Essential Corporate News – Week ending December 19, 2014

Publication | December 19, 2014

Introduction

Welcome to Essential Corporate News, our weekly news service covering the latest developments in the UK corporate world.

GC100: Directors’ Remuneration Reporting Guidance: 2014 Statement

On December 18, 2014 the GC100 and Investor Group published a statement relating to its October 2013 remuneration reporting guidance for directors (Guidance). The Guidance has been reviewed in light of the 2014 AGM season and recent developments and, as a result, the statement sets out supplementary guidance and clarifies or emphasises certain aspects of the Guidance to promote best practice in future reporting. The statement is to be seen as part of the Guidance.

The statement covers the following matters:

  • Linking remuneration to company strategy remains an important area for investors and many companies should give this area particular focus. While the requirement to show how each component of a director’s remuneration supports the company’s short and long term strategic objectives applies to the policy table, investors expect this to be supplemented by relevant disclosures in the annual remuneration report. Appropriate emphasis and explanation should also be included in the statement from the remuneration committee’s chairman.
  • The statement refers to the assurances given by a number of companies prior to their 2014 AGM about the use of discretion in cases where discretions were found to be too broad once the remuneration policy had been published. It notes that the provision of assurances is generally undesirable and the section on discretions in the Guidance should be read as a whole. A broad discretion to address unexpected developments is only likely to be approved if it is drafted and explained to make investors confident it will only be used if genuinely required and within an acceptable maximum.
  • Assurances that have been given about how policies will be implemented should be disclosed in the accounts and reports section of the company’s website and included in future remuneration reports in the following years of the policy’s term.
  • The statement notes the requirement in the September 2014 UK Corporate Governance Code for long and short term incentive schemes to provide for malus and clawback. It suggests that if companies want to extend their malus and recovery provisions as a result the, following consultation with investors, they could defer this to the next scheduled policy renewal, present a new policy for approval or devise another solution.
  • The remuneration policy need not be set out in full in every remuneration report but sufficient information to help shareholders easily assess the reported remuneration in the context of relevant aspects of the policy should be included, and at least the policy table should be included.
  • While it is recognised that prospective disclosure of measures and targets may be difficult, retrospective disclosure should be made once commercial sensitivity no longer applies.
  • A maximum level of remuneration should be disclosed for each executive director, including the maximum possible level of bonus.
  • Reporting on shareholding requirements or guidelines for directors and how compliance is enforced by the remuneration committee should be disclosed in accordance with the Guidance. If long or short term incentives that are share settled require shares to be retained until a specified shareholding is built up and retained, this should be disclosed in the explanation of how the incentive scheme operates and in the shareholding requirements section of the report.
  • While remuneration reporting has improved, companies need to continue to focus on clarity and conciseness in their reporting.

(GC100, Directors’ Remuneration Reporting Guidance: 2014 Statement, 12.18.14)

BIS: Government supports new ranking of companies’ human rights performance

On December 18, 2014 the Department for Business, Innovation & Skills (BIS) announced the Government’s support, including £80,000 of start-up funding, for a new human rights benchmark, the Corporate Human Rights Benchmark that will assess and rank the corporate human rights performance of international companies. The project has been established and is being led by six organisations, including Aviva Investors, Calvert Investments and the Business and Human Rights Resource Centre. Initially 500 of the top global companies in the agriculture, ICT, clothing and extractives sectors will be researched and ranked on their human rights performance.

The aims of the Corporate Human Rights Benchmark are to:

  • Make corporate performance on human rights easier to see and simpler to understand.
  • Rank and reward companies doing well while highlighting the poor performance of others.
  • Enable investors, society and regulators to challenge companies whose performance lags behind that of their peers.
  • Introduce a positive environment that companies can operate in.

In due course the results of the research being conducted will be made available on an online portal.

(BIS, Government supports new ranking of companies’ human rights performance, 12.18.14)

BIS: 2020 Campaign for more ethnic diversity in boardrooms launched

The media have reported that on December 15, 2014 Vince Cable called on FTSE 100 companies to ensure they have at least one non-white director on their boards by 2020. Apparently he had considered calling for companies to aim to have 20 per cent of their directors drawn from ethnic minorities by 2020 but the target was reduced after lobbying from the CBI and the Institute of Directors. The 2020 Campaign is being led by Sir John Parker, Trevor Phillips and Lenny Henry and they have been asked to create a strategy within the next six months that will encourage FTSE 100 companies to add more ethnic diversity to their boardrooms.

