they do not have this expertise in place, they have to explain why. in the uK, the corporate Governance code states that the board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience.

in their own wordsSenior executives explain the benefits to a CfO of taking on a non-executive director role:

“You go on boards for three reasons. The intellectual capital, which is what you learn; the social capital, which is who you meet; and the creative capital, which consists of the ideas and concepts that you can find out about and bring back to your own company.”Susan Stautberg, President of PartnerCom Corporation

“A CFO who is established in the role can derive real benefit from lifting their head out of their organization and thinking hard about the issues that face another company.”David Grigson, Chairman of Trinity Mirror and former CFO of Reuters and Emap

“… if you don’t have deep sector expertise, then that gives you permission to ask the more fundamental questions, because you’re not embarrassed if you don’t understand something.”Steve Hare, Head of the Portfolio Support Group, Apax Partners

“By spending time on the board of a very different institution, you gain a much better understanding of how groups work and how decisions get made.”Ritchy Drost, CFO for European Broadband Operations at Liberty Global

“You need to have a destination in mind and be practical about what is required to get there.”Lawrie Tremaine, Executive Vice-President and CFO, Woodside



“CFOs have assumed a much broader, more strategic set

of responsibilities”


Reporting

This hunger for recent and relevant experience means that serving cfOs are in particular demand for non-executive directorships. ernst & Young’s research shows that, between 2002 and 2012, the likelihood that a serving cfO holds a non-executive role alongside their core position has increased significantly. In 2002, 36% of serving CFOs from the largest companies researched held a non-executive position. By 2012, this proportion has increased to 46%.

thE doWnSidEWhile most CFOs recognize the benefits, more than 40% think that it is inappropriate for them to take on part-time roles. for some, the demands of their core responsibilities are too great and the risk of overstretch too significant. For others, the concern of exposure to personal liability, if it can be demonstrated that they have neglected their executive duties, is a deterrent.

as corporate governance legislation becomes more stringent, the time required to be an effective non-executive director is increasing. Despite cfOs’ appetite to take on non-executive roles, there is a growing mismatch between the amount of time they feel able to dedicate to such a role and the recommendation by corporate governance best practice. more than half of cfO respondents estimate that they can only spare five hours or less per week for a supplementary role, and yet

the recommendations from the uK Walker report (between 30 and 36 days a year) suggest that is the minimum time required.

thE othER SidE oF thE taBlEDespite these factors, leading cfOs interviewed for the study talked about using the experience of an additional board role to enhance their performance as a cfO. understanding board dynamics from the other side is the principal benefit, according to 75% of those surveyed. most cfOs spend a lot of time engaging with their own board members, but only by sitting on the other side of the table can they fully understand how the boardroom works.

A second key benefit, cited by over half the CFOs, is the opportunity to gain exposure to another company or industry. experience in a different sector is seen by many cfOs as particularly valuable, with the opportunity to gain new knowledge and transfer best practice across industries. There can also be a “halo effect” for those cfOs serving on the boards of large, well-respected companies, whereby the organization in which the cfO serves in their executive role also benefits.

Plan ahEadWhile cfOs may be in demand for non-executive positions, it doesn’t mean that they will find it easy to secure a seat at the top table. competition for



the best roles is extremely high, and boards are becoming much more rigorous in the way that they source, interview and select potential candidates.

Being successful will depend on planning ahead. Among the CFO respondents, those who identified themselves as long-term career planners were significantly more likely to have taken on additional roles than those with only a short-term plan, or no plan at all.

cfOs are also taking on board positions at a younger age than they were a decade ago. The increase in those cfOs from the companies studied who have taken on non-executive directorships is most marked among the younger generation — those aged between 40 and 49.

41%of audit committee chairmen in 2012 are serving or former CFOs, compared with 19% in 2002


although every non-executive director role has unique requirements, the ernst & Young research suggests that there are eight key ways for cfOs to maximize their attractiveness for a place on the board:

1. Develop a coherent cv2. Take on roles outside finance — and

even business3. Build networks4. Develop a personal profile5. Gain international experience6. Build relationships across the business7. Don’t get stuck at headquarters — work in a

business unit or division8. start planning early

To access a copy of CFO and beyond, go to www.ey.com/cfoandbeyond

46%of CFOs surveyed in 2012 hold a non-executive position — up from 36% in 2002

Reporting

http://www.ey.com/cfoandbeyond



The buy side

Big opportunities for small firms

kRiStEl kiVinURM-PRiiSalM, Co-FoUndER oF EStonia-BaSEd inVEStMEnt BoUtiqUE aVaRon, ExPlainS that loCal knoWlEdGE and in-dEPth RESEaRCh aRE ESSEntial in EaStERn EURoPE, WhERE StandaRdS oF CoRPoRatE GoVERnanCE and ManaGEMEnt aRE Still hiGhlY VaRiaBlE

