Pen & Graph

Corporate governance and narrative reporting developments – Spring 2017

Publication March 2017


Introduction

Since our Autumn 2016 publication, there have continued to be a number of corporate governance and narrative reporting developments. This briefing summarises those developments and looks at future developments in a number of areas that companies need to start preparing for.

Corporate governance developments

Corporate governance review

Government’s Green Paper on corporate governance reform

In November 2016, the Department for Business, Energy & Industrial Strategy (BEIS) published its much heralded Green Paper on corporate governance reform for discussion. A range of options are proposed for strengthening the UK’s corporate governance framework, since “the behaviour of a limited few has damaged the reputation of many”. Section 172 of the Companies Act 2006 enshrines the importance of wider interest groups in corporate governance. Under that section, directors are required to take account of wider interests when seeking to promote the success of a company for the benefit of its shareholders. Therefore, in the Green Paper, the Government is exploring new ways to connect boards to a wider range of interested groups and to build upon existing good governance practices. Options include: increasing shareholder influence over executive pay; strengthening the employee, customer and supplier voice at boardroom level; and extending higher minimum corporate governance and reporting standards to large, privately-held businesses.

Responses to the Green Paper were requested by February 17, 2017.

For more information, please see our briefing on the Green Paper.

FRC’s response to BEIS Select Committee inquiry on corporate governance

In December 2016, the Financial Reporting Council (FRC) published a letter containing its response to the Department for Business, Energy and Industrial Strategy (BEIS) Select Committee’s inquiry on corporate governance which was launched in September 2016. The letter sets out the FRC’s views on how its recommendations on corporate governance could be taken forward and whether additional powers would be needed.

The FRC’s recommendations include:

  • Improving the operation of section 172 of the Companies Act 2006 by amending the UK Corporate Governance Code (the Code), providing for disclosure in companies’ annual reports and related changes to the FRC’s Strategic Report Guidance. The FRC states that it can pursue this without requiring powers. However, its application to all companies, including private companies, would require a change to the reporting regulations.
  • A review of the Code and associated guidance to develop best practice on delivering board responsibilities to a range of stakeholders. 
  • A review of the Code to examine whether disclosures relating to board communication might be strengthened to enable appropriate scrutiny and challenge by shareholders and wider stakeholders. 
  • A code and/or guidance directly applicable to the governance arrangements of large private companies should be developed.
  • Monitoring the quality of reporting under the Code, including the option of more direct contact with companies where explanations are not adequate, and publicising good and poor practice. 
  • A Government review of the enforcement framework in order to establish an effective mechanism for holding directors and others in senior positions to account when they fail in their responsibilities. 
  • A review of the Code to consider a wider role for remuneration committees, including the pay and conditions of the company’s workforce and reporting on the link between remuneration structure and strategy. 
  • A Government inquiry into the issues raised by the quantum, growth, disparity and performance-linkage of rewards received by senior executives in a range of corporate forms. 
  • A review of the Code to explore whether and how, when there are significant shareholder votes against a remuneration report, companies should respond through additional shareholder consultation and reporting. 
  • A review of the Code and associated guidance against the recommendations proposed by the Hampton-Alexander Review and the Parker Review in order to improve board diversity, including reporting on actions and progress.

QCA and UHY Hacker Young’s Corporate Governance Behaviour Review 2016

In December 2016, the Quoted Companies Alliance (QCA) and UHY Hacker Young published their annual review of corporate governance behaviour, which focuses on the disclosures made by 100 small and mid-size quoted companies taken from the Main List, AIM and ISDX and compares these disclosures against the minimum disclosures set out in the QCA Corporate Governance Code for Small and Mid-Size Quoted Companies (the QCA Code).

The results were discussed with a group of institutional investors at a roundtable discussion and the QCA has used the feedback received to create five recommendations for companies to follow in order to improve the way they address corporate governance disclosures. The recommendations are as follows:

  • Demonstrate clear links between strategy, performance and remuneration – Clarity and transparency in matters of remuneration are important foundations upon which trust between companies and shareholders is built. Establishing well-structured remuneration arrangements indicates good governance. However, this can be fully appreciated only if the arrangements are articulated effectively to all shareholders.
  • Keep reporting concise and transparent – Each company should demonstrate that it can clearly articulate its business story and the company’s ambition and purpose. This will enhance the quality of engagement with all interested parties, namely, shareholders, other stakeholders and potential investors. 
  • Demonstrate an understanding of members’ and other stakeholders’ interests – Effective boards do not shy away from addressing the concerns of stakeholders. Instead, they take specific actions or provide clear descriptions and explanations about a particular situation. This enables stakeholders to better understand the company’s approach.
  • Publish the results of member votes online – Investors believe strongly that the results of shareholder votes should be disclosed by all companies. Given that AIM Rule 26 requires certain information to be readily available on the company’s website, investors question the reluctance to provide this information, or to be selective in its provision.
  • Describe and explain how board performance is evaluated – Disclosures on board evaluation provide a good opportunity to convey a sense of the operational culture within the business. They help to demonstrate how that culture influences the behaviours of all those involved with the company.

Letter to the Prime Minister urging her to strengthen corporate governance

In January 2017, the International Corporate Governance Network (ICGN), the Institute of Directors (IoD), Institute of Chartered Secretaries and Administrators (ICSA) and the Trades Union Congress (TUC) published a letter sent by them to the Prime Minister regarding corporate governance issues in the Green Paper published in November 2016.

While the signatories will be responding individually to the Green Paper setting out their own particular priorities, they all recognise the importance of section 172 Companies Act 2006. Section 172 requires directors to promote the success of the company for the benefit of shareholders, and in so doing to have regard for the interests of workers, consumers and other stakeholders. The letter notes that there is no effective mechanism for policing this law, which means that if companies, particularly private companies where there is little or no institutional shareholder oversight, do abuse the law, they are not always held to account. The letter suggests that establishing a regulator for companies would deliver economic benefits and greater fairness.

In addition, the letter notes that one of the most contentious governance issues is that of executive remuneration. While the letter acknowledges it is not likely that one single measure will remedy the problem, it states that perhaps what is most important is the Government’s voice in demanding that companies, their remuneration committees, advisers and shareholders, recognise the problem, and resolve a better, and perhaps a simpler, regime for corporate pay which can command broad support.

Finally the signatories urge the Prime Minister to do the following, at a minimum:

  • create a complaint and appropriate remedy mechanism for those whose interests should be protected by the law;
  • ensure investors and stakeholders are involved in the governance of the complaint mechanism;
  • strongly encourage, or mandate larger private companies to apply the principles of independence and transparency which have worked for public companies; and
  • help encourage more broadly acceptable frameworks for executive pay, and recognise that executive pay will require a long-term focus by directors, investors, stakeholders and government.

