Corporate governance and narrative reporting developments – Autumn 2017

Publication | November 2017

Introduction

There have been a number of corporate governance developments since the Summer of 2017, as well as developments in the narrative aspects of annual reports and accounts. This briefing summarises those developments and looks at some of the future developments in these areas that companies need to start preparing for. 

Corporate governance developments

Corporate governance review

BEIS Committee: Government responds to corporate governance report

In September 2017, the Business, Energy and Industrial Strategy Committee (BEIS Committee) published the Government's response to the BEIS Committee’s report on corporate governance which was published in April 2017. Since then, the Government, in August 2017, published its own response to its Green Paper consultation on corporate governance, which supports a number of the BEIS Committee’s recommendations.

The Government’s response to a number of BEIS Committee’s recommendations is as follows:

Promoting good corporate governance

  • Recommendation 1 – The Government agrees with the BEIS Committee that all companies of significant size (private as well as public) should explain how their directors have had regard to their employee and other non-shareholder interests set out in section 172 Companies Act 2006, and intends to make this form of reporting a legal requirement by introducing secondary legislation. The Government will publish a draft statutory instrument setting out details later this year.
  • Recommendation 2 – The Government believes that a formal annual rating exercise risks undermining the current valuable and legitimate flexibility of the UK’s ‘comply or explain’ approach to corporate governance.
  • Recommendation 3 – The Government does not, at this stage, believe that the Financial Reporting Council (FRC) should receive extra powers to engage and hold directors to account for their duties. However, it notes the steps it has set out in its own response to the Green Paper in this area.
  • Recommendation 4 – The Government supports further development of the role of the Investor Forum and notes that the Investment Association and other representative bodies offer additional means to facilitate dialogue between investors and boards.
  • Recommendation 5 – The Government agrees that companies should be required to explain how they are engaging with stakeholders and notes that further details will be set out in a draft statutory instrument to be published later this year.
  • Recommendation 6 – The Government agrees that institutional investors have a vital stewardship role in relation to the companies in which they are invested and welcomes ideas for strengthening this role.
  • Recommendation 7 – The Government agrees that companies’ use of advisers should be subject to appropriate transparency and accountability but does not plan to introduce any further requirements on private companies at present, though notes that this might be an area for consideration by the group developing corporate governance principles for large private companies. The Government will also consider some of the points raised as part of transposing the Shareholder Rights Directive in the UK.

Private companies

The Government shares the BEIS Committee’s view that good corporate governance is relevant to all companies, not just those with a public listing, and notes the steps it has taken in the response to the Green Paper for the development of an appropriate code or set of principles for large private companies.

Executive pay

The Government believes that companies should continue to have the flexibility to choose the long-term share remuneration policies and models that they put to investors for approval. At the same time, companies and shareholders should aim to be more open to alternatives to the currently dominant LTIP model. The Government notes the proposals it set out in its response to the Green Paper in this area. This includes steps taken by companies that receive significant shareholder dissent on executive pay, the position of chair of remuneration committees, the broader responsibilities of the remuneration committee in overseeing pay and reward across the company, and the requirement to publish the pay ratio between the CEO and average employee pay, as will be required by secondary legislation.

Composition of boards

In response to the BEIS Committee’s report, the Government is not preparing to mandate that, from May 2020, at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women as it believes the Hampton-Alexander Review targets of 33 per cent women on FTSE 350 boards and 33 per cent women on executive committees and their direct reports by 2020 should be met first in terms of diverse workforces. The Government also continues to believe that a non-legislative solution is the right approach for now, rather than legislation requiring FTSE 100 companies to publish their workforce data, broken down by ethnicity and by pay band. The Government also does not intend to guarantee the FRC an increased role in overseeing the rigour of the board evaluation process by the external facilitator.

BEIS: Government response to Green Paper consultation on corporate governance reform

The Department for Business, Energy & Industrial Strategy (BEIS) published the Government’s response to its Green Paper on corporate governance reform (Green Paper) in August 2017. The response document identifies nine proposals for reform which the Government intends to take forward.  It also includes a summary of the responses to the Green Paper.

Background to the Green Paper

The Green Paper was published in November 2016 and its purpose was to consider changes that might be appropriate to the UK’s corporate governance regime to help improve business performance and ensure that the economy works for all. The Government consulted on three specific aspects of corporate governance, namely executive pay, strengthening the employee, customer and supplier voice and corporate governance in large privately-held businesses.  The nine proposals for reform relate to these aspects of corporate governance.

Executive pay

Proposal 1

The Government is to invite the Financial Reporting Council (FRC) to revise the UK’s Corporate Governance Code:

  • To be more specific about the steps that premium listed companies should take when they encounter significant shareholder opposition to executive pay policies and awards (and other matters). The FRC will need to consult on the new measures in the UK Corporate Governance Code and the Government notes that the new provisions could include, for example, provisions for companies to respond publicly to dissent within a certain time period, or to verify that dissent has been sufficiently addressed by putting the company’s existing or revised remuneration policy to a shareholder vote at the next annual general meeting. Stakeholders will also be able to comment on whether the new measures should apply to all premium listed companies or only to those in the FTSE 350. The Government notes in the response document that it will monitor the impact of these measures carefully once they are in place and will consider further action at a future point unless there is clear evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes.
  • To give remuneration committees a broader responsibility for overseeing pay and incentives across their company and require them to engage with the wider workforce to explain how executive remuneration aligns with wider company pay policy (using pay ratios to help explain the approach where appropriate). This will involve the FRC consulting on revisions to the UK Corporate Governance Code and its supporting guidance and the Government notes that this consultation will provide an opportunity to seek best practice examples from those remuneration committees that already proactively engage with the wider workforce while enabling current work in this area by a number of prominent think-tanks to be taken into account. The Government also proposes to ask the FRC to include in its consultation a proposed new provision that chairs of remuneration committees should have served for at least 12 months on a remuneration committee, unless there is a clear and valid explanation why this may not be appropriate in a particular case.
  • To extend the recommended minimum vesting and post-vesting holding period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes in setting share based remuneration. The Government notes that lengthening the holding period in this way would bring the rules for executive remuneration closer to those introduced in 2015 for the banking sector which lengthened deferral periods for variable pay to seven years.

Proposal 2

The Government is to introduce secondary legislation to require quoted companies:

  • To report annually the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year and setting the ratio in the context of pay and conditions across the wider workforce. The Government notes that the new pay ratio reporting requirement should, for reasons of consistency and simplicity, cover UK employees only. However, multinational companies could publish a broader ratio alongside, covering all employees in their group. Currently the Government proposes that the ratio should be calculated based on the CEO’s total annual remuneration relative to the average total remuneration of the company’s UK workforce. This will enable the new reporting requirement to be based in most cases on existing payroll data. Further details will be set out in a draft statutory instrument to be published later in the year.
  • To provide a clearer explanation in remuneration policies of a range of potential outcomes from complex, share-based incentive schemes. This proposal reflects the arguments of a number of investors and other respondents that companies’ executive remuneration policies should be required to set out more clearly the potential remuneration outcomes of long-term incentive plans under a range of scenarios, including significant share price growth. The new requirement will build on the existing requirements governing the content of remuneration policies set out in Schedule 8 of the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended). The Government will also invite the FRC to seek stakeholder views during its consultation on changes to the UK Corporate Governance Code on whether and how new principles or detailed guidance on share-based remuneration could be included there.

Proposal 3

The Government intends to invite the Investment Association to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20 per cent or more, along with a record of what these companies say they are doing to address shareholder concerns.

Other issues in relation to executive pay

The Government notes in the response paper that it will commission an examination of the use of share buybacks to ensure that they cannot be used artificially to hit performance targets and inflate executive pay. The review will also consider concerns that share buybacks may be crowding out the allocation of surplus capital to productive investment and the Government will announce more details shortly.

In terms of other options included in the Green Paper in relation to executive pay, the Government will not be taking these forward at the moment. These are as follows:

  • The possibility of establishing a Shareholder Committee to oversee executive pay, directors’ nominations and strategy at every quoted company;
  • Mandatory disclosure of investor voting records;
  • Increasing retail investor voting through industry-led action or legislative change; and
  • Adding further regulation to the existing disclosure framework for directors’ bonus targets.

Strengthening the employee, customer and wider stakeholder voice

Proposal 4

The Government intends to introduce secondary legislation to require all companies of significant size (private as well as public) to explain how their directors comply with the requirements of section 172 Companies Act 2006 to have regard to employee and other interests. The Government notes that the operation of this new reporting requirement will be subject to further consideration. It envisages that it would include a requirement to explain how the company has identified and sought the views of key stakeholders, why the mechanisms adopted were appropriate and how this information has influenced decision-making in the boardroom. Such disclosures might have to be included on the company’s website as well as in its annual strategic report.

In terms of determining which companies should be subject to the new reporting requirement, the Government’s initial view is that a threshold based on employee numbers would be reasonable and its initial view is that a threshold of 1000 employees should be used. However, this will be subject to further consideration.