FCA expects to implement new Disclosure Rules and Transparency Rules in January 2015

On December 12, 2014 the Financial Conduct Authority (FCA) issued a press release stating that it expects to confirm new rules implementing the requirements in Directive 2013/50/EU amending the Transparency Directive (2004/109/EC) (the Amending Directive) before the end of 2014. This follows its August 2014 consultation paper, CP14/17, which set out a number of proposals in this area. The Amending Directive requires issuers that are active in the extractive or logging of primary forest industries to prepare an annual report on payments made to the governments in the countries in which they operate. The FCA's new rules are expected to take effect for financial years beginning on or after January 1, 2015. The FCA confirms that, subject to confirmation of the relevant powers from HM Treasury, the new Disclosure and Transparency Rules will be considered by the FCA board in December 2014 and a further announcement to confirm their adoption will be made on the FCA website. These powers came into effect via the Payments to Government and Miscellaneous Provisions Regulations 2014.

The FCA also confirms that responses to CP14/17 supported its proposal to align the implementation of the Disclosure and Transparency Rules with parallel rules in Directive 2013/34/EU on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings (the Accounting Directive), which were introduced by the Department for Business, Innovation & Skills via The Reports on Payments to Governments Regulations 2014 (SI 2014/3209). These came into force on December 1, 2014 and require all large and listed companies registered in the United Kingdom and active in the extractive industry (including those engaged in the extraction of oil, minerals and gas and the logging of primary forests) to report the payments they make to governments world-wide.

(FCA expects to implement new Disclosure Rules and Transparency Rules in January 2015, 12.12.14)

The Payments to Governments and Miscellaneous Provisions Regulations 2014 (2014/3293)

On December 17, 2014 the Payments to Governments and Miscellaneous Provisions Regulations 2014 (2014/3293) were published, together with an explanatory memorandum. The Regulations transpose the payments to governments reporting requirements in Directive 2013/50/EU amending the Transparency Directive (2004/109/EC) (the Amending Directive) and give the Financial Conduct Authority (FCA) the necessary powers to amend its transparency rules to take account of these new requirements. The FCA consulted on its proposals in this area in August 2014. The relevant provisions in the Regulations came into force on December 17, 2014.

Under the Amending Directive, issuers who are active in the extractive or logging of primary forest industries are required to prepare an annual report on payments made to the governments in the countries in which they operate. Currently, section 89C(4) of the Financial Services and Markets Act (FSMA) specifies that the FCA may make rules requiring an issuer to make public, or to notify to the FCA, information required by the Transparency Directive. The Regulations amend FSMA to enable the FCA to amend its transparency rules to require reports on payments to governments pursuant to the Amending Directive. The Regulations also insert new sections 87FA and 87FB into FSMA concerning final terms issued in relation to a prospectus. These state that the final terms issued in relation to a prospectus may only contain information relating to the securities note and cannot be used to supplement the prospectus. They also state that the FCA (as opposed to the issuer) must communicate the final terms to the host competent authority and European Securities and Markets Authority.

(The Payments to Governments and Miscellaneous Provisions Regulations 2014 (2014/3293), 12.17.14)

(Explanatory Memorandum, The Payments to Governments and Miscellaneous Provisions Regulations 2014 (2014/3293) 12.17.14)

BIS: An independent review for the Secretary of State for Business, Innovations & Skills – IPOs and bookbuilding in future HM Government primary share disposals

On December 18, 2014 the Department for Business, Innovation & Skills (BIS) published a report of a review, undertaken by a Panel led by Lord Myners, into how the Government should conduct initial public offerings (IPO). The Panel’s review looked at the central recommendations arising from the National Audit Office's report in April 2014 into the privatisation of Royal Mail via an IPO in September 2013. The process raised questions in relation to the Government's current approach to divesting its assets via an IPO. The Panel’s review covered IPO processes only and it also looked at alternatives to the conventional book building process to inform future stock market sales more generally.