FRC’s review of the UK Corporate Governance Code

On February 16, 2017 the Financial Reporting Council (FRC) announced that it will be undertaking a fundamental review of the UK Corporate Governance Code (the Code). The review will take account of work done by the FRC on corporate culture and succession planning, and the issues raised in the Government’s Green Paper on corporate governance reform and the BEIS Select Committee inquiry.

The FRC will commence a consultation on its proposals later in 2017, based on the outcome of the review and the Government’s response to its Green Paper.

ICSA’s The future of governance – Untangling corporate governance

In February 2017, the Institute of Chartered Secretaries and Administrators (ICSA) published the first in a series of reports on the future of UK corporate governance, which will look at some of the principal issues in the governance environment and seek to identify solutions to them.

This report, “Untangling corporate governance”, argues that the different components of corporate governance require untangling, in order for each of them to be addressed effectively. While the “comply or explain” framework remains appropriate for its original purpose, it is not well suited for delivering some of the other expected objectives of corporate governance. In particular, it is not capable of preventing or effectively sanctioning bad behaviour by boards or directors or of delivering public policy objectives that are relevant to the UK economy or society as a whole. Encouraging good business practices, punishing bad business behaviour and promoting the public interest are interrelated objectives, but they are not the same and cannot all be achieved through the same mechanisms. As a result, the report argues that the different components of corporate governance need to be untangled in order to address each of them effectively.

The report identifies actions that should be considered, in addition to those set out in the Government’s Green Paper on corporate governance reform, including:

  • a rethink in policy approach to issues such as income inequality, tackling them across the economy as a whole using tools better suited to the purpose;
  • promoting good governance standards across all sectors, and in other investment asset classes that receive a significant amount of money from UK investors;
  • improving the effectiveness of the various mechanisms by which listed companies are held to account; and
  • introducing effective legal sanctions to punish bad business behaviour.

Developments in institutional investor/proxy advisor guidelines

ISS’ UK and Ireland Proxy Voting Guidelines 2017

On November 21, 2016 Institutional Shareholder Services (ISS) updated its benchmark policy recommendations which, for the most part, take effect for shareholder meetings held on or after February 1, 2017.

The 2017 updates include the following:

Overboarding definition

Where directors have multiple board appointments, ISS may recommend a vote against the election/re-election of directors who appear to hold an excessive number of board roles at publicly-listed companies. ISS has amended the definition of overboarding to provide clarification on the precise number of board seats ISS believes can be held. A vote could be recommended against directors who hold more than five non-chair non-executive director positions, as well as against a non-executive chairman who also holds more than three other non-chair non-executive director positions, more than one other non-executive chair position and one non-chair non-executive director position or any executive position. In addition, a vote may be recommended against any executive director who holds more than two non-chair non-executive director positions, any other executive position or any non-executive chair position. The voting policy has also been amended to provide that an adverse vote recommendation in relation to a chairman will not generally be applied at the company where the individual is chairman unless that chairman exclusively holds other chair and/or executive positions or is being elected as chairman for the first time.

Remuneration policy

  • The wording of the remuneration sections has been amended to reflect developments in market practice and investor expectations. As a result, the introduction to the remuneration section includes a direct reference to companies which seek to implement pay structures (for example, non-performance related restricted shares) which sit outside the typical UK model, making it clear that structures which involve a greater level of certainty of reward should be matched by lower levels of award.
  • In relation to the voting recommendation on the remuneration policy, one of the factors ISS will now consider is whether the remuneration policy or specific scheme structure has an appropriate long-term focus and has been sufficiently justified in light of the company’s specific circumstances and strategic objectives. Again, in relation to variable pay, it is made clear that any increase in the level of certainty of reward must be accompanied by a material reduction in the size of award.
  • The policy now states that where a serious breach of good practice is identified in relation to the company’s remuneration policy, and typically where issues have been raised over a number of years, ISS might make a negative voting recommendation against the chair of the remuneration committee (or, where relevant, another member of the remuneration committee).

Remuneration report

  • In terms of the general recommendation on the remuneration report, ISS will now, where relevant, take into account its European Pay for Performance methodology (EP4P) and a definition of EP4P has been included.
  • One of the factors ISS will consider in relation to the remuneration report will be whether exit payments to good leavers were reasonable, with appropriate pro-rating (if any) applied to the outstanding long-term share awards, and special arrangements for new joiners should be in line with good market practice.
  • Again, if a serious breach of good practice is identified in relation to the company’s remuneration report, and typically where issues have been raised over a number of years, ISS might make a negative voting recommendation against the chair of the remuneration committee or, where relevant, another member of that committee.

Approval of new or amended LTIP

Factors ISS will consider when considering a resolution to approve a new or amended long-term incentive plan (LTIP) will include whether it is over-complex, and ISS will want to ensure that any increase in the level of certainty of reward is matched by a material reduction in the size of award.

Committee composition of smaller companies

ISS has now made it clear that for companies listed on AIM, and for other companies which are not a member of the FTSE All Share or FTSE Fledgling Indices, the membership of their audit and remuneration committees should reflect the standard set out in the QCA Corporate Governance Code for Small and Mid-Size Quoted Companies. This requires that audit and remuneration committees should include independent non-executive directors only, with half the membership of the nomination committee being independent directors.

Timing of changes to Guidelines

As mentioned above, these updates apply to shareholder meetings taking place on or after February 1, 2017. However, the policy with respect to committee composition of smaller companies will not apply until February 2018 since ISS recognises that this is a significant change and smaller companies will need time to comply with the new requirements if they wish to do so.

Glass Lewis’ 2017 UK Proxy Paper Guidelines

In January 2017, Glass Lewis published an update to its UK corporate governance policy guidelines. Updates from the 2016 Guidelines include:

  • Authority to set general meeting notice period at 14 days – Glass Lewis has revised its policy with respect to companies’ requests for authority to call general meetings (other than AGMs) on 14 days notice to generally support such requests. This change has been made in light of constructive engagement with a significant number of UK companies, a multi-year review of market practice, general shareholder support for such authorities and absence of misuse of the authority. Therefore, from 2017, Glass Lewis will generally support such authorities when, as is best practice in the UK, companies provide assurances that such authority would only be used when merited by exceptional circumstances.
  • Remuneration – The Guidelines have been updated to reflect current best practice as advocated by the Investment Association’s Principles of Remuneration, specifically to highlight the role of remuneration committees in selecting “a remuneration structure which is appropriate for the specific business, and efficient and cost-effective in delivering its longer-term strategy.”
  • Related party transactions – Glass Lewis’ policy on recommending a vote against directors who face a potential conflict of interest from a related party transaction with the company has been clarified. Generally, Glass Lewis will refrain from recommending a vote against directors with a material business relationship with a company that falls under the normal course of business conducted on reasonable terms for shareholders. Rather, such relationships will be considered in Glass Lewis’ assessment of the independence of the board and key committees. Glass Lewis generally recommends voting against directors with a material professional services relationship with a company, such as consulting or legal services, on that basis alone.
  • Director tenure – The policy on evaluating the independence of directors based on board tenure has been updated. Glass Lewis will generally refrain from recommending a vote against any directors on the basis of tenure alone. However, it may recommend voting against certain long-tenured directors when lack of board refreshment may have contributed to poor financial performance, lax risk oversight, misaligned remuneration practices, lack of shareholder responsiveness, diminution of shareholder rights or other concerns. In conducting such analysis, Glass Lewis will consider lengthy average board tenure over nine years, evidence of planned or recent board refreshment, and other concerns with the board’s independence or structure.