PRoFilEKristel Kivinurm-Priisalm has 15 years’ experience of investing in central and eastern europe. in 2007, she and her business partners launched avaron, an independent asset management company with a unique focus on “emerging europe”

value investments. she started her career as an equity analyst in corporate finance; before establishing avaron, she built up and headed an asset management unit in a regional investment bank. she has been elected a supervisory board member of estonia’s Guarantee fund and its service industry association and is a former chairwoman of the association of estonia’s fund management companies.

INSIGhT: ThE BuY SIdE

Reporting

at avaron, we employ a bottom-up, value-driven investment philosophy. This means that, as well as financial modeling, a key stage in our investment process is the qualitative assessment of the business model. having a thorough understanding of the business model is important, as it enables us to react and adjust our views in a timely manner during periods of macroeconomic volatility.

another crucial aspect is the quality of the management. There are a number of listed companies in the region that, in our view, lack transparency and basic management skills. a common feature among

a region of contrasts: Old Town Square in prague




Reporting

small — and mid-cap companies in eastern europe is the lack of global sector and technological know-how. To be a successful manager in a rapidly globalizing world, you need to think in global terms, even if you are running a small regional company.

information for this kind of qualitative analysis can only be acquired by putting a lot of hours into meetings with management. There is no other way, at least when operating in eastern europe, and especially among small — and mid-cap companies. The quarterly public disclosure of managerial information is often very sparse, and certainly not sufficient to build a thorough understanding of the business model.

REd FlaGSin companies we are considering, transparency, a balanced board structure and fair treatment of minority owners are important to us. There are a number of companies listed in eastern europe that are majority-owned by local businessmen and have a conflict of interest built into their management structure. in many cases, only the majority owner’s interests are represented on the board, and this can, at worst, result in mistreatment of minority shareholders, stock price manipulation and outright appropriation of assets by the majority owner. The latter is usually carried out via distribution or purchase contracts with unlisted companies that are 100% owned by the majority owner of the listed entity.

“The most common non-financial reasons for rejecting an investment

relate to issues of governance”

ESG iSSUESThe most common non-financial reasons for rejecting an investment relate to those issues of governance, as well as broader environmental, social and governance (esG) issues — unfair treatment of shareholders, for instance, or transfer pricing. esG concerns have long been neglected among eastern european public companies, but we’d like to think that things have started to change over the past three to five years.

On the plus side, the ongoing adoption of ifrs across eastern europe is facilitating the job of the analysts, as there is no longer any need to adjust local figures for comparability purposes. another important positive aspect of the ifrs implementation has been the increase in the quality and reliability of financial information. During the transition period in states that have recently become members of the european union, we have witnessed a significant change in the quality of financial disclosure as a result of the harmonization of accounting standards.

so, for each company we follow or invest in, we compile a quality assessment, which includes an evaluation of the quality of the management as well as the strategic and financial position of the company. We use the international corporate Governance Network’s Global corporate Governance Principles as a general benchmark, bearing in mind the possible local differences in the prevailing best practice code.

Old buildings reflected in a new one in Budapest




Reporting

a Big four audit report has become a quality stamp in terms of financial information in Eastern europe. in the past, many of the companies involved in a crisis or fraud have used small local firms as auditors; in our eyes, this has greatly diminished the reliability of those local firms. However, we scrutinize the financials of each company on the same basis, irrespective of their audit firm.

more generally, an audited report carries the value of having a professional opinion on the accuracy of the financial information. The audited information is especially useful to us in the case of companies that have privately held assets on their balance sheet, which is common in eastern europe. historically, we have witnessed many cases where the auditor’s opinion on certain asset valuations has differed significantly from the management’s.

a niChE MaRkEtOur investment universe currently consists of 15 countries, out of which only three (russia, Turkey and Poland) have a market capitalization above €50b. This means that the size of most of the markets in the region is insufficient for the large investment houses. To be successful in these smaller markets requires a lot of groundwork and/or a direct local presence; dedicated in-house research; and long-term local relationship building. all this requires resources that larger houses are unwilling to allocate, but these efforts are crucial in developing our regional expertise.

in truth, for a boutique like ours, the absence of larger investment houses broadens the opportunity base, as less global money means less liquidity. That neglect also results in wider mispricing of assets, aiding us in the search for attractive investment ideas.



