Sri Lanka 2.0 and Beyond: Part II

Tuesday, 22 July 2014 00:01 - - {{hitsCtrl.values.hits}}

By Shabiya Ali Ahlam and Senuri de Silva Aiming to shed light as to how Sri Lanka can achieve rapid development to make up for the time it lost in the 30-year war, the Institute of Certified Management Accountants of Sri Lanka (CMA) recently held its 14th National Management Accounting Conference under the

theme ‘Sri Lanka 2.0 and Beyond: Fast Tracking Economic Development’. The three-day conference that was held in Colombo had eight sessions on diverse topics and was addressed comprehensively by over 35 speakers. The Daily FT on 14 July carried full coverage of Day 1 of the conference. Following coverage is the discussions held on the second day which focused largely on financial reporting and fact tracking economic development.

Achieving sustainability for integrated reporting While Integrated Reporting (IR) is yet to be widely implemented in the developing and emerging regions, SAFA Past President A. N. Raman pointed out they are important for four key reasons. Businesses should consider integrated reporting because it is communicating versus complying where it reports the intangible assets, help break down silos, and increases transparency. With IR being a process that typically results in communication, most visibly a periodic integrated report about value creation over time since it is a concise communication about how an organisation’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term. It is important to prepare that report in accordance with the International IR framework. While the communications that result from IR will be of benefit to a range of stakeholders, they are principally aimed at providers of financial capital, said Raman during the session ‘Integrated Reporting and Sustainability, moderated by Ernst & Young Country Managing Partner Asite D. B. Talwatte. “Many financial executives have complained about the state of financial reporting. It seems like a compliance exercise versus a mechanism for communicating business performance. We need to get out of the compliance mindset and embrace mechanisms that tell the organisation’s financial story in the best and most transparent way. For this IR provides a holistic method for explaining how the organisation is doing, and how the management team thinks it will do in the future,” he said. While it is not about physical or financial assets any more, the value drivers of a company are increasingly intangible. It is observed that the transformation from a manufacturing economy to information or knowledge economy has not been matched by similar changes in financial reporting. “Integrated thinking is the active consideration by an organisation of the relationships between its various operating and functional units and the capitals that the organisation uses and affects. Integrated thinking leads to integrated decision-making and actions that consider the creation of long term, as well as short and medium term, value. Integrated thinking can be contrasted with traditional ‘silo thinking’. It takes into account the connectivity and interdependencies between the range of factors that have a material effect on an organisation’s ability to create value over time,” he explained. With IR being a shift of focus towards strategy, governance, performance and prospects, it has three fundamental concepts which are capital,

business model, and value creation. According to Raman, all organisations depend on a variety of resources and relationships for their success. These resources and relationships can be conceived as different forms of capital. The IIRC states that there are sic capitals, which are financial, social, natural, human, intellectual and manufactured and currently, corporate reporting tends to focus on the financial and manufactured capital. However, increasingly there is the understanding from all stakeholders that in order to convey a full story of value creation all these resources and relationships need to be communicated,” he said. Practical aspects of integrated corporate reporting Attempting to shed light on issues faced when implementing integrated corporate reporting, Diesel and Motor engineering (DIMO) Chief Financial Officer Suresh Gooneratne spoke on the practical aspects in this regard. Noting that currently financial reporting consists of four statements, the report essentially looks back at past activities. According to him it is serves as a rear view mirror as the statements helps in seeing how the company has fared, and more importantly it helps to predict the future of the company. An analysis conducted in 2010 on 500 companies rated by Standard and Poor’s (S&P) showed that in 1975, 83% of the company value was represented in the balance sheet in the way of physical and financial assets, whereas 17% was represented through non-financial assets. In 2009, the results showed that majority of the companies represent vale through non-financial assets. “There is no point in that. That is one reason why integrated reporting came into being,” he said. In terms of presenting information on the annual reports, Gooneratne asserted that companies disclose for the sake of disclosing, losing the meaning of the report. “It results in clutter. These are the typical problems in the corporate regime. The solution of integrated reporting is yet to be seen. In Sri Lanka, it is still at an initial stage. If you take upon integrated reporting, you are bound to face many issues initially, but it is important to take the first step,” advised Gooneratne. Pointing out the difference between sustainable reporting and integrated reporting, he stressed the former talks about being accountable for internal and external stakeholders for organisational performance whereas the latter is about responsibilities towards stakeholders and creating value over time. “The nexus between the two is that integrated reporting is border in scope. It includes non- monetised information. Integrated reporting is a paradigm change in corporate reporting because the current regime is focused in Return on Investment which is definitely monetinsed,” said Gooneratne.