PLSA’s Corporate Governance Policy and Voting Guidelines 2017

In January 2017, the Pensions and Lifetime Savings Association (PLSA) published an updated version of its Corporate Governance Policy and Voting Guidelines. The updated Guidelines include the following:

Executive pay

  • Pay policies should ensure that maximum pay-outs remain in line with the expectations of shareholders and other stakeholders, including workers and wider society. The pay policy should not permit any pay award larger than that necessary to successfully execute the company’s wider strategy, and to incentivise and reward success. 
  • Pay policies likely to result in pay awards that could bring the company into public disrepute or foster internal resentment owing to their excessive value and/or the overly-generous incentives and rewards that they offer, justify a vote against the policy.
  • If the process of engagement prior to the AGM vote fails to produce a remuneration policy that shareholders can support, this represents a serious failure on part of the chairman of the remuneration committee in the most fundamental aspect of their role. As such, a vote against the remuneration policy should in most circumstances be accompanied by a vote against the chairman of the remuneration committee if they have been in post for more than one year.
  • In the event of a vote against a revised remuneration policy, if the revised policy continues to fail to meet the principles outlined in the PLSA guidelines, it may also be appropriate to vote against the chairman of the board.
  • The evidence that pay incentives are necessary to motivate or reward executives and to achieve success for companies is questionable. Remuneration committee deliberations should take a critical and challenging approach to pay increases and be prepared to exert downward pressure on executive pay.
  • Given that the vote on the remuneration report is advisory and that many companies are too slow to heed the message on remuneration, it is more appropriate for shareholders to vote against any remuneration report that they feel unable to support, rather than abstain.

Diversity

The progress in recent years towards meeting Lord Davies’ target of 33 per cent of women on FTSE 100 boards has been positive but there is still considerable room for improvement in some cases and shareholders expect this momentum to be maintained.

The 33 per cent target is a useful benchmark for gender diversity, and a failure to move closer to the target is one example of a criterion that could justify a vote against the re-election of the board chairman or chairman of the nomination committee.

The 2016 Parker report proposed an ethnic diversity target of no ‘all white’ boards by 2021 and progress towards this target is another useful measure of whether diversity is being sufficiently considered.

Accountability

  • Corporate reporting should detail the composition, stability, training and skills, and engagement levels of a company’s workforce, explaining how this relates to the underlying business strategy as well as the risks and opportunities that derive from the employment models and practices.
  • Disclosure of the business model and strategy which fails to convey how the company intends to generate and preserve value over the longer term may lead to a vote against the report and accounts, or the submission of a shareholder resolution.
  • Gathering the data necessary to clearly communicate the composition, stability, skills and engagement levels of a company’s workforce may be a medium to long-term process, but if shareholders do not see better disclosure in this area in coming years, a vote against the annual report would be appropriate.

Remuneration developments

Hermes Investment Management: Remuneration Principles - Clarifying Expectations

In November 2016, Hermes Investment Management published a paper, “Remuneration Principles: Clarifying Expectations”, which is directed primarily towards large publically listed companies. The proposals in the paper seek to practically improve existing executive director pay practices to better achieve their intended objectives.

The paper identifies issues with the prevailing model of executive pay, including excessive quantum, misalignment to long-term value, excessive complexity, weak accountability and unfairness, and low levels of trust. It then proposes solutions to these issues based on its 2013 Remuneration Principles.

The paper also sets out an illustration of a new type of remuneration structure that companies should consider.

Big Innovation Centre’s “The Purposeful Company – Interim executive remuneration report”

In November 2016, the Big Innovation Centre published an interim report on executive remuneration by the Steering Group of its Purposeful Company Taskforce, which is developing a range of policy recommendations to support the development of UK companies pursuing sustainable growth inspired by purpose.

The Taskforce puts forward four proposals to help align executive incentives better with long-term purposeful behaviour and to help rebuild public confidence in executive pay:

  • Shareholder guidelines and the UK Corporate Governance Code should enable companies to adopt simpler pay structures for CEOs based on long-term equity and debt holdings to encourage long-term behaviour and to avoid the unintended consequences of over-reliance on performance-based incentives.
  • Companies should be required to publish a Fair Pay Charter explaining policy and outcomes for wider employee pay and fairness and to engage with employees on its content, including specified disclosures on pay comparisons.
  • The directors’ remuneration reporting regulations should be updated to enable greater stakeholder understanding of a company’s maximum pay and the relationship between pay and performance.
  • A binding vote regime should be triggered when companies lose or repeatedly fail to achieve a threshold level of support on the advisory remuneration vote.

PLSA’s AGM Season Report 2016

In December 2016, the Pensions and Lifetime Savings Association (PLSA) published its 2016 AGM report. This focuses on the issue of executive remuneration and includes an analysis of remuneration-related votes at FTSE 350 AGMs between September 2015 and August 2016, as well as the results of a PLSA survey examining the views of pension fund investors on executive pay.

The key findings in the report are as follows:

AGM voting

Overall dissent on remuneration-related votes did not change dramatically in 2016. Average dissent on remuneration reports and remuneration policies put to a vote was slightly under 8 per cent across the FTSE 350, a similar level to that in 2015 and 2014. However, the report notes that there were a number of prominent shareholder revolts at high profile companies and of the five FTSE 100 companies with the highest level of dissent on a remuneration-related vote in 2016, none were prepared to acknowledge that they had got their approach to remuneration wrong in their subsequent statements addressing the votes.

PLSA member survey

The findings from this survey suggest asset owners are concerned by the size of executive pay packets, not just their structure.

Conclusions

From the results, the PLSA has identified four key conclusions and will update its corporate governance policy and voting guidelines in line with the findings.

  • Boards must do more to address shareholder concerns over CEO pay.
  • Stakeholder anger over pay has become an annual event, without practice changing significantly.
  • Asset managers must do more to hold boards to account, and recognise the concerns of stakeholders, particularly asset owners.
  • The excessive value of pay packages is as much an issue for stakeholders, including pension funds, as their structure, and reductions need to occur.