Conclusions in the report relating to the Royal Mail IPO include the following:

  • Given the multiple execution challenges of pulling off a successful sale process, the key participants in the Royal Mail IPO were generally risk averse.
  • The standard system of bookbuilding that was used in the privatisation of Royal Mail demonstrated its limitations in a situation where orders came in large size at the top of the range during the early days of the bookbuild. The constraints of the range prevented share price discovery above 330 pence and the degree of oversubscription also meant that allocation was more opaque and subjective than usual.
  • Price leadership by pilot fish institutions (institutions with whom a seller engages at an early stage in a sale process to test potential demand and price range expectations - usually institutions considered to be likely to be supportive investors in the company) was valuable to the Government in providing comfort that a successful sale was achievable at the bottom of the range. However, they did not provide such leadership during the bookbuild process itself where the relatively limited size of orders from pilot fish at the top of the range compared to other investors led external advisers and the Government to doubt that sufficient levels of demand would be sustainable at a price above 330 pence. The expectation on the part of pilot fish that they would be rewarded with allocation without necessarily leading the price discovery during bookbuilding considerably limited their motivation to be at the top of the range.
  • The inclusion of a retail element, and particularly one that encapsulated a full retail offer by post, added significantly to the rigidity of the process given the requirement for withdrawal rights and the impact those rights could have had on the timetable. This complicated any decision to change the offer terms.

The report comments that while bookbuilding in its current form is not perfect, there are no better alternatives. However, the Panel believes that over time bookbuilding will move to a more digital online auction with transparent rules which has significant advantages over the current process. The report makes the following recommendations in light of the Panel's review:

  • There are a number of changes to UK market convention and, in some cases, regulation that should be actively encouraged. The changes include more flexibility to set a wider price range and ability to move the price range, publication of a prospectus as early as is possible in the process, changing the current approach to research blackout periods to enable better investor education and revising withdrawal right requirements, particularly as technology enables faster response time.
  • Secretaries of State should ensure that where orders are clustered at the top or bottom of the range, the range is then moved or expanded whenever practical. This would improve price discovery by achieving a bell shaped curve of demand. In support of this, innovative bookbuilding approaches should be adopted, including launching with an unpriced prospectus.
  • Future Government primary share sale processes should also give careful consideration to selling in tranches the stake to be sold. The report adds that the decision on the size of the stake to be sold will need to support the achievement of the sale's objectives.
  • A key debate for any Secretary of State considering future Government primary share disposals should be whether or not to include a retail offer. The report states that ensuring broad public access is a legitimate objective and that a retail offer can add price tension to the sale process and this should be more fully exploited in the future, but that a full retail offer considerably increases the complexity and rigidity of the offer process. In deciding whether to include a retail offer, the Panel recommends that careful consideration is given to the breadth of retail involvement sought.
  • Future primary share sales by the bookbuild method should ensure that the allocation criteria incentivise the role of pilot fish in price leadership. The report states that pilot fishing can be an important and positive part of an IPO process, enabling early engagement with potential investors. However allocation criteria should be clear that price leadership throughout the entire process will be rewarded, not just at an early stage.
  • A degree of discretion will sometimes be required in the allocation of shares but a 'cleaner', more transparent auction process should be encouraged. The report notes the transition of the bookbuilding process to a more digital online auction based on binding bids and encourages industry leaders to take up the challenge to transition book building towards a more auction-like, transparent mechanism and simultaneously to work proactively to develop digital online auctions.
  • The Government should make maximum use of in-house skill and experience where available to provide additional challenge to sale processes. One example of this would be to consider a larger role for the Advisory Board of the Shareholder Executive given the range of skill and experience contained therein.