Applicability of GRI G4 guidelines for corporate sustainability reporting John Keells Holdings Head of Sustainability and Enterprise Risk Management Chulendra de Silva started off his presentation by highlighting the four key benefits of sustainability. The first is it helps achieve improve financial performance through business process optimisation, cost reductions and savings. The second is that it helps improve stakeholder relationships by continuous engagement with various interest groups which builds trust and improves communication. The third is that it helps improved risk management by better understanding of non-financial material risks, which in turn saves company time, money and avoids loss of reputation. And lastly it helps in the identification of new markets and business opportunities through innovation and engagements with various stakeholders. Noting that the G4 will be the mandatory reporting framework for all companies reporting on the GRI framework from 2015, he said the G4 has an increased emphasis on the need to only focus on topics that are material to the organisation and key stakeholders. “The materiality focus will in turn make reports more relevant, credible and user-friendly to readers and the materiality is extended to the entire value chain. With the reporting being impact based and not indicator based, it enables companies to move towards integrated reporting. It will help move away from A, B, C graded report to a classification of ‘core’ and ‘comprehensive’,” said de Silva. He added that while with GRI G3.1 organisation based sustainability performance with focus on value chain in some aspects, GRI G4 has greater focus on sustainability performance of the entire value chain and the organisational responsibility of ensuring a responsible value chain. However there are a number of challenges in implementing GRI G4 according to de Silva.

While for single line businesses materiality assessments would be the same as under GRI G3.1, for conglomerates G4 requires the mapping of material impacts by each business area. The materiality assessments need to consider the entire value chain and identify significant members of the value chain. “For each material area, significant members of the value chain needs to be identified, assessed for risk and plans established for reducing any identified risks,” noted de Silva. Implementing risk management in corporate management With companies increasingly operating in a global environment, businesses are exposed to a number of risks in addition to those from the financial side. Such risks include liquidity, operational, regulatory, and reputation risks. Sri Lanka Telecom General Manager Treasury Sanath Wijesuriya during the session ‘Risk Management Challenges’ said that over the four key risks identified are corporate and credit risks. Defining a financial risk as a series of unplanned event with financial consequences that could be either profit or loss, Wijesuriya said it is about understanding the risk, measuring it and deciding how it is going to be managed. “In any scenario it is imperative to first identify the type of risk and quantity find its impact on the cash flow. There are many options to mitigate the risk so the optimal strategy should be picked. It should not only be implemented but should also be updated in a continual basis. Risk management is not a static one and but a continuing process,” noted Wijesuriya at the session moderated by National Savings Bank CEO and General Manager H. M. Hennayake.

Focusing on interest rate volatility, he shared there are five instruments to help mitigate them. The first is Interest Rate Swaps (IRS) which is an agreement to periodically exchange or swap one stream of Interest payments for another stream with different features based on a notional principal amount. While the principal amount is notional because it is never exchanged, it allows the user to switch their effective liability from floating to fixed and vice versa. The second is Interest Rate Cap (IRC) which for a premium, the seller of the cap agrees to compensate the buyer, whenever a reference interest rate exceeds a pre-agreed level (cap rate) for a period at specified intervals. The third is the Interest Rate Floor (IRF) where for a premium the seller of the floor agrees to compensate the buyer, whenever a reference interest rate declines beyond pre-agreed level (Floor Rate) for a period at specified intervals. The fourth is the Interest Rate Collar (IRC) that involves purchase of cap (pay premium) and sale of floor (receive premium). The fifth is the Floor Rate Agreement (FRA), which are forward contracts on interest rates which will assist in locking into an interest rate in future. It is an agreement obligating two parties to agree that a certain Interest Rate will apply to a notional Principal amount during a specified period.