Proposal 5

The Government will invite the FRC to consult on the development of a new UK Corporate Governance Code principle establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level as an important component of running a sustainable business. As part of this, the Government will ask the FRC to consider and consult on a specific provision requiring premium listed companies to adopt, on a “comply or explain” basis, one of three employee engagement mechanisms:

  • A designated non-executive director;
  • A formal employee advisory council; or
  • A director from the workforce.

The Government notes that many companies already have mechanisms in place to ensure that employee and other stakeholder voices are heard and taken into account in boardroom decision-making but it wants to ensure that good practice is adopted more widely and more consistently, including potentially to larger private companies.

Proposal 6

The Government intends to encourage industry-led solutions by asking the Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders. This is something that they are already developing. The Government will also invite the GC100 to complete and publish new advice and guidance on the practical interpretation of directors’ duties in section 172 Companies Act 2006. The Government notes that it has no plans to amend section 172 but it does consider that it would be useful to have more guidance for companies of all sizes on how the “enlightened shareholder value” model enshrined in section 172 should work in practice. It notes the recommendations in relation to employee voice made by Matthew Taylor in his Review of Modern Working Practices published in July 2017 and the Government will consider these and respond to the whole report later in 2017.

Corporate governance in large privately-held businesses

Proposal 7

The Government is to invite the FRC to work with the Institute of Directors, the CBI, the Institute for Family Businesses, the British Venture Capital Association and others to develop a voluntary set of corporate governance principles for large private companies under the chairmanship of a business figure with relevant experience. In making application of these principles voluntary, the Government notes that private companies would be able to continue to use other industry-developed codes and guidance if they are considered more appropriate. Companies will also be able to adopt, or to continue to use their own preferred approaches.

Proposal 8

Secondary legislation will be introduced to require companies of a significant size to disclose their corporate governance arrangements in their directors’ report and on their website, including whether they follow any formal code. This requirement will apply to all companies of a significant size unless they are subject to an existing corporate governance reporting requirement. The Government will also consider extending a similar requirement to limited liability partnerships of equivalent scale. Further consideration is to be given to the size of company that would be covered by the new reporting requirement, but the Government’s initial view is that it should apply to companies with over 2000 employees. It will apply to privately-owned and public companies but there will be an exemption for premium listed companies required to report against the UK Corporate Governance Code or companies required by the Disclosure Guidance and Transparency Rules to issue a corporate governance statement. The disclosure will include details of any UK Corporate Governance Code or other formal set of corporate governance principles that the company has adopted. Where a company departs from any of the provisions in the adopted code or principles, it should explain which parts these are and the reasons for the departure. If a company has decided not to adopt a formal code or set of principles, it will be required to explain the reasons.

Other issues relating to strengthening the UK’s corporate governance framework

Proposal 9

The Government notes that consultation on the Green Paper revealed questions over whether the FRC has the powers, resources and status to undertake its functions effectively. To address this, the Government is to ask the FRC, the Financial Conduct Authority and the Insolvency Service to conclude new, or in some cases revised letters of understanding with each other before the end of 2017 to ensure the most effective use of their existing powers to sanction directors and ensure the integrity of corporate governance reporting. In light of this work, the Government will then consider whether further action is required.

Next steps

The Government notes that the FRC intends to consult on amendments to the UK Corporate Governance Code in the late Autumn. The Government intends to lay before Parliament draft secondary legislation, where required, before March 2018. The work on developing voluntary corporate governance principles for large private companies will commence in the Autumn.

The current intention is to bring the reforms into effect by June 2018 to apply to company reporting years commencing on or after that date.

The Government notes that many of the recommendations set out in the House of Commons Business, Energy and Industrial Strategy Committee’s report on Corporate Governance published April 2017 are concerned with potential amendments and enhancements to the UK Corporate Governance Code and guidance. While the Government supports many of these recommendations, it notes that they are ultimately matters for the FRC to consider and states that many will be addressed in the consultation on the UK Corporate Governance Code that the FRC intends to undertake in the Autumn.

The Government also notes that the reforms set out in the response document will complement wider work that the Government and others such as Mathew Taylor, Sir Philip Hampton, Sir John Parker and Baroness McGregor-Smith have done and are leading in relation to matters such as increasing gender and ethnic diversity in the boardroom and the workforce.

Developments in relation to dialogue between shareholders and listed companies

ISS: Consultation on changes to UK/Ireland policy on virtual/hybrid shareholder meeting proposals

In October 2017, the Institutional Shareholder Services (ISS) published its 2018 benchmark policy consultation, seeking views on changes to certain of its voting policies for 2018.  In relation to its UK/Ireland policy and its European policy, ISS is considering adding a new policy on virtual/hybrid shareholder meetings.  While ISS notes that the practice of holding virtual shareholder meetings is rare in the UK, it comments that a growing number of companies have sought shareholder approval for article amendments that allow for the possibility of hybrid or virtual shareholder meetings in the future.  While in continental Europe the practice of holding virtual or hybrid shareholder meetings has not been observed, it notes that it is thought that the practice could emerge at some point if UK and US-based companies continue to adopt it.

Key changes under consideration

Under the proposed policy, ISS will generally recommend FOR proposals that allow for the convening of hybrid shareholder meetings and will generally recommend AGAINST proposals that allow for the convening of virtual-only shareholder meetings.

ISS is proposing these changes in light of investors’ views on virtual shareholder meetings. It notes that some investors are concerned about moves to completely eliminate physical shareholder meetings, arguing that virtual meetings may hinder meaningful exchanges between management and shareholders and enable management to avoid uncomfortable questions.  However, investors generally support “hybrid” meetings, where companies employ technological means to allow for virtual participation as a supplement to the physical shareholder meeting.

Questions for comment

While ISS welcomes any comments on the topic, it specifically seeks feedback on the following:

  • If investors would be willing to support “virtual-only” shareholder meetings if they provide the same shareholder rights as a physical meeting, what rationale or assurances would be required for investors to support changes to the articles of association allowing for “virtual-only” shareholder meetings?
  • Should ISS provide additional disclosure or alter its voting policies in markets where shareholder approval is not required for companies to switch to virtual-only meetings?

Next steps

ISS expects to publish its final 2018 benchmark policy changes in the second half of November 2017 and it will apply the revised policies to shareholder meetings on or after February 1, 2018.

Investment Association: FTSE companies asked to explain how they have tackled shareholder concerns

In October 2017, the Investment Association (IA) announced that it is writing to FTSE companies that are due to appear on the Public Register of shareholder votes. The letter is being sent to companies in the FTSE All-Share who received votes of 20 per cent against any resolution or withdrew a resolution in 2017.

The Government announced the setting up of the Public Register in its August 2017 response to the Green Paper on corporate governance reform. The IA is prompting companies to provide a public explanation on how they have addressed their shareholders concerns since the shareholder vote before the Public Register goes live later this year. The main aim of the Public Register is to focus attention on those companies who have received a significant vote against and to track whether and how they are responding to shareholder concerns.

The Public Register will be launched in the fourth quarter of this year and will be updated regularly. The Public Register will include:

  • a description of the resolution;
  • the result of the shareholder vote;
  • a link to the AGM results announcement (including any statement the company has made under Provision E 2.2 of the UK Corporate Governance Code); and
  • a link to any further statement the company has made on the actions they have taken since the vote.
ICSA and the Investment Association: The stakeholder voice in board decision making – Guidance

In September 2017, the Governance Institute of the Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association issued joint guidance on stakeholder engagement which is aimed at helping company boards think about how to ensure they understand and weigh up interests of their key stakeholders when taking strategic decisions (Guidance).

In the Government’s response to its Green Paper consultation on corporate governance reform published in August 2017, in the context of its proposals for strengthening the employee, customer and wider stakeholder voice, the Government said that it would be encouraging industry-led solutions in this area by asking ICSA and the Investment Association to complete the joint guidance they announced in January 2017 on practical ways on which companies can engage with their employees and other stakeholders.  This is the Guidance which has now been published.

The Guidance is designed to take boards through the different elements involved in understanding and assessing the company’s impact on key stakeholders, noting that while almost all companies will have common key stakeholders such as workers and customers, for each company the list will be different depending on factors such as their size, location and the nature of their activities and business relationships. As a result, the mechanisms used by boards to gain an understanding of the views of their key stakeholders will vary and each company’s approach needs to be informed by its purpose, culture and value.

In light of this, the Guidance does not attempt to set out a comprehensive range of different approaches that should be considered but it includes a list of ten core principles that should guide the way boards approach the issue and the Guidance also contains illustrative examples of how some companies have gone about the process. In addition, the Guidance considers a potential change to the UK Corporate Governance Code, as announced by the Government in its August 2017 response document, which would require listed companies to have either a designated non-executive director, a formal employee advisory council or a director from the workforce, or to explain why they do not have one.  The Guidance covers these approaches, among others, but states that companies should choose whichever approach or approaches are, in the opinion of the board, most likely to lead to effective engagement and an enhanced understanding of the impact of their decisions on their key stakeholders.

The Guidance is divided into seven sections as follows:

Directors’ duties

The Guidance notes the general statutory duties of directors set out in sections 171-181 Companies Act 2006, noting in particular the duty to promote the success of the company set out in section 172.