A number of professional accounting bodies and standard-setters have recently issued papers exploring ways to reduce the volume of financial statement disclosures. Christian Doherty talks to the experts about ways in which disclosures can be improved — and whether disclosure reduction is really the central issue

Theimportance of insight

INfOrmaTION: fINaNCIal STaTEmENT dISClOSurES

Reporting

In financial reporting, disclosures — initially intended as supplementary addenda to the primary financial statements — have become increasingly central to much corporate reporting. Disclosures have always been important to the understanding of the financial statements as a whole, but is more disclosure better or worse for financial statement users?

Numerous bodies, including the financial reporting council (frc) and the european financial reporting advisory Group, have used the term “disclosure overload” to describe the increase in disclosure requirements. however, overload is not necessarily just a question of the volume of disclosures; there is also the issue of their readability for users.



“If something significant in a company’s reporting is confusing, or it looks like they aren’t being transparent, doubts can emerge and investment may well go somewhere else, to avoid the real or

perceived risk”Sue harding, harding analysis


Reporting

too MUCh inFoRMation?“There is often an accusation that disclosures provide too much information and not enough insight, and i’d agree with that,” says sue harding, an independent analyst who combines running harding analysis with contributing to the frc’s reporting Lab. “at the same time, i still feel, from a user standpoint, that there is information that’s missing as well.”

in harding’s view, some basic and fundamental elements of company performance and risk management used in corporate analysis can actually be obscured, or even missed, under the current regime. “We have certainly found this in researching and publishing the Lab’s work on debt and cash flow disclosure. in our work with investors and analysts, we found that, at times, investors can have difficulties in confirming how much debt needs to be repaid when it needs to be repaid.”

Through her work with the frc Lab, harding and her colleagues have also focused on the conversion of operating income to operating cash flows, noting how difficult it can be to arrive at a definitive figure at times, depending on how the cash flow statement information is presented.

“The accounts are getting longer, for sure, but are even the basic questions being answered?” she asks. “it’s far too easy, in my view, for a company not to realize that its accounts haven’t answered fairly basic questions for investors, even with a set of compliant

accounts. equally, though, some companies are doing a very good job of addressing this, and our reports have highlighted examples of disclosure that was well received by investors.”

thE WRonG taRGEtSsome share the view that this central question — whether the financial statements, including the primary statements and the disclosures, are actually helping to explain a company’s current financial

position and performance to the users of the accounts — is being lost in the drive toward simply reducing the number of disclosures.

ruth Picker, Global Leader, ifrs services at ernst & Young, agrees that the “slicing back” approach focuses on the wrong targets. “i think the problem with what these papers are focusing on at the moment is that they are taking the tree and they’re pruning it in parts, chopping off bits and pieces, and saying ‘let’s cut out this disclosure and that one.’ But they’re not taking a holistic look at what is being reported and for whom.

“financial statements are designed to meet the needs of users, primarily investors and creditors. Ideally, if financial statements could also help preparers tell the story of their business in a clear, readable way, this would be a valuable step forward



take a closer — and fresher — look at their disclosure strategy and approach? What changes to the current regime are needed?

“For companies preparing financial statements in accordance with international financial reporting standards, that is a current project for the international accounting standards Board,” says Picker. “While it’s doing that, it is consulting with preparers and users, with auditors and regulators.”

Picker identifies readability, clarity and comparability as being guiding principles that companies should

aim for in their disclosures. hsBc’s Group chief Accounting Officer, Russell Picot, who has led the bank’s work on reducing the number of its disclosures (see panel page 40), agrees that providing investors with clear information must be the central goal and foundation of any good annual report.

“What you’ll see right up front in our annual report is the risk section, which outlines hsBc’s top emerging risks — the list of risks that the senior management really worries about,” he explains. “Then, in front of each of the risk types — market risk, liquidity risk and so on — you’ll see a description that simply outlines what’s happened in this area. for example, it was an external event, but we did the following things: we took these risk management actions, here are the financial consequences of that. and then, toward the back of that section, there sits much of the boilerplate material.

“Our responseto financial crises has always been to get on the front foot and make early, and very transparent, disclosures around

our risk position”Russell Picot, hSBC

Reporting

for financial reporting. This doesn’t necessarily mean reducing the number of disclosures, but rather, focusing on the way the financial statements are presented overall, while still being compliant with relevant accounting standards.”