(BIS, An independent review for the Secretary of State for Business, Innovations & Skills – IPOs and bookbuilding in future HM Government primary share disposals, 12.18.14)

BIS: Auditor Regulation – Discussion document on the implications of the EU and wider reforms

On December 18, 2014 the Department for Business, Innovation & Skills (BIS) published a discussion paper seeking views on a range of reforms to the regulatory framework for statutory audits as introduced by Directive 2014/56/EU amending the Statutory Audit Directive (2006/43/EC) (the Audit Directive) and Regulation 537/2014 on specific requirements regarding the statutory audit of public-interest entities (the Audit Regulation). The discussion paper looks at the legislative and non-legislative changes needed to improve standards for the audit of public interest entities (PIEs), improve confidence in the independence of auditors, avoid excessive concentration in the audit market and make audit reporting more informative. The discussion paper looks at the structure for regulation, oversight and standards, taking into account the new European requirements, recent Competition and Markets Authority measures and recommendations and work by the Financial Reporting Council (FRC) to refine technical and ethical standards. It then considers the necessary steps that will need to be taken to implement the changes via amendments to the Companies Act 2006 (CA 2006) or regulations made under it.

The closing date for comments on the consultation paper is February 19, 2015 and BIS confirms that, after consideration of responses, it will run a formal consultation on detailed proposals to change the audit regulatory regime.

The discussion paper looks at the following areas:

Audits of PIEs and application of the Audit Regulation and Audit Directive

BIS is proposing to amend the application of Part 42 of CA 2006 so that, in addition to the audits of entities already subject to the requirements of that Part, it should also apply to entities (other than companies and other entities already covered) whose securities are admitted to trading on a regulated market, electronic money institutions, payment institutions, MiFiD investment firms, undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs).

The Government is not seeking to expand the definition of a PIE beyond the EU minimum requirement – that is listed companies, banks, building societies and insurers. The main impact of the changes in scope results from the removal of the option to exclude non-listed entities from the definition of a PIE. This means that unlisted insurers and some unlisted banks will have to have an audit committee and auditors of unlisted banks and insurance companies that do not also audit listed entities will be required for the first time to prepare an annual transparency report and be subject to the tighter independence requirements in the Regulation.

Competent authorities – Designation and delegation of tasks

The current provision of powers to the FRC in relation to the regulation of auditors is not consistent with the concept of a single competent authority having ultimate responsibility for the regulatory tasks or with it having the ability to delegate tasks to other bodies. BIS proposes that the FRC should be the single competent authority for these purposes but its responsibilities will need to be allocated directly in legislation. This would require a new statutory framework on audit regulation in a number of areas.

Audit fees and non-audit services

BIS notes that the provision of non-audit services to audit clients is already regulated by the FRC’s ethical standards for auditors to a greater degree than in many Member States and that some significant non-audit services are already prohibited in the UK. BIS proposes that the related rules on non-audit services should be addressed by the FRC through development of the ethical standards framework. As a result, the FRC has now published a consultation document on the changes to the ethical and auditing standards that could give effect to the EU requirements. BIS is seeking views on, among other things, the FRC being able to exempt firms from the 70 per cent non-audit cap for up to two financial years and whether the blacklist of non-audit services should be included in amendments to the FRC’s ethical standards for auditors.

Tendering and duration of audit engagements

BIS is also proposing to make it possible for a company to retender the auditor appointment earlier than ten years, but still be able to extend the maximum duration of the audit engagement beyond ten years. It is proposing to introduce a framework for mandatory tendering at ten years whilst permitting audit committees to provide for a shorter period in the annual report. BIS is also considering provisions so that, where a PIE has stated that it will complete a tender process before the expiry of the maximum duration of ten years, the PIE could still take advantage of an extension of the maximum duration following that tender. The discussion paper contains a diagram explaining how this would work in practice.

BIS is proposing that each year after the auditor’s initial engagement, the audited entity would state in its annual report when it next intends that the auditor appointment should be based on a retender. Where a PIE reports that it intends that the auditor’s appointment in relation to the next but one accounting year following that covered by the report should be based on a retender, this would be binding on the PIE.

BIS is also seeking views as to whether plans on retendering should be part of a new element of the directors’ report setting out key matters for the audit committee on the appointment of auditors. BIS sets out the possible content of such a report including the date of the beginning of the audit engagement, the date the last audit engagement was retendered and the start of the next accounting year in relation to which the company expects that the auditor appointment will be based on a tender.