Stakeholder identification

The Guidance points out that boards should identify and prioritise their stakeholders. They should identify the groups which have a positive or negative impact on the company’s ability to operate or are potentially impacted by the company’s activities.  They could then conduct a mapping exercise to prioritise these stakeholders for the purposes of engagement by identifying the key stakeholders and/or the issues or activities with the most material impact on a range of stakeholders.  The Guidance notes that once the prioritisation exercise has been completed, it should lead to a discussion of the extent to which the board needs information on and from those stakeholders, how extensively the company should engage with them, and how best to do so.  It includes, as an example, a matrix developed by the Royal Bank of Scotland Group to identify the significant issues that impact on its different stakeholder groups.

The Guidance also points out that boards should consider in the identification process the types of individuals or groups that they will use as points of contact for a particular stakeholder group. The board should also have a process in place for reviewing the groups identified as key stakeholders to make sure that engagement remains appropriate for the relevant audience.  It notes the manner in which Intu Properties conducted a review of its stakeholder programme in 2016.

Board composition

The Guidance notes that the board’s knowledge and understanding of the interests of the company’s key stakeholders should be among the factors considered when assessing the overall composition of the balance of the board and whether there is a need to recruit new directors. In relation to the approach to acquiring expertise, it suggests that one broad approach would be to reserve one or more board positions for directors drawn from a stakeholder group, such as the workforce.  Another approach would be to extend the selection criteria and search methods for non-executive directors to identify individuals with relevant experience or understanding of one or more stakeholder groups.  It considers the merits of both of these approaches and points out that they need not be mutually exclusive.

Given that directors share collective responsibility for the board’s actions and have the same legal responsibilities and liabilities, the Guidance recommends that unless there are exceptional considerations, the terms of appointment for these directors should be the same as for other directors.

The Guidance looks at the selection and search procedures in relation to finding a new director and sets out a number of questions to be considered if it is decided that one or more new directors are needed to bring an understanding of particular stakeholders. It also sets out particular questions to be considered by a board if it is decided that one or more directors should be appointed to represent the views of the workforce and it suggests companies may also wish to consider whether there is a case for appointing one or more non-executive directors with specific responsibility for other key stakeholders.

Induction and training

The Guidance notes that directors will be more effective in their role if they have benefited from a well-thought-out and effective induction programme which enables them to build an understanding of the nature of the company, its business and its markets, build a link with the workforce and build an understanding of the company’s main relationships.

The Guidance looks at designing a directors’ induction programme and it suggests a non-exhaustive list of activities that could be considered to give the new director an understanding of the role and nature of the company’s principal stakeholders. The Guidance also stresses the need for ongoing director training.

Board discussion

The Guidance points out that having relevant expertise on the board is only of limited use if that expertise is deployed and engaging with important stakeholders is only of limited value unless the results of that engagement are used to inform the board’s decisions. It notes that many boards suffer from a shortage of time and an excess of information so it looks at the following:

  • the management of the board’s agenda;
  • the form and frequency of the information the board wishes to receive, including any relevant performance measures; and
  • whether any board committees or individual directors should have specific responsibilities for some stakeholder-related issues.

The Guidance also looks at the approach of designating to one or more individual directors the task of understanding the views of, and impact on, key stakeholders in ensuring these are fed into the board’s discussions. It considers issues that will arise if this approach is adopted and sets out a list of points for boards to consider if they do decide to designate one or more non-executive directors.

Engagement mechanisms

This section of the Guidance gives some illustrative examples of approaches already being used by companies to engage with their important stakeholders, with the aim of prompting companies to review their own existing mechanisms and to consider whether there would be value in adopting alternative or additional ways of engaging with the stakeholders concerned. In assessing the overall engagement carried out by the company, the Guidance sets out a number of key questions boards should consider.

In terms of engagement mechanisms, it looks at forums and advisory panels, as well as at other engagement mechanisms such as surveys and social media. It also considers staff engagement mechanisms and includes examples in each case.

Reporting and feedback

This section of the Guidance considers both how companies should report to shareholders and to their other stakeholders. It notes that reporting to shareholders will primarily be done through the annual report and accounts and through subsequent ongoing or specific engagement, such as meetings or discussions at and before the annual general meeting. It notes that reporting should cover the following three questions:

  • Who are the key stakeholders?
  • How does the board hear from its key stakeholders?
  • What were the outcomes of the company’s engagements with its key stakeholders, and what impact did that all have on the board’s decisions?

The Guidance notes that one approach would be for the board to disclose its key stakeholders and explain concisely the processes that the board has in place to receive input and information from stakeholders. It could then demonstrate how the directors have fulfilled their duties under section 172 by explaining how information gathered through engagement with stakeholders has informed the board’s decisions during the year.

The Guidance also considers reporting to other stakeholders and notes that companies should consider what other reporting and feedback mechanisms might be necessary. It considers publications and online resources as well as other forms of reporting and feedback. It also points out that different stakeholders may want or require reporting on different timescales so while annual reports may be appropriate for groups such as shareholders, social media and other forms of communication could be used to update other stakeholders on a more regular basis.

Next steps

The Guidance notes that the Government’s intention is that the various reforms to corporate governance that it announced in August 2017 will come into effect by June 2018. ICSA and the Investment Association will update the Guidance if necessary to reflect the new reporting requirements and potential changes to the UK Corporate Governance Code. They state that in any event, they will review the Guidance in the second half of 2019 to learn from companies’ experience of applying it.

The Investment Association: FTSE 350 companies respond to shareholders’ executive remuneration concerns

In August 2017, the Investment Association (IA) published a press release containing an analysis of voting data from the 2017 AGM season.

When compared to voting data from the 2016 AGM season, the IA notes that:

  • FTSE100 companies have listened to shareholders and acted on 2016 investor concerns regarding remuneration reports, with a 35 per cent decrease in 2017 remuneration resolutions that received over 20 per cent dissent (down from 14 in 2016 to nine in 2017);
  • Meanwhile, FTSE250 companies witnessed a 100 per cent increase in companies getting 20 per cent or more of votes against their remuneration resolutions compared to 2016 (with 29 companies affected this year, up from 15 in 2016);
  • Overall, FTSE350 companies saw a 400 per cent increase in votes against a director re-election (from four directors in 2016 to 21 directors in 2017); and
  • Six FTSE350 companies withdrew resolutions on pay ahead of the company AGMs to avoid a shareholder rebellion.

Developments in institutional investor/proxy adviser matters

Best Practice Principles Group: Consultation on Shareholder Voting Research and Analysis

In October 2017, the Best Practice Principles Group (BPP Group) launched a consultation that seeks views from investors and companies on whether the Best Practice Principles for Shareholder Voting Research and Analysis (the Principles) have been effective in ensuring the integrity and efficiency of the services provided by shareholder voting analysts and advisors.

The Principles, introduced in 2014, were developed by the industry to provide a voluntary performance and reporting framework, to promote a greater understanding of its role, and to promote the integrity and efficiency of processes and controls related to the provision of these services and management of any conflicts of interest.

The BPP Group has also published a consultation questionnaire, which asks various questions including the following:

  • Would it be beneficial to have a set of principles that are capable of being applied in all markets?
  • Are there any other issues or activities that should also be covered by the Principles, such as intermediary vote processing and confirmation, ESG advisory services and indices or governance engagement services?
  • Is the structure of the Principles, whereby each principle is accompanied by guidance which sets out practices to be followed and information to be disclosed on a "comply or explain" basis, clear and appropriate?
  • Should details of any other potential sources of conflict of interest be included in the non-exhaustive list currently set out in the Principles?
  • How satisfied are companies with their communication with signatories to the Principles?
  • What are the views of investors in relation to many companies' belief that they should have the opportunity to comment on the analysis and recommendations in research reports before they are finalised?

The BPP Group is keen to hear from investors, companies and other providers of voting research and related services on their experience by December 15, 2017. A decision has not yet been taken on whether there will be a second consultation on draft revised Principles and reporting arrangements. This is likely to depend on the extent of any revisions proposed, and will be informed by the responses to this consultation.  If it is decided that a second consultation is not necessary, then the aim would be to publish a report setting out the findings and conclusions of the review, together with the revised Principles and details of the reporting and monitoring arrangements in April 2018. If there is a second consultation, it will begin in April 2018 and the revised Principles and other documents will be published in July or August 2018.

Pre-Emption Group: No change to pre-emption thresholds for Prospectus Regulation

In July 2017, the Pre-Emption Group announced that the Investment Association and the Pensions and Lifetime Savings Association will continue to support the current overall limit of a ten per cent disapplication authority, as specified in the 2015 Statement of Principles – Disapplying Pre-Emption Rights (and the two template resolutions for the two separate five per cent authorities), despite the newly introduced exemption from the obligation to publish a prospectus for up to a 20 per cent increase in securities admitted to trading.

The provisions in the Prospectus Regulation that introduce the new threshold came into force on July 20, 2017 (although the majority of its provisions will apply 24 months thereafter and will take effect from July 2019). However, the Financial Reporting Council (FRC) notes that no change to the flexibility permitted by the Statement of Principles is expected as a consequence of the Prospectus Regulation.