CFA’s analysis of CEO pay arrangements and value creation in FTSE 350 companies

In December 2016 the CFA Society of the UK published a study carried out by Steven Young and Weijia Li of the Lancaster University Management School examining chief executive officer (CEO) pay structures and their alignment with corporate value creation for FTSE 350 companies between 2003 and 2014/15.

Specifically, the study analyses:

  • the performance metrics FTSE 350 companies use as the basis for determining CEO pay;
  • how commonly used performance metrics such as earnings per share (EPS) and total shareholder return (TSR) correlate with established measures of long-term value creation to all capital providers; and 
  • the strength of the association between realized CEO pay and company performance, where performance is measured using both traditional metrics and established measures of long-term value creation.

The major findings of the study include:

  • The total annual realised pay for the median FTSE 350 CEO during the sample period is £1.5 million measured at 2014 prices. Total pay for the median CEO has increased by 82 per cent in real terms over the period, with an otherwise linear trend halted only by the financial crisis in 2008-2009 when pay levels slipped back to 2006 levels.
  • The level of value creation over the period analysed has been low in absolute terms and erratic from year to year. The median FTSE 350 company generated little in the way of a meaningful economic profit over the period 2003-2009 and although performance improved from 2010 onwards, the median firm generated less than 1 per cent economic return on invested capital per year. The compound growth in annual mean return on invested capital benchmarked against the cost of capital over the 12 year sample period is less than 8.5 per cent.
  • Simplistic metrics of short-term performance such as EPS growth and TSR are the dominant means of measuring performance in CEO remuneration contracts. These metrics correlate poorly with theoretically more robust measures of value creation that relate performance to the cost of capital. 
  • Pay is correlated with value generation at a primitive level. CEOs generating positive economic profits receive 30 per cent higher median total pay than their counterparts generating negative economic profits. Additionally, pay outcomes distinguish between value creation realized in share prices and value creation that remains unrealized.
  • Despite relentless pressure from regulators and governance reformers over the last two decades to ensure closer alignment between executive pay and performance, evidence of more granular distinction between pay outcomes and fundamental value creation remains negligible.
  • Firm size, industry, and previous year remuneration remain the primary drivers of CEO remuneration in the UK. These dimensions may correlate with aspects of value-generation, but at best they represent imperfect tools for assessing long-term corporate success. Structural concerns over pay arrangements therefore persist.

The two key themes emerging from the study are:

  • the critical nature of performance measure choice in the debate over CEO pay arrangements; and 
  • the need for future recommendations on pay to focus more attention on linking incentives and rewards more directly to performance metrics that reflect long-term value creation for capital providers.

Diversity developments

BEIS: Review of issues affecting black and minority ethnic groups in the workplace

On February 28, 2017 the Department for Business, Energy and Industrial Strategy (BEIS) published an independent review by Baroness McGregor-Smith considering the issues affecting black and minority ethnic (BME) groups in the workplace. This follows terms of reference published in April 2016 which stated that the review would look at the business and economic case for employers to harness potential from the widest pool of talent in the workforce. It was tasked with identifying the obstacles faced by BME groups in progressing through the labour market, assessing the impact of those obstacles, highlighting best practice and making cost-effective recommendations. The Government response to the review was published alongside the review.

The review sets out a number of changes that can be made by employers in the public, private sector and voluntary and community organisations to improve diversity within their organisations, including:

  • Measuring success - Given the impact ethnic diversity can have on organisational success, it should be given the same prominence as other key performance indicators. To do this, organisations need to establish a baseline picture of where they stand today, set aspirational targets for what they expect their organisations to look like in five years’ time, and measure progress against those targets annually. They must also be open with their staff about what they are trying to achieve and how they are performing. 
  • Changing the culture - Improving diversity across an organisation takes time. Aspirational targets provide an essential catalyst for change, but to achieve lasting results, the culture of an organisation has to change. Those from BME backgrounds need to have confidence that they have access to the same opportunities, and feel able to speak up if they find themselves subject to direct or indirect discrimination or bias. 
  • Improving processes - From initial recruitment, to the support an individual gets and their progression opportunities, processes need to be transparent and fair. In many organisations, the well-established processes in place can act as a barrier to ethnic minorities and hinder their progress through an organisation. 
  • Supporting progression - Getting a job is only the first step of the career ladder. For those who have friends or family with experience of particular professions, there can be an advantage that supports them in their development. However, this does not result in a business placing the very best candidates in every role.
  • Inclusive workplaces - The greatest benefits for an employer will be experienced when diversity is completely embedded and is ‘business as usual’. This means more than simply reaching set targets and changing the processes. It means that everyone in an organisation sees diverse teams as the norm and celebrates the benefits that a truly inclusive workforce can deliver.

The review includes a list of 26 recommendations, many of them directed at listed companies and all businesses and public bodies with more than 50 employees. The review also includes a number of best practice case studies.

The Government’s response includes the following:

  • BEIS will work with businesses to ensure they have the resources they need to improve diversity and inclusion and fully embed change within their organisation.
  • It sees a business-led, voluntary approach and not legislation as a way of bringing about lasting change. 
  • The attention of investment funds will be drawn to the importance of effective diversity and inclusion. 
  • It hopes employers will do what they can to improve their contracts to encourage greater diversity in their supply chains. 
  • It encourages all employers to accept the review’s recommendations. 

The Government will monitor how things develop over the next 12 months and take the necessary action where required.

UK Government Investments: Launch of Future Board Scheme

On March 8, 2017 UK Government Investments announced that in November 2016 the Government launched the Future Board Scheme, in partnership with 30% Club and Board Apprentice. The scheme gives women from a wide range of backgrounds the opportunity to spend 12 months with boards in a developmental capacity.

The scheme is aimed at FTSE 350 companies, small and medium-sized enterprises, and other major organisations. Each organisation involved hosts a participant on their own board and in return puts forward an employee of their own to be placed on another participating board. Companies such as Aviva and Hammerson have signed up to participate in the scheme.

The Government believes the scheme has the potential to significantly grow the talent pipeline of women executives by giving women 12 months’ experience on a major board.

Stewardship developments

FRC’s tiering of signatories to the UK Stewardship Code

In November 2016, the Financial Reporting Council (FRC) advised that it has categorised signatories to the UK Stewardship Code (the Code) into tiers based on the quality of their Code statements. The FRC also published the list of asset managers, asset owners and service providers split into the relevant tiers. Asset managers have been categorised in three tiers and other signatories in two tiers.