The small companies and audit exemption

BIS is of the view that the small companies audit exemption thresholds in the UK should be allowed to increase in line with those for the small companies accounting regime.

Audit reporting and additional reporting to the audit committee

BIS is proposing to include in the legislation on auditor reporting a requirement for the auditor to include a statement in the audit report where there is a material uncertainty relating to events or conditions that may cast significant doubt about the entity's ability to continue as a going concern.

Audit committees

BIS confirms that the Financial Conduct Authority (FCA) will be consulting on implementing new requirements on audit committees via amendments to Disclosure and Transparency Rule 7.1 (DTR). BIS confirms that it has agreed with the FCA and the FRC that the DTRs on audit committees will continue to be supported by the FRC’s Guidance on audit committees. BIS notes that the DTRs only apply to entities with securities admitted to trading on a regulated market and that another mechanism may be needed for other banks, building societies and other insurers, adding that it has discussed with the Prudential Regulation Authority (PRA) whether it could include provisions on audit committees to implement the requirements in its rules. The PRA will be consulting separately on this issue in due course.

Dismissal of auditors

BIS is considering amending the CA 2006 to include the changes set out by the Audit Directive in relation to PIEs (which create new powers for shareholders representing five per cent or more of the voting rights of the share capital and “competent authorities” to go to court to seek the dismissal of the auditor of a PIE where there are “proper grounds”). It does not propose to go beyond the terms of the Audit Directive, or to prescribe what may constitute “proper” or “improper” grounds for the dismissal of auditors, other than to state that divergence of opinions on accounting treatments or audit procedures shall not be “proper grounds”.

(BIS, Auditor Regulation, Discussion document on the on the implications of the EU and wider reforms, 18.12.14)

FRC: Consultation paper on auditing and ethical standards – Implementation of the EU Audit Directive and Audit Regulation

On December 18, 2014 the Financial Reporting Council (FRC) published a consultation paper containing options for amending its framework of auditing and ethical standards for auditors to give effect to Directive 2014/56/EU amending the Statutory Audit Directive (2006/43/EC) (the Audit Directive) and new Regulation 537/2014 on specific requirements regarding the statutory audit of public-interest entities (the Audit Regulation). Both were published in the Official Journal in May 2014. On the same day, the Department for Business, Innovation & Skills (BIS) published a discussion paper "Auditor Regulation – Discussion document on the implications of the EU and wider reforms".

Articles in both the Audit Directive and the Audit Regulation set out provisions relating to matters that are the subject of the FRC's auditing standards and ethical standards for auditors. The consultation paper seeks views on a range of options open to Member States under the EU legislation. In some respects, the UK's current requirements go beyond those of the legislation. In those cases, and where the Member State options allow, the FRC seeks views on whether or not to retain current provisions, or to extend them further, or to align with the new legislation in the following areas:

  • Entities not covered by the definition of Public Interest Entities: The EU definition of a public interest entity (PIE) is different to the current requirements of the FRC’s auditing and ethical standards;
  • Non-audit services: The Audit Regulation prohibits the provision of certain non-audit services by auditors of PIEs through a "black list" and places a cap on permitted services. The FRC is consulting on how to apply the cap and the list most effectively in the UK; and
  • The geographic extent of application: Under the Audit Regulation, the prohibitions on non-audit services to PIEs or their controlled entities within Europe apply to auditors and their network firms. The consultation seeks views on whether these prohibitions should apply in relation to all audited group entities, irrespective of their location.

BIS and the FRC consider that it would be most appropriate for the application of the provisions that clearly relate to matters currently covered by the FRC's standards to be allocated to the FRC to implement via development of the audit and ethical standards framework and revision of the relevant standards. BIS is seeking views on whether, in a revised statutory framework, the FRC should be given specific responsibility to deal with the subject matter of these articles, including the ability to exercise all the associated Member State options, in accordance with the FRC's usual processes for setting such standards.

The FRC will consult on specific changes to its standards during 2015, taking into account responses received to this initial consultation. The closing date for this consultation is March 20, 2015. The FRC confirms that it will consult on other revisions to the audit and ethical standards to implement new requirements introduced by the Audit Directive and the Audit Regulation, taking into consideration the responses received to this consultation.