Diversity developments

Hampton-Alexander Review: Improving gender balance in FTSE leadership

In November 2017, the Hampton-Alexander Review published a “one year on” report, summarising how women’s representation is progressing on FTSE 350 boards and in the “executive pipeline”, the executive committee and those who report to members of the executive committee.  This follows the targets set in November 2016 by the Hampton-Alexander Review which included a target of 33 per cent women on FTSE 350 boards and 33 per cent women in FTSE 100 leadership teams by 2020.  The target of 33 per cent women in leadership teams also now applies to FTSE 250 companies.

The report includes the following:

Executive committee and direct reports

  • While the number of women on the combined executive committee and direct reports of FTSE 100 companies has only increased from 25.1 per cent in 2016 to 25.2 per cent in 2017, the report notes that transparency has been much improved, with all FTSE 100 companies submitting their leadership data and an automated collection process and robust guidance.
  • All but 10 FTSE 250 companies submitted data in 2017 and their combined executive committee and direct reports are 25 per cent, although women’s representation on executive committees within the FTSE 250 is 16.6 per cent, compared to 19.3 per cent for the FTSE 100.
  • 55 FTSE 350 companies are at or above the 33 per cent target currently.
  • The report notes that a step change is needed in pace as less than a third of FTSE 350 leadership roles went to women in 2017. It notes that almost one in two or around 40 per cent of all appointments will need to go to women over the next three years to achieve the 33 per cent target.

Women on boards

  • The FTSE 100 figure has increased from 26.6 per cent in 2016 to 27.7 per cent. Over one third of the FTSE 350 are already at 33 per cent or more, or are on track to achieve this by 2020.
  • In order for FTSE 100 boards to reach the 33 per cent target by the end of 2020, the report notes that they need to achieve the same rate of progress over the next three years as they did in the previous three years and similarly with a step up in appointment rates.
  • There were 10 all-male boards in the FTSE 350 as at the beginning of November 2017.

Other information

  • The report lists those companies which have made significant progress during the past year and also consider the drivers of progress. The two variables that drive progress are the turnover rate and the appointment rate.
  • The report features some of the recent innovations and different thinking seen across a variety of industries in order to provide examples of initiatives that have had a high impact.
  • The report includes a number of FTSE “board stories” providing perspectives from chairs, a company secretary and a non-executive director.
  • The report includes a section on international comparators, reviewing progress being made elsewhere and summarising how other countries are tackling the gap in diverse leadership on listed company boards.
  • The report includes detailed analysis of progress in appendices.
Parker Review Committee: Final report into the ethnic diversity of UK boards

In October 2017, the Parker Review Committee, led by Sir John Parker, published its final report (Report) into the ethnic diversity of UK boards. This follows the report that the Parker Review Committee published in November 2016 which summarised the findings of their review so far and was prepared for consultation purposes.

The Report notes that UK citizen directors of colour represent only about two per cent of the total director population and 51 out of the FTSE 100 companies do not have any directors of colour. The Parker Review Committee believes that it is important that FTSE 100 and FTSE 250 companies change the way they approach the issue of ethnic diversity in the boardroom and the pipeline and as well as highlighting clear business reasons for increasing ethnic diversity on UK boards, the Report includes a number of recommendations as follows:

Increasing the ethnic diversity of UK boards

  • Each FTSE 100 board should have at least one director of colour by 2021 and each FTSE 250 board should have at least one director of colour by 2024.
  • Nomination committees of FTSE 350 companies should require their human resources teams or search firms (as applicable) to identify and present qualified people of colour to be considered for board appointment when vacancies occur.
  • Relevant principles of the Standard Voluntary Code of Conduct for executive search firms, which have been used successfully for gender-based recruitment, should be extended on a similar basis to apply to the recruitment of minority ethnic candidates as board directors of FTSE 350 companies.

Development of candidates for the pipeline and plan for succession

  • FTSE 350 companies should develop mechanisms to identify, develop and promote people of colour within their organisations to ensure over time that there is a pipeline of board capable candidates in their managerial and executive ranks that appropriately reflects the importance of diversity to their organisation.
  • Led by board chairs, existing board directors of FTSE 350 companies should mentor and/or sponsor people of colour within their own companies to ensure their readiness to assume senior managerial or executive positions internally or non-executive board positions externally.
  • Companies should encourage and support candidates drawn from diverse backgrounds, including people of colour, to take on board roles internally (e.g. subsidiaries) where appropriate, as well as board and trustee roles with external organisations to give experience and develop oversight, leadership and stewardship skills.

Enhanced transparency and disclosure

  • The board’s policy on diversity should be described in the annual report and this should include a description of the company’s efforts to increase, amongst other things, ethnic diversity within its organisation, including at board level.
  • Companies that do not meet board composition recommendations by the relevant date should disclose in their annual report why they have not been able to achieve compliance.

The Report includes “Questions for Directors” in Appendix A and a “Directors Resource Toolkit” in Appendix B to help existing boards deliver on the recommendations of the Report. Appendix C sets out case studies, with organisations providing practical examples of the steps they have taken to improve diversity in their organisations and within their executive and board ranks.

Next steps

The Report notes that based on the current rates of turnover amongst FTSE 100 directors, the Parker Review Committee estimates that to reach an ethnically diverse mix similar to that of the overall adult working population by 2021 (approximately 15 per cent), one in five new board appointees would need to be a person of colour. Taking into account typical board appointment cycles, they calculate that this would mean that, on average, each FTSE 100 company would need to appoint one minority director in the period to 2021. 

The Parker Review Committee plans to stay intact at least through 2021 and will meet at least annually to assess efforts being made and progress in relation to the Report’s recommendations. It encourages FTSE 350 companies to adopt the recommendations on a voluntary basis but notes that if there is insufficient progress it may endorse that the recommendations (or relevant parts) become mandatory.

Remuneration developments

Investment Association: Revised Principles of Remuneration

In November 2017, the Investment Association published their updated Principles of Remuneration (Principles) which set out, through over-arching Principles and general guidance, the views of Investment Association members on the role of shareholders and directors in relation to remuneration and the manner in which it should be determined and structured. While predominantly aimed at Main List companies, the Investment Association notes that the Principles are also relevant to companies on other public markets, such as AIM, and other entities.

Key changes from the October 2016 Principles include the following:

  • Discretion specific to a particular incentive scheme should be disclosed in the remuneration policy in addition to the plan rules.
  • In reporting on matters such as the gender pay gap or publishing executive pay to employee pay ratios, the remuneration committee should provide numbers in the context of the company’s business and fully explain why these figures are appropriate.
  • In consulting with shareholders on remuneration, details of the whole remuneration structure, not just the proposed changes, should be provided.
  • Following consultation and before the remuneration report is finalised, the remuneration committee should review the proposals in light of subsequent events between the consultation and implementation of the policy, to ensure the proposals remain appropriate.
  • Relocation benefits should be disclosed when an executive director is appointed. If needed, they should be for a limited period, disclosed to shareholders and each element detailed in the remuneration report.
  • In relation to annual bonuses, the definition of performance measures should be clearly disclosed, any adjustments to the metrics set out in the accounts should be clearly explained and the impact of the adjustment on the outcome disclosed.
  • When a bonus is paid, a full analysis of the performance relative to targets should be provided in the remuneration report and bonus targets should be disclosed no later than 12 months following payment of the bonus award.
  • Deferral of a portion of the bonus into shares is expected for any bonus opportunity of greater than 100 per cent of salary.
  • In looking at long-term incentives, remuneration committees should select a remuneration structure that is appropriate, efficient and cost-effective in delivering long-term strategy and its selection should be well justified to shareholders.
  • If an LTIP-type structure is chosen, performance conditions should be carefully chosen so they are suitable for measurement over a long period of time, threshold vesting amounts should not be significant compared to annual base salary and full vesting should reflect exceptional performance and depend on achieving significantly greater value creation than that applicable to threshold vesting.
  • In relation to restricted share awards, the discount rate for moving to these from an LTIP should be a minimum of 50 per cent. The total vesting and post-vesting holding period should be at least five years and some Investment Association members expect restricted share awards to be subject to an appropriate underpin.
Investment Association: Remuneration issues to consider for 2018 AGMs

In November 2017, the Investment Association wrote to chairs of remuneration committees outlining key changes to their updated Principles of Remuneration and highlighting items of focus for their members in the 2018 AGM season.