The question of what is reported, and how, goes to the very heart of the reporting debate. Take debt, for example.

“from the user’s standpoint, there is probably a range of views,” explains harding, “but to take one example, there are probably a number of different ways in which a company could go about answering the question of how much debt it has to repay and when it’s due. it can list the terms of each debt obligation and/or provide summary information that’s clear enough.”

GUidinG PRinCiPlESclearly, the need for clarity on such a central element of company performance cannot be ignored. so what can be done to encourage companies to

“What you’ll see right up front in our annual report is the risk section, which outlines HSBC’s top emerging risks — the list of risks that the senior management really

worries about”Russell Picot, hSBC


http://www.ifrs.org/The-organisation/Pages/IFRS-Foundation-and-the-IASB.aspx




Reporting

“so by undergoing that restructuring, we have tried to clarify the ‘here and now’ and put it right up front,” he concludes. “We then separate that from the longer, compliance-driven disclosures.”

a ChanGE oF FoCUSmoving away from compliance toward communication sits at the heart of hsBc’s work on this. and harding, coming from the investor side (she is also affiliated with the corporate reporting users’ forum), believes this approach can go a long way toward making a significant difference in the way in which a company is viewed by investors.

“in my work, i hear anecdotally that companies that don’t provide the information that is needed for analysis are being overlooked by investors or rated less highly by analysts,” she says. “if something significant in their reporting is confusing, or it looks like they aren’t being transparent, questions may be raised, doubts can emerge and investment may well go somewhere else, to avoid the real or perceived risk.

“clear disclosure can help eliminate some of these concerns and questions that might, in some instances, arise as a distraction from the case for investment,” she concludes.

How HSBC refined its disclosuresRUSSEll PiCot, GRoUP ChiEF aCCoUntinG oFFiCER oF hSBC, oUtlinES thE WoRk thE Bank haS donE in CUttinG and REShaPinG itS USE oF diSCloSURES

hSBC has a strong belief that good-quality disclosure is important. What makes us different is that we don’t have a preliminary results announcement. So when we announce our results — typically at the end of February — we actually release our 500-page Annual Report and Accounts in its entirety, our Pillar 3 report [capital and risk management disclosures required by the Basel II accord] and our investor relations material in one go.

managing our approach to disclosures is an all-year-round process and it builds through the year. It starts off by taking stock, assessing changes in best practice guidelines and technical issues and reflecting on any major messages that have come out of the investor relations process. We will also look at disclosures from our peer group.

As well as that, we work with the British Bankers’ Association, which has a disclosure group that meets regularly through the year to talk about emerging disclosure issues. This feeds into the dialogue with the uK financial Services authority.

All through this, we’re thinking about ways of improving the disclosures and making sure that we continue to be one of the leading banks in this area.

Then, from time to time, we stand back and look at

the document and ask, “What could we do to change it radically, to restructure it, to reduce it?” We last did that three years ago, and we took out 25% of the document.

That process involves us asking, “why are we actually saying this? Is that boilerplate? let’s try to clean up our investment story and make it clearer.”

Taking the 25% out was quite a challenge, as it entailed taking out 100 pages. We looked at content, duplication, formatting, regulatory and legislative requirements, and best practice. We talked to a couple of external investors as well as our uS securities advisors. So we spent quite a lot of our time thinking about this and engaging in various forums and trying to distil what may be changing in terms of investor needs.

Over the past 20 years, we’ve been through four or five financial crises, and our response has always been to get on the front foot and make early, and very transparent, disclosures around our risk position, to make sure that the market doesn’t have to guess what’s going on.

From our experience over time, we have learned that, when you go through a crisis, if you make early disclosures, the market reacts well and doesn’t penalize your share price, so you are better positioned to survive the next crisis. This cycle can be positive, and we firmly believe that transparent disclosure is really important in helping to influence opinions about your organization in world markets.


Uli Fricke is co-founder of Triangle Venture Capital Group, which specializes in funding technology start-ups. She explains the particular challenges of communicating the progress of businesses in this sector to investors

things I’ve learned

Set clear goalsWe work with small research spin-offs and start-ups that have groundbreaking technologies that can be put to use in

different markets. Often, start-up founders try to do too much too quickly. rather than focusing on one market, they try to play a role in several and aren’t successful in any. Defining clear goals for a company helps it to prioritize its daily tasks and organize its work efficiently. It also helps when explaining the strategy to investors — and if they understand the plan, they have an easier time supporting the company, even if things go poorly in the short term.