The FRC first announced this exercise in December 2015 with the intention of improving reporting against the principles of the Code and assisting investors in judging how well their fund manager is delivering on their commitments. The FRC believes that the recent assessment demonstrates much improved reporting against the Code and greater transparency in the UK market.

Signatories to the Code have been tiered according to the quality of the reporting in their statements based on the seven principles of the Code and the supporting guidance:

  • Tier 1 – Signatories provide a good quality and transparent description of their approach to stewardship and explanations of an alternative approach where necessary.
  • Tier 2 – Signatories meet many of the reporting expectations but report less transparently on their approach to stewardship or do not provide explanations where they depart from provisions of the Code.
  • Tier 3 – Significant reporting improvements need to be made to ensure the approach is more transparent. Signatories have not engaged with the process of improving their statements and their statements continue to be generic and provide no, or poor, explanations where they depart from provisions of the Code.

Of the nearly 300 signatures to the Code, more than 120 are in Tier 1 now. Asset managers who have not achieved at least Tier 2 status after six months will be removed from the list of signatories as their reporting does not demonstrate commitment to the objectives of the Code.

Developments in stakeholder engagement

ICSA’s project to help boards take account of employee and other stakeholder views

In January 2017, the Institute of Chartered Secretaries & Administrators (ICSA) announced the launch of a joint project with the Investment Association (the IA) intended to ensure that UK public company boards understand the views of their employees and other stakeholders which should then be factored into their decision-making. ICSA and the IA will identify existing best practice and produce practical guidance to enhance understanding of the interests of employees and other stakeholders, in accordance with board duties under section 172 Companies Act 2006.

The guidance will identify different approaches to stakeholder engagement for companies to consider, summarising the issues to be addressed and the practical steps to be taken. These will include the different approaches identified in the Government’s November 2016 Green Paper on corporate governance reform. Specifically, the guidance will set out:

  • the ways in which companies can identify non-executive directors with relevant stakeholder experience;
  • the processes by which boards can receive the views of their key stakeholders;
  • how training and induction can be used to enhance directors’ understanding of their duties and the interests of, and impact on, different stakeholders; and
  • a set of options for companies to appropriately report how they have fulfilled their duties in this area.

The guidance will be published in the second quarter of 2017.

Investor Forum’s review for 2015-2016

In January 2017, the Investor Forum (Forum) published its first review, the first time that its engagements have been disclosed publicly. Launched in October 2014, the Forum aims to facilitate a frank but constructive dialogue between investors and companies that focuses on long-term strategic issues and seeks to build trust and confidence through collective engagement.

The review notes that the underlying source of tension between companies and investors typically centres on one of more of four key issues:

  • strategy and capital allocation;
  • leadership and succession;
  • operational performance; and
  • reporting and communication.

In the first two years of operation, investors have asked the Forum to investigate 16 company situations for collective engagement. Most of the Forum’s work has been in situations where investors were seeking to recover value after a series of disappointing developments and six proposed engagements related to some form of corporate action by a company, where investors felt their interests could benefit from collective engagement. In eight cases there was comprehensive collective engagement. Three situations did not result in a full collective engagement, but investor feedback was provided to the company, three situations were narrowly defined or did not achieve critical mass for collective engagement, and two continental European situations did not lead to collective engagement as they are outside the Forum’s current remit. In both these cases, however, there was interest in a collective exchange of views and the Forum identified and connected investors who then engaged directly.

Among other things, the review also considers the following matters:

  • developments in stewardship;
  • common themes in engagements;
  • what companies can expect from the Forum;
  • what the Forum expects from companies; and
  • the Forum’s other activities.

Audit and tender developments

FRC’s Notes on best practice for audit tenders

In February 2017, the Financial Reporting Council (FRC) published a set of best practice guidelines for audit tenders which highlight how audit committees can approach the audit tender process to get the best outcome. These guidelines are based on experiences of audit tenders since the requirement was first introduced into the UK Corporate Governance Code in 2012. The FRC published a previous note on best practice with regard to audit tenders in July 2013.

The updated guidelines include the following:

  • In terms of timing of a tender, it may be beneficial to tender the audit before the last possible date, in order to have a wider choice of audit firms and audit partners. The guidance sets out factors to consider when determining the timing of the tender.
  • The audit committees of public interest entities (PIEs) related to PIEs in other member states, should consider co-ordination of the tender timing around the group as different member states will have differing rotation requirements. The audit committees of subsidiary PIEs will need to be involved in the tender process to discharge their responsibilities.
  • Companies that use several firms for different advice, should develop a long-term strategy for the procurement of professional services which ensures that at least two firms are able to participate in the audit tender process, and satisfy auditor independence requirements by the time of appointment, without unforeseen impacts on other services received by the company, and all members of the audit committee should be involved throughout the tender process.
  • The audit committee of a PIE is required to make a recommendation to the board for appointment of an auditor. The audit committee must validate or approve a report on the tendering and appointment process. That report is to allow the audited entity to demonstrate to the FRC that the process has been carried out independently and fairly, and in accordance with legislative requirements. It is a decision for the board of the audited entity if it wishes to make such a report public. The FRC considers that the legislative requirements can be satisfied by a combination of some or all of: (i) the paper prepared for the audit committee to support its deliberations and recommendation to the board for appointment; (ii) the board paper which sets out the audit committee’s assessment and recommendations; and (iii) material contained in the report of the audit committee in the company’s annual report, as that will set out the main areas of focus of the audit committee during the year being reported upon.
  • Audit committees should seek views on audit fees in their engagement with major investors regarding the tender process.

Investment Association’s Guidelines on audit tenders

In February 2017, the Investment Association published guidelines setting out the expectations of its members when companies tender their audit. The guidelines cover planning the tender, tender candidates, the tender process and the tender decision. The guidelines are aimed at companies whose shares are admitted to the Premium and Standard segment of the Official List of the UK Listing Authority, to trading on AIM, and to the High Growth Segment of the London Stock Exchange’s Main Market.

Planning the tender

The guidelines state that the audit committee should direct the planning and oversee the process of the tender, including identifying candidates, setting the criteria for selection and the interviews and that the whole of the audit committee should be involved, not just the chair of the audit committee. The tender process should be planned carefully and well in advance since managing a mix of non-audit services is now more complex and likely to need time and input from a range of stakeholders. A company planning to enter into a tender should issue an RNS announcement so that its investors can, if they wish, engage with it on the process and major shareholders should be engaged on the timetable and process, how the audit committee intends to assess audit quality, the selection criteria and assessment mechanism to be applied and the conclusion reached. In relation to giving advance notice of a tender and the timetable, standardised disclosure should be avoided and the company should explain why it is proposing to tender at that time, particularly if it is re-tendering well within the new statutory limit.