Issues to be considered for 2018 AGMs include the following:

  • Levels of remuneration – It is hoped all companies will follow the approach of some large companies who have reduced potential variable remuneration rewards and limited overall pay in renewing their remuneration policies in 2017. Increases to variable remuneration maximums in revised remuneration policies, salary increases and “automatic” inflationary salary increases are matters of concern. Disclosure of pay ratios between the CEO and median or average employee and between the CEO and executive team are welcomed. Contribution rates to pensions for executive directors should be at the same level as for the general workforce.
  • Remuneration structures – The letter notes the move by some companies to restricted shares and states that growing numbers of shareholders will support this for the right company, in the right circumstances. However, new remuneration structures should not be proposed only when the current structure is not paying out to the executive directors and remuneration committees are urged to adopt a remuneration structure which is most appropriate for the company and the implementation of its business strategy.
  • Shareholder consultation – The letter notes the consultation process could be improved in some cases. Where companies withdraw resolutions prior to the AGM, they should conduct a full analysis of shareholder feedback and consult further before resubmitting their remuneration policies.
  • Pay for performance – Robust transparency on targets and structures is required so that the link between remuneration and company performance can be clearly seen. Full disclosure of all performance targets is needed, either through disclosure at the time of the award or within 12 months where there is commercial sensitivity. Where adjusted metrics for executive remuneration are used, an explanation of why this is appropriate should be given and a breakdown of how the remuneration target has been adjusted from the headline key performance indicator should be provided. A thorough explanation as to why personal and strategic performance targets have paid out should be provided and IVIS will Amber Top reports where insufficient information on non-financial targets is provided.
  • Accountability of remuneration committee chairs – The letter notes the different approaches investors are taking in their voting policies in relation to the re-election of directors based on decisions made by the remuneration committee.

Narrative reporting developments

Developments in corporate reporting

FRC: Corporate reporting thematic reviews

In November 2017, the Financial Reporting Council (FRC) published three thematic reports to help companies improve the quality of their corporate reporting in acknowledged areas of difficulty, namely judgements and estimates, pension disclosures and alternative performance measures.

The Corporate Reporting Review (CRR) is responsible for the FRC’s thematic reviews. The CRR monitors company reports and accounts for compliance with the Companies Act 2006, including applicable accounting standards and other reporting requirements. In December 2016, the FRC approached 60 companies and informed them that the CRR would review one of the three themes in their next annual report and accounts.

Thematic review – Judgements and estimates

The report sets out the CRR’s principal findings on judgements in corporate reporting and the most commonly disclosed estimates. Overall the CRR found that:

  • Many companies had reconsidered which judgements, assumptions and other areas of estimation uncertainty are genuinely the most difficult, subjective or complex to report.
  • A greater number of companies had clearly distinguished judgements from estimates than in their prior year accounts.
  • The reports of higher quality identified a smaller number of judgements and estimates but provided richer information about the supporting assumptions and sensitivities.
  • The average number of estimates disclosed by the companies reviewed decreased when compared with their previous annual report.
  • While most improved the granularity and level of detail their disclosures a minority of companies still used elements of ‘boilerplate’ text that could apply to any company and gave no additional useful information.

Section 4 of the report sets out the review’s principal findings in more detail and includes examples of better disclosures that illustrate how companies could address these findings. Section 5 sets out the areas where the CRR will challenge companies, including where they do not:

  • identify the assets and liabilities at significant risk of material change in the next 12 months;
  • quantify the specific amounts; and
  • provide sensitivity analysis of the possible range of outcomes.

Thematic review – Pension disclosures

A second report by the CRR on pension disclosures welcomes the new or extended commentaries in strategic reports focusing on how any pension deficit would be addressed and notes that:

  • Most companies disclosed information relating to contributions that are expected to be paid several years into the future distinguishing between those made to cover the deficit and those in respect of current service, but companies could go further to explain that these are reviewed as part of each funding valuation.
  • A number of companies disclosed that, going forward, an increase in dividend payments to shareholders would trigger an increase in the pension scheme contributions and the report notes that this appears to be an increasingly popular mechanism for securing pension scheme funding.
  • Some companies presented complex information using graphics.
  • By disaggregating the analysis of quoted and unquoted assets into further sub-classes, some companies provided more informative disclosures about the assets held by their pension schemes.
  • There is room for improvement in the way companies articulate their schemes’ strategy for matching assets and liabilities better, in particular how they use liability driven investments. Companies that do not provide clear disclosures about the nature and valuation basis of all material asset classes will be challenged.
  • Companies with material net pension assets explained why they considered the asset to be recoverable in terms of IAS 19 and IFRIC 14.
  • Generally, pension disclosures in strategic reports have improved with examples of good practice being the provision of more information about the risks and uncertainties companies face arising from their pension scheme and clear explanations of the reasons for the marked increase in deficits and discussion of action being taken to remedy them.

Thematic review – Alternative Performance Measures

The CRR found that Alternative Performance Measures (APMs) were used by all the companies they reviewed. Compliance with ESMA’s Guidelines on Alternative Performance Measures was generally good and had improved from previous year’s annual  reports. The CRR notes in its report:

  • All companies gave definitions. Labels used generally conveyed an accurate description of each APM, though companies should be clear to identify whether a measure used was an APM or an International Financial Reporting Standards (IFRS) measure.
  • Explanations for the use of APMs were given in all cases and less ‘boilerplate’ language was used than in the CRR’s 2016 review.
  • Reconciliations were given by all companies but not necessarily for every APM used, the most frequently omitted being for ratio’s such as return on capital and cash conversion.
  • Most of the reports gave equal prominence to APMs and IFRS measures.

The CRR was concerned with some of the language used in reports and recommends that companies remove descriptions, such as “non-recurring” from their definitions of APMs and select more accurate labels. A number of examples are given in sections 4 and 5 of the report.

ESMA: Updated Q&As on Guidelines on Alternative Performance Measures

In October 2017, the European Securities and Markets Authority (ESMA) updated its Q&As on its Guidelines on Alternative Performance Measures (APM Guidelines). ESMA’s APM Guidelines aim to promote the usefulness and transparency of APMs in prospectuses and regulated information.

ESMA has added six new Q&As:

  • Question 12 on the definition of APMs – This clarifies that financial measures originally defined or specified in the applicable financial reporting framework and adjusted with the aim of isolating the effect of foreign currency on the measures qualify as APMs.
  • Question 13 on the scope of the APM guidelines – This notes that a segment measure of profitability, which is determined on a different accounting basis than the basis defined or specified in the applicable reporting framework, does fall within the definition of an APM. The application of the APM Guidelines depends on where these measures are presented (for example inside or outside financial statements, regulated information documents or voluntary information).
  • Question 14 on the application of the scope exemption – This notes that the scope of the exemption in paragraph 19 of the APM Guidelines is only applicable when an issuer uses APMs solely to explain compliance with terms of an agreement or legislative requirement.
  • Question 15 on the definition and basis of calculation – This highlights how paragraph 20 of the APM Guidelines requires issuers to provide users with definitions of the APMs used and the basis of calculation adopted, including details of any material hypotheses or assumptions used.
  • Question 16 on reconciliation – This states that issuers should provide a numeric reconciliation between “the most directly reconcilable line item, total or subtotal” presented in financial statements and the APM used. As required in paragraph 26 of the APM Guidelines, the reconciliation should separately identify and explain the material reconciling items.
  • Question 17 on the application of the fair review principle to APMs – This notes that paragraph 8 of the APM Guidelines is based on Articles 4 and 5 of the Transparency Directive, while paragraph 6 of the APM Guidelines aims to contribute to transparent and useful information to the market and improve comparability, reliability and comprehensibility of APMs used.
ESMA: Public Statement on European common enforcement priorities for 2017 IFRS financial statements

In October 2017, the European Securities and Markets Authority (ESMA) published the priorities to be considered by listed companies and their auditors when preparing and auditing their 2017 financial statements. These priorities are set out in the annual Public Statement on European common enforcement priorities in which ESMA promotes the consistent application of International Financial Reporting Standards (IFRS).

The common enforcement priorities for the 2017 year-end are as follows:

  • Disclosure of the expected impact of implementation of major new standards in the period of their initial application: ESMA stresses the need for high-quality implementation of IFRS 9 Financial Instruments, IFRS 15 Revenue from Contracts with Customers and IFRS 16 Leases.
  • Specific recognition, measurement and disclosure issues of IFRS 3 Business Combinations: ESMA draws issuers’ attention to the treatment of intangible assets, adjustments during the measurement period, bargain purchases, mandatory tender offers, business combinations under common control, contingent payments and disclosures on fair value.
  • Specific issues of IAS 7 such as reconciliation of liabilities arising from financial activities: ESMA reminds issuers of the importance of specific disclosure aspects.
  • Requirements of the amended Accounting Directive: ESMA reminds issuers that the 2017 year-end will be the first time that companies are required to disclose non-financial and diversity information and it recommends that the European Commission’s Guidelines on non-financial reporting which describe the methodology for reporting non-financial information should be considered.
  • Inclusion of alternative performance measures in annual financial reports: ESMA urges issuers to meet the principles in its Guidelines on Alternative Performance Measures published in July 2017.
FRC: Auditors and preliminary announcements – Feedback Statement

In October 2017, the Financial Reporting Council (FRC) published its Feedback Statement following its consultation via a Discussion Paper published in April 2017on the role of the auditor in preliminary announcements.