1 Don’t be afraid of bad newsif something bad happens to a start-up — say, it loses an important client or is accused of infringing patents — some

founders find it difficult to talk to us. The worst thing that can happen in this case is that our investors read about it in the newspaper, and then we’ll have a hard time explaining why we didn’t warn them. i understand that founders might think they can solve the problem alone, but it’s always better to get all sides involved as soon as possible. Our team and our investors have a lot of experience, and we might be able to help. if we know about problems early, we have still a lot of options. if not, those options often narrow. We try hard to build trust with our start-ups so that they feel comfortable reporting to us, even if things don’t work out as planned.

2


ReportingINSpIraTION: ulI frICKE


Explain complex technology simplyTech start-ups tend to deal with innovative technologies that are complicated. Dealing

with them on a daily basis, you run the risk of forgetting how difficult it is for outsiders to understand these solutions. But when talking to investors, it pays to keep it simple. Otherwise, they don’t have a fair chance of understanding their investment. That’s bad for both sides: the investors have a hard time assessing the business, and we lose the chance to get meaningful input from them.

3 4 5Keep valuations steadyYou can’t rely on cash flow analysis with small start-ups. instead, we use other valuation models such as peer group analysis. But different valuation models

can lead to massive changes in value, and investors find it difficult to deal with that — their shares can’t be worth €10m one day and €27m the next. so we try to make sure that valuations stay stable and consistent, even if methodologies change. if investors use different valuation models, we talk to them and find a compromise that satisfies both sides.

Report often — it’s less workit sounds counterintuitive, but it’s true. The more often all sides report to each other, the quicker and easier the workflow is organized, and everyone becomes

familiar with the companies and their technologies. as the understanding grows, investors can give advice and contribute ideas. it’s also a good exercise for start-up ceOs. They get used to reporting standards, and preparing for meetings with investors eats up less of their time. They learn to explain themselves better and to focus on the important steps their business needs to take. With our portfolio companies, we sometimes talk on a daily basis, and we have board meetings once a month.

Ulrike W. Fricke is a managing General Partner at Triangle, a German venture capital group that invests in research spin-offs, which she co-founded in 1997. Today, Triangle has six partners and five venture partners and administers funds of €200m. In 2010, Real Deals magazine named fricke as the most powerful person in private equity, while Dow Jones has recognized her as one of the 100 most influential women in Europe’s finance industry. She was chairwoman of the european Private equity and venture capital association from 2010–11 and sits on the boards of tech companies fg microtec, iOpener, takwak and xaitment.


ReportingINSpIraTION: ulI frICKE


mY wISh lIST: lOuIS r. huGhES


Reporting

lEt thE BoaRd do itS joBin the Tapestry Network’s discussions with parliamentarians in europe and the us, the sobering realization we’ve come to is that most political leaders have very limited knowledge of what an audit committee, for example, actually does. Nor do they understand how that role has changed significantly over the last few years.

i think some horror stories have led politicians to think there isn’t any oversight, but that couldn’t be further from the truth. There is an extraordinary amount of oversight and engagement in boardrooms, especially since the sarbanes-Oxley act was introduced in the us. a typical audit committee meeting is very intense these days, undertaking a highly in-depth review of the company’s financial condition and compliance.

loUiS R. hUGhES, ChaiR oF thE aUdit CoMMittEE at aBB ltd, ShaRES hiS thoUGhtS on hoW CoRPoRatE REPoRtinG and GoVERnanCE CoUld BE iMPRoVEd

mywish list

ProfileuS-born louis r. hughes has been a non-executive member of the board of Swiss-based multinational engineering firm aBB ltd since 2003 and is currently Chair of the Finance, Audit and Compliance Committee. He is also a board member at akzoNobel in the Netherlands and french-based Alcatel-lucent. In the 1980s and 90s, Hughes held a series of key posts at General motors, including President of Gm’s International Operations, before becoming President and COO of lockheed martin in 2000. In 2004, he founded privately held cybersecurity firm InZero Systems (formerly GBS laboratories), of which he is Chairman.


mY wISh lIST: lOuIS r. huGhES


Reporting

no ChanGE FoR ChanGE’S SakEThere are proposals to rotate the external auditor every few years to create greater independence. But forced rotation does not guarantee independence or greater effectiveness. i would far rather keep an auditor that really knows my company than get in a new set of eyes. Will the new auditors be as smart or as experienced, or as knowledgeable of the company’s affairs? it makes all the difference when it comes to ascertaining whether internal controls are adequate or not.

forced rotation is also not a particularly good way to improve controls. The focus should be less on the auditor and more on the board itself. We would be far better served by companies understanding their fiduciary responsibilities and getting competent directors in place who know they will have to put in a lot of time and effort, but accept the responsibility of doing so. That is certainly the case in the three companies where i serve on the board.