Tender candidates

The guidelines point out that audit committees need to consider the range of firms invited to tender, ensure that they are objective and independent and also whether the incumbent is to be included. Depending on each group’s circumstances, the guidelines state that investors believe only the larger multi-national groups may have to restrict their choice to the four largest audit firms. Where the incumbent auditor is being invited to tender, the tender process should address any potential advantage the incumbent firm, or an audit firm with a substantial business relationship with the company, may have and ensure there are appropriate mitigating factors and there should be transparency about how the audit committee decided on the candidates to be invited to tender.

The tender process

The guidelines state that for the tender process to be successful and focused, clear objectives should be set as to what it wants to achieve and what is looked for in an auditor. The guidelines state that investors would appreciate audit committees disclosing the selection criteria used, for example, audit quality, cultural fit, industry expertise and transition experience.

The tender decision

The guidelines state that it is important that the audit committee ensures that in making its recommendation to the board as to the preferred firm, it puts audit quality as its main criterion. While fees should be reasonable, they should not be the main deciding factor, particularly in the early stages of the tender process. Major investors’ views should be sought before the appointment is made, particularly if there are issues they want to discuss and at the time the decision is confirmed, there should be an RNS announcement rather than delaying any announcement until the final annual report and accounts is issued. If investor input is received, then the report of the audit committee in the annual report should consider explaining how it went about that engagement and the outcome.

Human rights developments

Corporate Human Rights Benchmark - Key findings for 2017

In March 2017, the Corporate Human Rights Benchmark for 2017 was published. The Benchmark assesses 98 of the largest publicly traded companies in the world on the implementation of the UN Guiding Principles on Business and Human Rights and other internationally recognised human rights and industry standards. The companies assessed are all from high-risk industries – agricultural products, apparel and extractives.

The Benchmark examines companies’ policies, governance, processes, practices, and transparency, as well as how they respond to serious allegations of human rights abuse. This is done by scoring the companies on 100 indicators across six measurement themes. The analysis found that a small number of companies (including BHP Billiton, Marks & Spencer Group, Rio Tinto, Nestle, Adidas and Unilever) emerged as leaders scoring between 55-69 per cent, but the results skewed significantly to the lower bands. A clear majority, 63 out of 98 companies, scored below 30 per cent.

The Benchmark’s creators hope that investors will use its results in their analysis of companies and investment decision making, including the identification of key human rights risks to discuss with management. The Benchmark creators also believe that the ranking paves the way for governments to use a mix of regulation and incentives to enhance transparency and minimum standards of corporate behaviour to make the business case for the respect of human rights.

Narrative reporting developments

Financial Reporting Lab reports

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

In December 2016, the Financial Reporting Lab published an implementation study on the disclosure of dividends, examining how companies have responded to investor calls for better disclosure of dividends, as set out in the Lab’s November 2015 project report, “Disclosure of dividends – policy and practice”.

In summer 2016 the Lab undertook a review of FTSE 350 dividend disclosures to assess how practice had changed following its 2015 project report. 177 companies published their annual reports in the scope period. The Lab identified 120 annual reports for detailed review and found enhancements in reporting from 28 companies. Key areas where companies enhanced disclosure include examples that explain the details of the dividend policy and how it is intended to operate, add context on factors considered in adopting the policy (with some including the approach to capital management), explain the relevance of dividend resources, and bring together disclosure related to dividends.

The implementation study includes examples of good practice for various types of disclosure and notes that enhancements in the following areas would be welcomed by investors:

  • more detailed disclosure of how dividend policies operate in practice, with more clarity on factors considered in both the setting of the policy and in dividend declaration; and
  • disclosure of risks and constraints where they impact dividend policy and declaration decisions (especially pertinent to concerns around pension deficits, the potential impact of Brexit and other factors that may have a bearing on capital management decisions).

Financial Reporting Lab’s case study report on WM Morrison Supermarkets PLC – Supplier relationships and emergent issues reporting

In January 2017, the Financial Reporting Council’s Financial Reporting Lab published a case study report on WM Morrisons supermarket PLC. The report focuses on two areas of disclosure of Morrisons’ supplier arrangements: commercial income and relationships with suppliers.

Reporting by a company to investors is often a fine balancing act between providing too much information and not enough detail. This is especially the case in areas where there is limited guidance, regulation, and practice. In 2015 Morrisons found itself managing this balance when responding to increased investor interest in the nature and impact of commercial income (a type of payment between suppliers and retailers), following recognition issues identified at Tesco plc.

In its 2014/15 annual report Morrisons adopted a level of disclosure of commercial income which was more comprehensive than others in the sector. Through its disclosure, Morrisons sought to:

  • Improve understanding of the context of commercial income by providing the background to and describing the nature of commercial income; and providing details of the impact on profit, debtors, and creditors.
  • Generate a level of comfort over commercial income by describing the controls and processes in place around commercial income, concentrating on the recording, accrual, and collectability; and describing the work of the Audit Committee, focusing on what they did in gaining comfort over commercial income.

In 2015/16 the focus of value to investors of the Morrisons disclosures changed, with the initial concern of investors having been satisfied the importance of trend and industry comparative information came to the fore. The disclosures provide additional insight into the Morrisons business, and over time add to investors’ understanding of margins and how the company works with suppliers.

Information on commercial income provides some insight into how a retailer works with suppliers. This feeds into the broader desire from investors to understand the quality of supplier relationships and their place in a food retailer’s wider business model. Investors recognise that the multi-faceted nature of relationships can be difficult to report in the confines of the annual report. However, by drawing out the differential aspects of its relationship with the supply base, Morrisons’ business model disclosure helps investors understand the importance of these relationships to the company.

Developments in corporate reporting

IA guidelines on viability statements

In November 2016, the Investment Association (IA) published Guidelines on Viability Statements. Under Code Provision C.2.2 of the UK Corporate Governance Code (Code), directors are required to prepare a viability statement that explains how they have assessed the prospects of the company, what period the assessment covered and why this period is appropriate, and confirm 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.

The IA Guidelines set out the expectations of institutional investors in relation to the disclosures to be made in the context of viability reporting and they include the following:

The period for the viability assessment

  • Consider longer time horizons – The IA considers that viability statements should address a longer timeframe than three or five years (which has become standard), given the long-term nature of equity capital and directors’ fiduciary duties.
  • State clearly why the period was chosen – It is important to investors that directors are clear as to why they have selected the particular timeframe. Investors value directors making it apparent how they have considered wider factors, in particular, the specifics of the company’s business and sector need to be considered, and not only its business cycle but its investment cycle as well.
  • Differentiate time horizons for prospects and viability – A company may have different plans to cover short, medium and long-term horizons and it is helpful if the disclosures around prospects address the long-term strategic plans and look longer than the period over which viability is assessed.