The FRC notes that the majority of respondents believe the current regime for preliminary announcements is adequate and does not require significant change. As a result, the FRC is proposing only minor changes to its current auditor guidance as follows:

  • it does not propose to convert the current guidance (Bulletin 2008/2) into an engagement standard;
  • the FRC sees a potential benefit to a formal requirement being established by the FCA/UK Listing Authority for auditors to follow the FRC’s guidance, or any potential engagement standard, when agreeing to the publication of preliminary announcements as this would formalise current arrangements, but this is something the FRC will have to discuss with the UK Listing Authority;
  • the FRC will revise the Bulletin to ensure it is relevant to all listed entities, including AIM companies;
  • the FRC does not propose to require auditors to have completed the statutory financial statement audit and sign the auditor’s report before agreeing to the publication of preliminary announcements. Nonetheless the FRC will continue to highlight that this is best practice and consistent with most market practice;
  • the FRC will amend its guidance to include a draft report which sets out clearly the status of the statutory financial statements and the procedures which the auditor has carried out to agree the publication of the preliminary announcement;
  • neither the definition of a preliminary announcement nor the scope of the engagement will be changed as part of the revision of Bulletin 2008/2 and there will be no significant changes to the guidance on materiality;
  • the FRC will make a final assessment of the viability of the option to encourage or require auditors to make an assessment of whether the material included within preliminary statements is “fair, balanced and understandable”, mirroring the UK Corporate Governance Code requirements in respect of the annual report, when its wider investor outreach is complete and its corporate reporting team, in liaison with the FCA/UK Listing Authority, has finalised any relevant proposals;
  • the FRC will not change its guidance to require auditors to have completed their review of “other information” before agreeing to the publication of preliminary announcements, although the FRC will reiterate its view that it is best practice for the audit to be complete and the auditor’s report to be signed before auditors agree to the publication of preliminary announcements; and
  • the FRC will revise its guidance to reflect developments since 2007, including ESMA’s guidelines on alternative performance measures (APMs), to the extent that they are relevant to the auditor’s work on preliminary announcements.
FRC: Annual review of corporate reporting 2016/2017

In October 2017, the Financial Reporting Council (FRC) published its annual review of corporate reporting in the UK, based primarily on the FRC’s own monitoring work in the year to March 31, 2017 and more recently performed thematic reviews. The report is aimed at helping preparers and auditors aid companies in improving the quality of their reporting. The FRC notes that while the standard of corporate reporting, particularly by the largest listed companies, remains generally good, there is still more work to be done in improving the quality of reporting.

The report notes that companies should pay particular attention to the following four areas:

  • properly explaining and quantifying key judgements and estimates;
  • providing a fair and balanced assessment of performance and prospects that covers both positive and negative aspects;
  • ensuring the links between the financial statements and discussions of strategy, performance including Key Performance Indicators (KPIs), financial position and cash flows, including the use of alternative performance measurements, are clear; and
  • providing information that is company-specific and material to an understanding of the business, its performance and prospects.

Other areas the FRC comments on include the following:

  • Companies can expect to be questioned and encouraged to improve where their strategic report lacks balance. If changes in performance measures are reported, the reasons for the changes and their impact should also be reported.
  • Most companies reviewed reported on the continuing uncertainties resulting from the effects of the EU referendum and while many stated that it was too early to measure the longer term effects of the decision and how business strategies would be impacted, many are beginning to identify in more detail the specific nature of the likely risks. The FRC notes that it expects companies to provide increasingly focused disclosures, identifying the company specific risks and opportunities as the economic and political effects of the vote develop and become more certain.
  • The FRC notes that further improvements to the viability statement are needed, as many annual reports lack proper explanation as to how the company has carried out its analysis.
  • Reference should be made to the impact of climate change where relevant for an understanding of the company’s activities.
  • Companies have responded to investor calls to add clarity to disclosures around distributable profit/reserves but companies are urged to further enhance dividend disclosures such as information on distributable reserves, risks and constraints to the dividend policy and links to viability.
  • There is room for improvement in the quality of remuneration reporting. Companies are encouraged to demonstrate a link between strategy and remuneration in their annual reports and the FRC calls upon remuneration committees to improve quality by using their report to demonstrate accountability and justify the pay of their executives.

The report notes that expectations of corporate reporting are evolving with an increased demand for information about how a company promotes its long-term success in line with section 172 Companies Act 2006. Requirements are also changing alongside the implementation of new standards for Financial Instruments, Revenue from Contracts with Customers and Leases (IFRS 9, 15 and 16) and the Non-Financial Reporting Directive.

The report sets out a number of future developments that may affect corporate reporting in coming years, in particular, the implications of Brexit for the UK’s accounting framework and developments in relation to the FRC’s Guidance on the Strategic Report, in respect of which a consultation document was published in August 2017.

FRC: Advice for preparing 2017/18 annual reports

In October 2017, the Financial Reporting Council (FRC) wrote to companies highlighting changes to UK reporting requirements and setting out key areas where the FRC believes improvements can be made when companies prepare their annual reports for the 2017/18 reporting season.

The areas that the FRC considers require improvement include the following:

  • The implementation of new accounting standards IFRS 9 “Financial Instruments”, IFRS 15 “Revenue from contracts with customers” and IFRS 16 “Leases” – the FRC notes that these standards have the potential to have a significant impact on many companies’ results and financial position. As a result, companies should be disclosing the likely impact of the new accounting standards on their financial statements as soon as they can be reliably measured. In the last set of financial statements before the implementation date of the standards, the FRC will expect to see detailed quantitative disclosure regarding the effects of the new standards. These quantitative disclosures should be accompanied by informative and sufficiently detailed explanations of the company’s analysis. Key judgements that management will need to make in complying with the new standards should be described.
  • Strategic report – the FRC notes that quality can be further improved by ensuring that strategic reports explain the relationships and linkages between different pieces of information. The FRC encourages companies to improve their strategic report where a compliance focused approach leads to lack of coverage or the strategic report appears to be lacking balance.
  • Non-financial reporting – the FRC notes that it aims to finalise its revised Guidance on the Strategic Report that it published for consultation in August 2017in the first half of 2018. It also notes that it is undertaking a fundamental review of the UK Corporate Governance Code on which it will consult in November 2017. In looking to improve the effectiveness of section 172 Companies Act 2006, the FRC encourages companies to consider the broader drivers of value that contribute to the long-term success of the company, including disclosures relating to sources of value that have not been recognised in the financial statements and how those sources of value are managed, sustained and developed.
  • Performance reporting – the FRC notes that reasons for changes to key performance indicators (KPIs) and the impact of this should be explained. Disclosure should be sufficiently case specific and be clear and informative.
  • Risk reporting and viability statements – the FRC notes that its Financial Reporting Lab will publish a report on risk and viability reporting later in 2017 to provide practical guidance for companies. The FRC encourages companies to consider developing their viability statements in two stages – first, to consider and report on the proposals of the company over a period reflecting its business and investment cycles, and second to state whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, drawing attending to any qualifications or assumptions as necessary.
  • UK referendum result – companies should consider how their assessment of the potential impact on their business of the UK referendum result has developed over the year and make appropriate disclosures to reflect their latest analysis.
  • Statement of cash flows – the FRC draws attention to the amendments to IAS 7 “Statement of Cash Flows” which require an explanation of changes in a company’s financing obligations over the period. It notes that the new requirements provide an opportunity for companies to improve the clarity of their disclosures, particularly in areas where investors have voiced disappointment, for example, on the use of financing facilities such invoice discounting arrangements.
  • Dividends – the FRC urges companies to adopt the recommendations in the Financial Reporting Lab’s implementation study on this topic published earlier in October 2017. In particular, the FRC encourages further adoption of reporting on the capacity to pay dividends, including the extent to which profits can be distributed by subsidiary companies and the extent of any restrictions.
  • Critical judgements and estimates – the FRC notes that information value can be approved by providing more granular information about a smaller set of judgements and estimates that had a significant impact on results and explaining why certain assets were subject to significant risk of material change. It notes that the FRC has carried out a thematic review of this topic which will be published in Q4 2017.
  • Accounting policies – the FRC notes that companies should ensure that their disclosures are sufficiently tailored to their circumstances.
  • Business combinations – the FRC states that the impact of contingent and deferred consideration arrangements can be difficult to determine as they rely on a high level of estimation and multiple assumptions, making clear disclosure imperative. It points out that sometimes it is also not clear why few or no intangible assets, other than goodwill, were recognised in accounting for an acquisition.
  • Pensions – pension disclosures should provide sufficient transparency of the nature and risks to which the schemes expose the company, including informative explanations of deficit funding arrangements, risk management strategies and scheme assets. Again, the FRC notes that it has carried out a thematic review on this topic which will be published in Q4 2017.
  • Audit quality and effectiveness – the FRC notes that in its monitoring of 2017/2018 year end audits, it will be seeking evidence that the auditor has challenged management and reported clearly to the audit committee in several of the areas featured in this letter, including critical judgements, estimates and pensions.
IA: Quarterly reporting falls as companies focus on the long-term

In September 2017, the Investment Association (IA) reported that its call for companies to stop quarterly reporting is being heeded, with the number of FTSE100 and 250 companies issuing quarterly reports since October 2016 declining by 19 and 25 per cent, respectively.

In a bid to discourage companies from engaging in short-term behaviour, such as managing the business to meet quarterly targets rather than developing their long term strategies, in November 2016 the IA called on companies to stop issuing quarterly reports and earnings guidance.