Noting that different products will be appropriate for different scenarios and corporate, Wijesuria said that with any of the alternatives one gives up something either premium paid for options or the profit one would have made without hedging. Managing reputational risks Sustainability reporting is the practice of companies measuring, disclosing, and making themselves accountable to their stakeholders, for their organisational economic, environmental, and social performance. And the term ‘sustainability reporting’ is preferred to CSR and social reporting as it essentially incorporates all aspects that contribute to the sustainability of an organisation. As a result it contributes to the sustainable development of a nation, said STING Consultants Chief Executive Officer Ruchi Gunewardene. “These aspects are the economic performance of a company, as well as its environmental, social and corporate governance performance. Many wrongly view sustainability reporting as an end result done with the objective of winning various awards, which results in forgone opportunities,” he expressed. Measuring and reporting on sustainability performance is not a final step, rather, it is a tool that companies can and should use to facilitate their overall sustainability management process. Guneardene shared that in the CA model, sustainability reporting is an interconnecting step in an ongoing cycle. He stressed the previous stages are necessary in order to facilitate the reporting process, but the reporting process itself will insist in ongoing stakeholder engagement, risk management, and so on. With the world becoming smaller due the greater access to different avenues of communication, when expectations are not met the voices of consumers are demonstrated through various mediums which make the management of reputation risks crucial.

However, while many companies use sustainability reporting as a crutch for this purpose, in practice it is really done, said Gunewardene. “There is a huge gap. The report is a useless effort of time unless it is a part and parcel of the business. This can only happen if the belief is there from the top.” He stressed it is essential to handle sustainability reporting in a transparent manner and ensure that all information should be disclosed, even the negative impacts. According to him doing so will push companies to address those negative issues so it can be reported in the following year publication. Gunewardene pointed out three levels to handling reputation risks. The first is to be a good citizen by ensuring that taxes, ETF, EPF are paid. The second level is to set high standards at a continuous level which allows institutions to move into the whole aspect of stakeholder identification and have a close dialog. The third is to have an effective benchmarking system which can help companies become a global leader by effective transformation of the industry. Importance of performing due diligence in the right manner Noting that due diligence form an aspect of acquisition and investment and is based on that context, Ernst and Young Partner and CA Sri Lanka President Arjuna Herath took the example of the recent acquisition made by Cargills. He explored if the company had gone through a proper due diligence before acquiring the brewery which it is already looking to sell. Cargills entered the alcohol industry early 2011 by acquiring the McCallum Brewery. It invested massively in the expanding capacity where it increased it from 50,000 hl per annum to 600,000 hl. The brewery was purchased for Rs. 1 billion and invested a further Rs. 2 billion to improve capacity. The aspiration of Cargills was to capture a market share of 35%. Upon commissioning of the new plant its management was confident the brewery would give a substantial boost to its group’s results with its brands emerging as market movers. With tourism arrival having continued to show growth at the time, coupled with the 22.5% growth in malt liquor production in 2011, the company was confident that indicated the ‘timely nature’ of their investment. However, after about three years since the brewery was brought Cargills was already looking to sell. The sale was made to Lions Brewery, market leader in the industry, in June 2014 for Rs. 5.15 billion.

“The question is that had a proper due diligence been done would this situation have come. The target on the market share, was it realistic and was it assessed in the report. It would have been possible to mitigate the risks if a proper due diligence was done,” said Herath. Pointing out that financials is not the only critical aspect of a due diligence, he stressed it is critical to go into the ‘nitty gritty’. “Look behind the numbers since from that will surface the business model. That is critical to plan the future and the acquisition. The biggest reason for failures in mergers and acquisitions are people and soft issues,” he added. Pix by Upul Abayasekara