(FRC, Consultation paper on auditing and ethical standards – Implementation of the EU Audit Directive and Audit Regulation, 12.18.14)

ACCA: Reporting risk

On December 15, 2014, the Association of Chartered Certified Accountants (ACCA) published a report on risk reporting. The report, the result of research carried out via a series of interviews with investors and regulators, as well as preparers of risk reports, examines current practice in risk reporting, the barriers to better risk reporting, the wishes of users and the concerns of preparers. It notes that there is a growing agreement among stakeholders that risk reporting needs to improve and that better risk reporting is integral to better governance. ACCA comments that the question of how best to balance what investors and other users want to see in a risk report with what organisations are willing to disclose remains to be answered, with organisations reluctant to disclose anything that might threaten competitive advantage, or to discuss potential risks in detail in case this alarms stakeholders (especially providers of finance). It states that this often results in a boilerplate, generic risk report that serves no one's interests.

The report consists of the following sections:

Risk reporting today

This section considers the impact of high profile corporate failures and risk reporting after the financial crisis. It notes that most of the guidance and regulatory requirements for risk reporting were developed after the financial crisis and some nations have a better record than others, historically, of forcing or encouraging companies to report on risk. It comments that many users believe that risk reporting has improved since the crisis, but most would argue there is room for improvement. It cites the increased profile of risk management and reporting as one of the most important legacies of the crisis.

The report comments that the raised profile of risk reporting in the financial sector is having a "trickle-down effect" on other sectors, but notes that some sectors are inherently more risky than others (notably the extractives industry) and that, although internal risk management is well developed, it does not necessarily follow that risk reporting is equally advanced. The report comments that companies in the financial services and extractive industries sectors are generally considered to be producing some of the most thorough and innovative risk reports.

What is wrong with risk reporting today?

The report notes widespread concern about the quality of risk reporting among stakeholders, adding that users, who tend to be the most critical, argue that risk information is either difficult to find or too unspecific to be of significant use. The report comments that users consulted spoke of a wariness on the part of organisations to talk openly and fully about risk, while preparers argued that there was a basic conflict between the instinct to be positive in an annual report and the nature of risk reporting, which requires "an examination of dark recesses".

What does a good risk report look like?

The report notes that improving risk reporting will be a delicate balancing act between the needs of users and the concerns of preparers. It argues that, on a superficial level, the debate over what should and should not be included in a risk report can be summed up as: users want more and preparers want to provide less. The report includes a "wish list" of content for a risk report and this includes the identification of the key risks the company faces (in plain English) and an explanation of why management believes these risks to be critical. The report states that many preparers argue that the main purpose of a risk report should be to provide enough information for a useful conversation about risk between stakeholders and management.

What is the future of risk reporting?

The report notes divergent views as to the role of regulation in encouraging better risk reporting, pointing out that although the possibility of an internationally recognised standard or guidance on risk has been mooted, it has not generally gained a great deal of support. It comments that many observers argue that the move towards integrated reporting might encourage better risk reporting over time. Participants in the research noted the importance of peer pressure in encouraging companies to be more transparent.

(ACCA, Reporting risk, 12.15.14)

FRC: Consultation paper on amendments to FRS 101 (reduced disclosure framework) (2014/15 Cycle)

On December 15, 2014 the Financial Reporting Council (FRC) published a consultation paper on its UK Generally Accepted Accounting Principles standard on the reduced disclosure framework (FRS 101). FRS 101 allows qualifying entities within groups, where the parent of that group prepares publicly available consolidated financial statements, to apply the recognition and measurement requirements of EU-adopted International Financial Reporting Standards (IFRS), whilst reducing their disclosure requirements.

The consultation paper is line with advice from the Accounting Council to update FRS 101 at regular intervals to ensure that the reduced disclosure framework maintains consistency with EU-adopted IFRS. The consultation paper does not include any amendments to FRS 101 that may be necessary as a result of the implementation of the Accounting Directive in UK and the FRC confirms that those amendments will be consulted on separately, possibly in early 2015.

(FRC, Consultation paper on amendments to FRS 101 (reduced disclosure framework) (2014/15 Cycle), 12.15.14)


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