A table included in the IA’s press release shows that in October 2016 a total of 70 FTSE100 companies reported quarterly, but only 57 did so by August 2017. Meanwhile 111 FTSE250 companies reported quarterly in October 2016, compared with 83 in August 2017.

ICAEW: Consultation paper on prospective financial information

In July 2017, the Corporate Finance Faculty of the ICAEW published a consultation paper setting out its plans to update “Prospective Financial Information: Guidance for UK Directors” published in 2003 (2003 Guidance).  The 2003 Guidance sets out a framework of principles and application notes for preparing and publishing prospective financial information (PFI) in a capital markets transaction context.  The definition of PFI comprises “primary financial statements and elements, extracts and summaries of such statements and financial disclosures drawn up to a date, of for a period, in the future”.  As a result it includes profit forecasts and warnings, working capital statements, merger benefit statements and a range of other financial projections.

Following initial soundings on its proposals from stakeholders and market participants, the ICAEW is now seeking input on a number of proposals and consultation questions including the following:

  • The proposed new framework for PFI will comprise general principles for its preparation and guidance notes on applying the principles and application notes covering specific types of PFI, in certain circumstances.
  • The ICAEW intends to keep the four existing attributes of useful PFI, being “relevant”, “understandable”, “reliable” and “comparable” but it also proposes adding two new attributes, namely “aligned” and “not misleading”. At the same time, it will maintain the three principles for preparing PFI set out in the 2003 Guidance.
  • The ICAEW proposes extending the scope of the framework to PFI that is prepared for private finance-raising situations, subject to a proportionate approach.
  • The ICAEW proposes developing new application notes for preparing PFI in the context of regulated capital markets transactions. Such notes will address topics including profit forecasts and estimates, changes in expectations of performance, working capital statements, and synergy benefits and quantified financial benefit statements.
  • The ICAEW proposes to develop an application note for private finance-raising situations where proportionate application of the PFI framework is appropriate. It asks whether other forms of application support could be useful for preparing PFI for private finance-raising and whether additional application notes should be developed for specific types of private finance-raising.
  • The ICAEW plans to explore whether the new framework could be extended to a wider range of PFI, such as PFI that underpins financial reporting and broader corporate reporting requirements and PFI prepared for purposes other than finance-raising.
  • The deadline for responses to the consultation paper was October 31, 2017. The ICAEW hopes to publish a response statement and a further public consultation on the exposure draft of the new guidance in the second quarter of 2018, with the new technical guidance for preparers of PFI, replacing the 2003 Guidance after a transition period, being available in the first quarter of 2019.

Developments in non-financial reporting

BEIS: Streamlined Energy and Carbon Reporting – Consultation

In October 2017 the Department for Business, Energy and Industrial Strategy (BEIS) published a consultation paper seeking views on the UK Government’s proposals for a streamlined and more effective energy and carbon reporting framework. The consultation builds on responses to a consultation in 2015, “Reforming the business energy efficiency tax landscape” which showed support for mandatory reporting of energy use and carbon data  by certain large organisations.  

The proposals include the following:

  • UK quoted companies – They would still be required to report annually on their global greenhouse gas (GHG) emissions, but should also disclose total global energy use across all energy types in their annual report.
  • UK unquoted companies – Certain of these (and their corporate groups) would need to report certain UK energy and associated GHG emissions and energy use via their annual reports.  Respondents are asked whether those in scope should be “large” (and whether the Companies Act 2006 definition or the definition in the Energy Savings Opportunity Scheme should be used for these purposes) or whether the existing CRC Energy Efficiency Scheme qualification threshold of over 6GWh of electricity use per year  should be used, or whether a different threshold of energy use should determine those in scope.
  • Limited Liability Partnerships – The consultation asks whether the reporting requirements should apply to these.
  • Voluntary participation by out of scope organisations – The Government wants to encourage this and asks for views on how support might be given, possibly through guidance.
  • Reporting of information – The information would need to be included in annual reports. The consultation asks whether it would best sit within the strategic report, directors’ report or a new bespoke report forming part of the annual report. The information would require board level sign off.
  • Information to be reported – UK quoted companies would continue to have to report on their global Scope 1 and Scope 2 GHG emissions and an intensity metric, with the addition of reporting on total global energy use across all energy types. Scope 3 reporting would remain voluntary. Unquoted UK companies would have to report energy use and associated emissions, but scope would be restricted to electricity, gas and energy used for transport and they would also have to report on an intensity metric.
  • Reporting of complementary energy and carbon information – The consultation asks whether it should be mandatory for UK quoted and unquoted companies in scope to include information from the most recent audit on any identified energy savings opportunities and any energy efficiency action taken.
  • Guidance – The consultation asks for views on what guidance, tools and data companies might need for financial managers to understand climate risks and their implications for their business and for companies to implement the recommendations of the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures in financial disclosures.
  • Complementary policies - The consultation also seeks views on other policy mechanisms such as regulation and incentives, that can work with reporting to drive energy efficiency.

Next steps

The Government asks for responses by January 4, 2018 and encourages respondents to use the online e-Consultation platform.

CDSB: Corporate sustainability reporting

In September 2017, the Climate Disclosure Standards Board (CDSB) launched The Reporting Exchange, a free online platform designed to help businesses understand sustainability reporting requirements.

The Reporting Exchange includes information on environmental, social and governance reporting requirements and resources from 70 sectors and 60 countries and it includes supporting guidance, voluntary standards and stock exchange listing requirements.

The tool is public and it is noted that it should assist people involved in preparing and delivering corporate sustainability, annual or integrated reports.

FRC: Draft amendments to Guidance on the Strategic Report – Non-financial reporting

In August 2017, the Financial Reporting Council (FRC) published a consultation on draft amendments to its Guidance on the Strategic Report. The proposed amendments reflect changes to the strategic report requirements made by the Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016, which apply to companies and qualifying partnerships beginning on or after January 1, 2017.

The consultation encourages companies to provide better information on how they have fulfilled their duties to promote the long-term success of the company, as set out in section 172 of the Companies Act 2006 (CA 2006), to improve accountability to shareholders and other stakeholders.

The proposed amendments include (amongst other things) the following:

  • Section 4 (purpose) – changes to strengthen the link between the purpose of the strategic report and the directors’ obligations under section 172 CA 2006.
  • Section 5 (materiality)– changes to enhance the focus on non-financial information and long-term value, and to clarify the scope of the derogation from the general requirements to disclose material information.
  • Section 6 (communication principles)– changes to encourage entities to better integrate related information in their reports and to communicate information that will allow shareholders to assess any factors that may impact upon the long-term success of the business.
  • Section 7 (content elements)– changes to encourage companies to focus on the broader matters that may impact the value of the company over the longer term and to place greater emphasis on the notion of value creation.

Next steps

The FRC asked for all comments and feedback to be submitted by October 24, 2017.

FRC: Non-Financial Reporting Directive Factsheet

In July 2017 the Financial Reporting Council (FRC) published a factsheet with an overview of the new regulations implementing the EU Directive on the disclosure of non-financial and diversity information (the Non-Financial Reporting Directive).

The 2017 regulations have amended the Companies Act 2006 requirements for strategic reports and the Financial Conduct Authority has revised DTR 7.2 in the Disclosure Guidance and Transparency Rules to require certain information about a listed company’s diversity policy to be disclosed in its corporate governance statement as a result of the Directive.

The factsheet sets out what companies caught by the 2017 regulations need to disclose in their strategic reports and corporate governance statements and how the new requirements fit within the narrative reporting framework.

Modern Slavery Act developments

Home Office: Transparency in supply chains etc – A practical guide

In October 2017, the Home Office published updated statutory guidance for organisations on how to ensure that slavery and human trafficking is not taking place in their business or supply chain.

The statutory guidance was first issued in October 2015. The key revisions to the statutory guidance include the following:

  • Smaller organisations: The guidance points out that organisations which do not meet the requirements in the Modern Slavery Act 2015 (MSA) can still choose to voluntarily produce a slavery and human trafficking statement and even if the legislation does not apply, all businesses are encouraged to be open and transparent about their recruitment practices, policies and procedures in relation to modern slavery and to take steps that are consistent and proportionate with their sector, size and operational reach.
  • The structure of a statement: The guidance notes that the public, investors, the media and other external parties will expect to see year-on-year improvements outlining practical progress on how an organisation is tackling the risks and incidents of modern slavery in its operations and supply chain.
  • Approving a statement: The MSA requires a modern slavery statement to be approved by the board of directors and signed by a director or equivalent. The guidance notes that it is best practice for the director who signs the statement to also sit on the board that approved the statement and it is also best practice for the statement to include the date on which the board or members approved it.
  • Publishing a statement: Organisations should publish their modern slavery statement as soon as possible after their financial year end with the expectation being that it will be published, at most, within six months of the organisation’s financial year end. The guidance also points out that organisations should look to keep historic statements from previous years available online even when new statements are published so that the public can compare statements between years and monitor the progress of the organisation over time.
CORE: Risk Averse: Company reporting on raw material and sector-specific risks under the Transparency and Supply Chains clause in Modern Slavery Act 2015

In October 2017, CORE, a UK civil society coalition on corporate accountability, published a report which provides a snapshot of company slavery and human trafficking statements published in compliance with section 54 Modern Slavery Act 2015. The report looks at 50 companies’ statements.  25 companies source raw materials known to be linked to labour exploitation (cocoa from West Africa, mined gold, mica from India, palm oil from Indonesia and tea from Assam) and 25 operate in sectors known to be at risk of modern slavery (clothing and footwear, hotels, construction, Premier League football and service outsourcing).