SPlit thE toP PoStSit is essential that the role of chairman be split from that of chief executive officer, as the roles are quite distinct. To create real accountability and to be able to judge objectively whether the ceO is doing a good job, you need a non-executive chairman. That means that, if there are issues with the ceO’s performance, they can be addressed in an orderly way. if you

have a ceO who is also serving as the chairman, you effectively have the “fox in the chicken coop” and it’s much more difficult for the board to make necessary changes at the top.

SiMPliFY aCCoUntinG PRoCEdURESPeople are looking for more simplicity to replace the current complexity and duplication. i would like to see the us move over to international financial reporting standards (ifrs), creating one worldwide standard. There has been a movement to bring accounting standards closer together, which is a good development.

There is also a great deal of effort spent in reporting some items that provide questionable value for investors. for example, for pension accounting, the current market discount rate is used. volatility in that rate creates enormous volatility in the balances that companies are reporting for their unfunded pension liabilities. You may have the same number of employees as last year, with the same life expectancy, but the unfunded pension liability reported on the company books may be a billion dollars higher because the discount rate moved down.

additionally, you virtually need a doctorate in mathematics to do foreign currency flow and derivatives accounting. it’s a very arcane area. aBB, which is long on Swiss francs, can have significant volatility in its reported cash flow and balances as

a result of exchange rate movements between the swiss franc and the us dollar.

Maintain liqUiditYLiquidity is key. While interest rates have never been lower, there is still very little liquidity for a company that is experiencing financial difficulties. corporations around the world need to maintain the keen focus they acquired after 2009 on cash and keeping their balance sheets as strong as possible.

Within audit committees, there is a high level of sensitivity to this, and in particular to ensuring that the level of operating earnings, the use of net working capital and capital expenditures receive significant management attention and remain within acceptable parameters.

BUild on CoMMUniCationS iMPRoVEMEntScompanies now work very hard to communicate and explain in great detail what their strategies are and how they are executing them. There is a real concentration on transparency, which is good.

There is also greater use of social media to communicate. some large companies are still lagging behind on that, but there is at least a recognition that there is a need to embrace this valuable new outreach tool.



Ernst & Young Steering Groupchristian mouillon, Global vice chair, assurance Don Zimmerman, assurance services felice friedman, Director, Global Public Policy Philippe Peuch-Lestrade, assurance services r. Balachander, assurance markets Leader, india richard Wilson, assurance services ruth Picker, Global Leader, ifrs services, Global Professional Practice stephane Kherroubi, financial accounting advisory services Warmolt Prins, assurance markets Leader, emeia

Ernst & Young assurance leadersemeia — felice Persicoamericas — Tom houghAsia Pacific — Clive SaundersonJapan — Koichi hanabusa

Editor Tim Turnerassistant Editor chris erasmusSenior designer Jenni Dennisaccount director emma KingProduction director John faulkner

For Ernst & YoungJosy roberts-Pay, marketing Director, emeia assuranceJoan fulton, Program manager

for more information about Reporting, please contact [email protected]

Reporting is published on behalf of ernst & Young byWardourDrury house34–43 russell streetLondon Wc2B 5ahTel + 44 20 7010 0999wardour.co.uk

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t MaGazinEin this 10th issue of T Magazine, we explore how tax risk and controversy have changed since the financial crisis. We look at emerging risk areas and explore how the relationship between companies and their external stakeholders, including the media, tax administrations and campaign groups, is evolving. Perhaps most crucially, we examine how companies are identifying and managing these risks.tmagazine.ey.com

RaPid-GRoWth MaRkEtS and thE SECREtS oF thEiR SUCCESSin the current edition, you will find out which key lessons can be learnt from development paths of the past. You will also discover how China’s gradual move up the value chain will create opportunities for other RGMs.ey.com/rapidgrowth

thE FUtURE oF GloBal CaRBon MaRkEtSWe uncover how a future global carbon market may form, what scenarios could emerge if an agreement is not reached and the sectors that will have the most challenges and opportunities in relation to carbon markets.ey.com/ccass

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