Consideration of prospects and risks when assessing viability

  • Current state of affairs – Investors consider it important that the directors do not limit consideration of viability to medium or long-term risks, but also look at the current state of affairs.
  • Sustainability of dividends – Dividends received are an important return on investors’ capital and investors would welcome the viability assessment addressing the sustainability of those dividends.
  • Distinguish risks that impact performance from those that threaten operations – A company will be exposed to risks that impact its performance and which could prevent it delivering its strategy. These risks should be distinguished from those that threaten its day to day operations and the company’s existence. It is the latter risks that should be considered for the viability assessment.
  • Separate prospects from viability – Investors want companies to give them an insight into their plans for the future which may be separate from the plans that support the viability statement so directors could consider separating their assessment of prospects from their assessment of viability.
  • State clearly why the risks are important, and how they are managed and controlled – Investors would welcome disclosures that address the likelihood of the risk occurring and its possible impact. It is also helpful if the potential timing, and any significant changes in either the risks and/or their impact, are highlighted.
  • Prioritise risks – Directors should exercise their professional judgement in determining which risks are important and how they should be disclosed. Risks disclosed should be pertinent to the business and the company’s strategy. It would be helpful if they are ranked and if it is stated whether the risk has increased in likelihood or decreased from the prior year.

IA’s statement on quarterly reporting and quarterly earnings guidance

In November 2016, the Investment Association (IA) published a Public Position Statement providing its view on quarterly reports and the issuance of quarterly earnings guidance. The Statement calls for companies to cease reporting quarterly and refocus reporting on a broader range of strategic issues.

The IA notes that the Transparency Directive has removed mandatory quarterly reporting requirements. Since it is no longer required, the IA is calling for companies to cease reporting quarterly and refocus reporting on a broader range of strategic issues. Companies should focus on improvements in reporting on the long-term drivers of sustainable value creation and shift resources towards improved reporting on long-term strategy and capital management. The IA encourages companies to review how their current reporting cycle is adding value, and to make necessary amendments to ensure it is appropriately focused on the long-term drivers of productive growth within the business. For those companies that believe it is important to continue to report quarterly, either due to competitive market pressures or shorter market cycles, the IA asks that they publicly explain this position, and how it is relevant to the achievement of their long-term strategy.

Going forward, the IA’s Institutional Voting Information Service (IVIS) will monitor each company’s approach to reporting and outline to IA members which companies continue to report on a quarterly basis and provide the company’s public explanation.

FRC’s thematic review of alternative performance measures

In November 2016, the Financial Reporting Council (FRC) published a thematic review of the reporting of alternative performance measures (APMs) following concerns about such measures expressed by a number of commentators and stakeholders. In June 2015 the European Securities and Markets Authority (ESMA) published its “Guidelines on alternative performance measures” (Guidelines). Listed companies are required to make every effort to comply with the Guidelines which apply to all regulated information, including interim statements and annual reports, published by listed companies on or after July 3, 2016. The Guidelines do not, however, apply to financial statements prepared in accordance with IFRS. The FRC’s report concludes that, although the use of APMs in narrative reporting has progressed, further improvements are required.

The thematic review was conducted by the FRC’s Corporate Reporting Review team and looked at 20 sets of June 30, 2016 interim statements published after the Guidelines came into force. The main findings of the review are:

  • APMs are very widely used and definitions and reconciliations are usually given;
  • 35 per cent of companies sampled had made improvements in the last year;
  • some good explanations for why APMs were used were given, but in other cases explanations were either not given or were cursory/boilerplate;
  • narratives usually dealt with IFRS measures as well as APMs;
  • there was no common definition of adjusted profit but some commonality in items were added back;
  • adjusted profit was higher than the equivalent IFRS measure in 78 per cent of cases; and
  • there was concern over some of the items added back, for example, restructuring costs.

To achieve continuous improvement in reporting, the FRC expects many companies to make changes in response to the coming into force of the Guidelines. In its reviews of reports and accounts ending December 31, 2016 onwards, the FRC will consider whether APMs disclosed in strategic reports are consistent with the Guidelines and, where there are material inconsistencies, it will write to the companies concerned. The FRC will also take into account any such inconsistencies when deciding whether strategic reports are fair, balanced and comprehensive as required by the Companies Act 2006.

FRC expects 2017/18 thematic reviews to prompt improvements

In December 2016, the Financial Reporting Council (FRC) announced that it will, in 2017, undertake thematic reviews of certain aspects of companies’ corporate reports and audits where it believes there is scope for improvement and particular shareholder interest.

The following topics are to be covered:

Corporate reporting

The FRC will write to a number of companies prior to their year-end, informing them that it will review disclosures in their next published reports, specifying the topic under review. The FRC will also monitor and report on companies’ disclosures relating to:

  • The impact of new IFRSs; including the timeliness and usefulness of the information provided.
  • Principal risks and uncertainties relating to Brexit and the low interest rate environment and the extent to which they are company specific.

Audit

  • Auditors’ responsibilities relating to other information
  • Audit firm governance and culture
  • Materiality: update on 2013 thematic review

The FRC will consider the six largest audit firms’ policies and procedures and will review a number of audits in these specific areas to make a comparison with a view to identifying both good practice and scope for improvement.

Priority sectors

As well as the thematic reviews in its corporate reporting and audit monitoring activities, the FRC will give priority to reports and audits in the property, travel and leisure and support services sectors. Audit monitoring will additionally also focus on the financial services sector and audit monitoring will pay particular attention in the audits reviewed to changes in auditor appointment, audit of pension balances and disclosures and the audit of impact of currency fluctuations.

FRC’s report on developments in corporate governance and stewardship 2016

In January 2017, the Financial Reporting Council (FRC) published its annual report, “Developments in Corporate Governance and Stewardship 2016”. The purpose of the report is to give an assessment of corporate governance and stewardship in the UK; to report on the quality of compliance with, and reporting against, the UK Corporate Governance Code and the Stewardship Code; to provide findings on the quality of engagement between companies and shareholders; and to indicate to the market where the FRC would like to see changes in corporate governance behaviour or reporting.