Key findings include the following:

  • A number of top cosmetic companies make no mention in their statements of child labour in mica supply chains. Mica is a mineral used in make-up and a large proportion of it comes from North East India where around 20,000 children are estimated to work in hundreds of mica mines.
  • A number of chocolate companies do not provide information in their statements on their cocoa supply chains, in spite of those companies acknowledging in other publicly available documents that they source from West Africa, where child labour and forced labour are endemic in cocoa production.
  • A number of jewellery firms do not include any detail on the risks of slavery and trafficking associated with gold mining.
  • Only one company made one specific reference to Assam in its statement although much tea comes from there and low wages are a contributing factor to human trafficking on tea estates in the region.

However, the report also notes examples of good practice reporting:

  • Mars specifically acknowledges that that severe human rights risks including forced labour may be present in the cocoa supply chain.
  • Lidl has published a list of tier-1 factories for all its own-brand textiles and footwear.
  • Nestle reports on 11 key human rights risks in its business, seven related to labour rights.
  • Unilever’s 2015 Human Rights Report notes that low minimum wages are an issue in many tea producing countries.
  • Three construction companies acknowledge specific risks of modern slavery in the construction sector and in their own business.

CORE concludes that overall compliance with the reporting requirement in the Modern Slavery Act is low with an estimated 9,000-14,000 companies still to publish. In relation to the published statements examined, in general, many are not compliant with the basic requirements of the legislation and the majority do not address in substantive detail the six topic areas listed in the Modern Slavery Act. Many companies are not reporting on human rights due diligence and are not considering how their own business models can create risks of severe labour rights abuses.

Developments in other reporting obligations

BEIS: Updated guidance and webpage on reporting requirements relating to business payment practices and performance

In October 2017, the Department for Business, Energy and Industrial Strategy (BEIS) updated its webpage which provides guidance on the reporting requirements for business payment practices and performance. This now states that businesses can publish their reports online.

The Reporting on Payment Practices and Performance Regulations 2017 and the Limited Liability Partnerships (Reporting on Payment Practices and Performance) Regulations 2017 came into force on April 6, 2017 and they have introduced a “duty to report” which requires qualifying companies and limited liability partnerships to publicly report twice a year on their payment practices and performance on a Government-provided web service.

The webpage provides a link to updated guidance for those businesses which have to comply with the new statutory reporting duty as well as details about the Government’s new digital service. Businesses can use the digital service to check if they need to publish a report, publish the report itself or search for a report. A contact address is also given for queries related to the reporting requirement or digital service.

The Investment Association: Gender Pay Gap Reporting Obligations

The Investment Association (IA) has published a short guide summarising the Gender Pay Gap Regulations introduced in April 2017 and giving an overview of the requirements that these Regulations place on firms. The guide is intended to help the IA’s members and the asset management industry prepare for the April 8, 2018 deadline to publish their gender pay gap results.

The guide also highlights other initiatives to be aware of including the Hampton-Alexander Review and the Women in Finance Charter.

Financial Reporting Lab developments

Financial Reporting Lab: Lab implementation study on disclosure of dividends – policy and practice

In October 2017, the Financial Reporting Lab of the Financial Reporting Council published a report examining how companies have responded, in the second year of reporting, to suggestions for enhanced disclosure which were made in the Lab’s Disclosure of dividends – policy and practice report published in November 2015.

In the summer of 2016 the Financial Reporting Lab undertook a review of FTSE 350 dividend disclosures to assess how early practice had developed following the November 2015 report. The results of that review were published in a report published in December 2016.

For the purposes of this review, the Lab reviewed all the FTSE 350 annual reports published in 2016 that were also in the FTSE 350 at the end of 2015 to assess the extent to which disclosure practice had changed. It identified developments in how companies described their dividend policies, the risks to dividend payments and the factors considered in setting the dividend policy.  58 per cent of FTSE 100 companies now disclose information about distributable profits or distributable reserves, an increase from 40 per cent in 2015.  However, progress in the FTSE 250 has been less significant, with only 30 per cent of companies making some disclosure on distributable profits or distributable reserves.

The study includes examples of practice in the following areas:

  • Disclosure that details the policy and provides insight into factors relevant to the setting of the dividend.
  • Disclosure which provides information about factors relevant to setting the dividend and level of reserves.
  • Disclosure which highlights level of reserves.
  • Disclosure which highlights the link between risk and distributable reserves.

The Financial Reporting Lab believes that there are a number of areas where improvements could still be made, or where there are opportunities to take disclosures further. Key areas include the following:

  • Identifying the explicit links between dividend, principal risks and viability.
  • Enhancing disclosure on constraints, either by providing details on the sustainability of the dividend or by clarifying the level of distributable profits/cash or other constraining factor.
  • Explaining more fully what the policy means in practice.
Financial Reporting Lab: Quarterly update

The Financial Reporting Lab (Lab) published its quarterly newsletter in June 2017. The newsletter highlights the Lab’s most recent activities over the last three months:

  • Lab Stakeholder survey – launched in April 2017, the survey asked for feedback on previous projects and sought views on topics the Lab might undertake going forward. The response was continued support for the Lab’s series of projects on the strategic report. The Lab plans to prioritise annual reports and remuneration reporting over the coming months.
  • Digital Future – in May 2017, the first in a series of reports on the Digital Future Project was released. It set out a framework of 12 characteristics which are important to consider in any future (or current) system of digitally enabled reporting. The Lab invites people with the relevant skills or experience in digital reporting to join their workshops over the summer and autumn in London.
  • Risk and viability reporting – the Lab is currently working on a project on risk and viability reporting, which follows its 2016 report on business models. The Lab is currently obtaining the views of members of the investment community in a private investor survey.
  • Improvements in dividend disclosures – in June 2017, the Lab decided to review developments in dividend disclosures following on from its implementation study which was released in December 2016.

Audit committee developments

FRC: Call for participants in audit committee reporting project

In July 2017, the Financial Reporting Council (FRC) invited audit committee members, companies, investors and audit firms to take part in a pilot project of the FRC’s Audit and Assurance Lab, to explore the role of the audit committee reporting in promoting audit quality.

The project will investigate how investors’ confidence in the audit can be maintained through:

  • Phase 1 – the external reporting by audit committees in the annual report, in accordance with the UK Corporate Governance Code; and
  • Phase 2 – auditors’ reports to audit committees, including how they can better support audit committee reporting.

Next steps

The Phase 1 project report will be published in time for consideration for December 2017 year-ends and will focus on the good practice elements of existing audit committee reporting, and encourage audit committees to consider adopting the practices, if appropriate, in the context of their own reporting. The Phase 2 project report will be published in the first half of 2018.

Reporting standards developments

FRC: Consultation on annual review of FRS 101 – Reduced Disclosure Framework

In October 2017’ the Financial Reporting Council (FRC) published FRED 69 following its annual review of FRS 101 Reduced Disclosure Framework.  This annual review considers whether additional disclosure exemptions are needed as IFRS evolve and it is also used to respond to stakeholder feedback about other possible improvements.

Having considered the 2017/18 annual review of FRS 101, the FRC is proposing no amendments to FRS 101. More detailed consideration of IFRS 17 Insurance Contracts will be required, but this work will be deferred until a clearer picture of the progress with the endorsement of the standard is known.

The FRC asks for comments by February 2, 2018. It will publish a summary of the consultation responses, either as part of, or alongside, its final decision.

FRC: Approach to changes in IFRS

In June 2017, the Financial Reporting Council (FRC) published a Feedback Statement ‘Triennial review of UK and Ireland accounting standards: Approach to changes in IFRS’. The Feedback Statement summarises respondents’ comments to its consultation document on updating Financial Reporting Standards (FRS) 102 for changes in IFRS, published in September 2016.

The consultation document asked for views on whether FRS 102 should be kept up to date with IFRS as IFRS changes, particularly in relation to major new standards that have been issued. It outlined a timetable for the possible changes in relation to financial instruments, revenue and leases.

The Feedback Statement shows that almost all respondents agree with the proposed revised principles (set out in FRED 67: Draft amendments to FRS 102, March 2017). However questions were raised over the proposed timetable and implementation. Respondents felt that more IFRS implementation experience is needed before assessing if and how requirements based on these standards should be incorporated.

The FRC agrees that further evidence-gathering and analysis needs to be undertaken before a second FRED is issued. Currently there is no effective date for any changes to FRS 102 or FRS 103 and the FRC will consult on any detailed proposals in due course.


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Contacts

Raj Karia

Raj Karia

London
Jo Chattle

Jo Chattle

London