South Asian experiences in fast tracking economic development

To explore how some countries in the region are achieving further economic progress, the conference held a session titled ‘South Asian Experiences in Fast Tracking Economic Development’. The session featured the journey taken by India, Pakistan and Bangladesh in this regard. Moderated by Siddhalepa Group Managing Director/CEO Asoka Hettigoda, speakers of the session were Axisbank CEO Ashok Kumar Basu, CMA Former Council Member Muhammad Arif Nara, and ICMA Bangladesh Vice President A. S. M. Shaykhul Islam. India Presenting the Indian story first, Axisbank CEO Basu flaunted the country’s success by stating that India is the pioneering democratic governance in the non-Western world and that it has managed to maintain a secular state in spite of challenges of a multi religious population and problematic history of violence during the ending days of the Raj. With rapid economic growth, it is the second fastest growing large economy in the world, he highlighted. Despite success in certain areas, the country, like any other, has a number of blind spots that calls for immediate attention and action. An area where this is evident is the education sphere. According to him, although there is emphasis in high quality science and technology education, there are no commensurate job opportunities and the education of the girl child is not prioritised, even societally. “The school and education infrastructure has been bad. It is a tragedy that a large part of the schools in India is actually run by the government. It has been demonstrated in research that the cost per child on education provided by the government is higher than the quality education provided by the private sector,” shared Basu. On the reforms, corruption is an issue in India and the accountability in the public sector has typically been weak and needs to be strengthening more. He noted that the productivity in the public sector has been low and needs to be looked at. Stressing that improving the administrative, judicial and legislation is necessary, Basu pointed out that while India does have the necessary infrastructure for this purpose, the efforts gets knocked off at some point or the other. “There is political pluralism and that is evident in the infrastructure. There are examples of Indian companies setting up manufacturing companies in Sri Lanka to support the supply chains of the southern Indian markets. It is easier to supply form Sri Lanka to the South East Indian markets rather than supplying from the northern parts of India since the road infrastructure does not support this,” noted Basu. Pakistan Former CMA Council Nara started off by stating that because of the hostile relationship Pakistan has with most of its peers in the region, the country has not been able to develop. “Our problem is that Pakistan has a strategic location. With this I mean that our neighbours are Afghanistan, India and Iran. At this stage I would rather say that there must be an end to nuclear technology and the use of nuclear power in the whole world, especially in our region. If we do not have good relationship with our neighbours we are not going to grow or develop the economy properly,” expressed Nara. Pakistan’s regional trade is only of 15%, and this stands as a limitation to achieved fast track development, he added. However, it is projected the nation’s will grow by 15 times in the next 35 years, if the law and order conditions are improved. “We are very much confident in our army and I hope that by the end of this government we will be able to control the law and order situation. Let us think positive in this regard,” expressed Nara. If Pakistan grows at this forecasted rate by the stated period, it will become the18th largest economy, whereas today it is the 44th largest. Pointing out the challenges faced, he stressed it is imperative for savings to be increased as currently it is low with it standing at 15% on investments. If this is not increased up to 25% it will have a negative impact on investments which in turn affect the economic growth, opined Nara. At low levels is also its trade which is at 0.12%. He cautioned that if Pakistan fails to have proper trade share, it is unrealistic to expect growth and development. On social indicators the country has very high poverty levels as nearly 50% of its population falls under this category. If this is not addressed immediately it is expected that in the future there may be 120 million people under the poverty level, which is only add on the existing burden of the country. Bangladesh Noting that Bangladesh is rapidly developing under market based economy, ICMA Bangladesh Vice President Islam shared that around 45% of its people are currently employed in the agriculture sector, while 30% are in the in industry sector and 25% in the service sector. “Bangladesh has undergone a major shift in its economic philosophy and management in late 1975 and until 1990 the country moved towards privatisation of the state owned enterprises and practiced a mixed economy. However, fast tracking economic development in Bangladesh got momentum after the formation of Bangladesh Securities & Exchange Commission in 1993,” said Islam. Providing a snapshot of the economic growth in Bangladesh, agriculture, industry, transport and other service sectors altogether play key roles to the economic growth of Bangladesh, he said. In the outgoing fiscal all these sectors were severely disrupted due to political unrest in the first half on the issue of general election that affected both domestic and export activities. Today, export of textiles and garments are the largest sources of foreign exchange earnings. Garment alone contributes 81% of the total export earnings. Shipping’s, pharmaceuticals and consumer goods manufacturing are also important emerging industries, while the remittances from Bangladeshis working overseas, mainly in the Middle East, are another major source of foreign exchange earnings. “Amidst political turmoil in first half of the outgoing fiscal the economic development in Bangladesh is neither robust nor disappointing. At the moment the country has a foreign exchange reserve of around $ 21 billion which is more than the expectation. Economists in Bangladesh believe that with prudent economic policies, the country can achieve more than 6.6% GDP growth in next fiscal,” stated Islam.