UK Corporate Governance Code

In respect of the UK Corporate Governance Code (Code), the FRC highlights the following:

  • Overall compliance rates – The number of FTSE 350 companies reporting full compliance with all provisions has increased from 57 per cent to 62 per cent, with 90 per cent reporting full compliance with all but one or two of the Code’s provisions.
  • Explanations – The FRC notes that overall too many explanations for non-compliance are of poor quality. Better practice explanations include company-specific context and historical background, and information on what mitigating actions have been taken to address any additional risk. The FRC comments that it is important the company explains how its alternative approach is consistent with the Code provision it is deviating from and whether it is time limited.
  • Frequent non-compliance – The Code provision most often not complied with is for at least half the board, excluding the chairman, to be independent non-executive directors – 26 FTSE 350 companies in 2016, compared to 42 in 2015, did not comply with this provision.
  • Clawback and malus provisions – The majority of FTSE 350 companies have taken forward the 2014 Code recommendation for companies to put in place arrangements to enable them to recover or withhold variable pay. 91 per cent have now implemented a clawback provision on the annual bonus and 78 per cent on long-term plans.
  • Viability statements – Amendments to the Code in 2014 introduced reporting of a longer-term view of a company’s prospects in the form of a viability statement. There is little variation in time horizon between the different business sectors, with two thirds of the sample reviewed choosing three years and the remainder mainly electing five years. The FRC finds the lack of variation between sectors surprising and encourages companies to provide clearer disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company. In addition, the FRC notes that there is room for improvement in explaining what qualifications and assumptions have been made and the quality of reporting of the principal risk linkages.

UK Stewardship Code

In respect of the Stewardship Code, the FRC highlights the following:

  • The tiering exercise – The tiering exercise involved consideration of all signatory statements to identify best practice reporting against the Stewardship Code. Initial assessments of statements, sent to signatories in early 2016, indicated whether the FRC considered the signatory to be in Tier 1 or Tier 2 on the basis of their reporting. Many signatories improved their statements in response to this exercise and following feedback from market participants, the FRC decided to introduce a third tier for asset managers. The third tier reflects the greater relevance of the Stewardship Code’s provisions to asset managers, their role as agents and the wide range of quality in the statements in the initial Tier 2.
  • Engagement in the 2016 annual general meeting season – The FRC continues to hear from both companies and investors that there is too much focus on remuneration at meetings and while remuneration is inextricably linked to issues such as performance and strategy, both company and investor representatives feel that it can overshadow these important topics. Additionally, some investors have displayed a growing appetite for more disclosure on a broader range of risks, including climate-related matters where these are relevant to the company.
  • Compliance with other stewardship codes – After the introduction of stewardship codes in a number of international markets, the FRC states that if signatories meet the reporting requirements of the UK Stewardship Code, the FRC is comfortable for their statements also to address the requirements of other codes and will publish a matrix of the differences between the UK and international codes.

Future developments

The FRC will consider how to encourage further improvements in reporting and possible revisions to the Stewardship Code in 2018. It also plans to consult on revisions to the Code, the FRC’s Guidance on Board Effectiveness and the FRC’s Guidance on the Strategic Report, taking account of the FRC’s work on culture and succession planning, the EU Non-Financial Reporting Directive and wider corporate governance changes in light of the Government’s Green Paper. In addition, it is considering guidance for nomination committees as part of wider consultation in light of responses to its October 2015 discussion paper on succession planning.

ESMA’s Q&A on ESMA Guidelines on Alternative Performance Measures

In January 2017, the European Securities and Markets Authority (ESMA) published a new set of Q&A relating to its Guidelines on Alternative Performance Measures (APMs) (the Guidelines) published in June 2015. The purpose of the Q&A is to promote common supervisory approaches and practices in the application of the Guidelines which are aimed at promoting the usefulness and transparency of APMs in prospectuses and/or regulated information.

The Q&A addresses:

  • the applicability of the Guidelines to prospectuses comprising documents published before and on or after July 3, 2016;
  • measures presented simultaneously inside and outside financial statements;
  • financial measures calculated exclusively using figures stemming from financial statements;
  • interim financial reports;
  • segment information;
  • labels used on APMs; and
  • the concept of “corresponding previous periods”;

The Q&A will be updated where relevant as and when appropriate.

Developments in ESG reporting

Recommendations of the Financial Stability Board’s Task Force on climate-related financial disclosures

In December 2016, the Task Force set up by the Financial Stability Board in December 2015 to design a set of recommendations for consistent disclosures to help market participants understand their climate-related risks, published those recommendations.

For more information click here.

London Stock Exchange’s guidance on environmental, social and governance (ESG) reporting

In February 2017, the London Stock Exchange (LSE) issued guidance setting out recommendations for good practice in environmental, social and governance (ESG) reporting. The guidance is to help companies understand what ESG information they should provide and how they should go about providing it.

The main aims of the new guidance are to do the following:

  • make companies more aware of the importance of providing high quality ESG information, and engaging investors on sustainability-related issues;
  • stimulate interest in the innovation opportunities opened by this new economic paradigm;
  • help issuers and investors to navigate the complex landscape of ESG reporting;
  • enable richer data flows and dialogue on ESG between issuers and investors;
  • support the consolidation of sound global reporting standards;
  • enable investors to make better informed investment decisions.

The report identifies eight priorities for ESG reporting:

  • strategic relevance – relevance of ESG issues to business strategy and business models;
  • investor materiality – what investors mean by ‘materiality’;
  • investment grade data – the essential characteristics of ESG data;
  • global frameworks – the most important ESG reporting standards;
  • reporting formats – looking at how ESG data should be reported;
  • regulation and investor communication – considering how companies can navigate regulations and communicate efficiently;
  • green Revenue reporting – how companies can get recognition for green products and services;
  • debt finance – looking at what debt issuers should report and at the emerging standards here.

New reporting requirements

Implementation of the EU Non-Financial Reporting Directive

Government response to consultation

In November 2016, the Department for Business, Energy and Industrial Strategy (BEIS) published its response to its February 2016 consultation on the implementation of the Non-Financial Reporting Directive in which it sought views on the best way to transpose the Directive, including how best to address the differences between the EU and existing UK framework and how to use the flexibilities that the Directive offers.

The Government’s responses include:

  • Placement of information – BEIS notes interest from respondents for increased flexibility in placing information and will continue to work with the Financial Reporting Council (FRC) to encourage companies to use the scope in the Directive for innovation and flexibility. The Government also acknowledges the concerns raised by respondents concerning the possible use of a separate report on non-financial information and will not pursue this further.
  • Scope of the Directive – Obliging companies outside the scope of the Directive to report under the new framework would go beyond the minimum requirements of the Directive, place a greater burden on these companies and effectively “gold plate” an EU requirement. Therefore, the legislation will require companies that fall within the scope of the Directive to report using the requirements laid out in the Directive. Companies outside the scope of the Directive will continue to be required to comply with the current UK requirements. This means implementing the Directive requirements as an addition to the current UK strategic reporting framework. However, the Government wishes to avoid a situation where a company may, because of a change in size of their workforce for example, report using the UK framework one year and the EU’s the next. Therefore, the legislation will permit companies to voluntarily comply with the EU requirements and will exempt those who do so from the comparable domestic provisions.
  • Third party verification of non-financial information – The Government will not mandate independent verification of non-financial information. However, as now, companies may voluntarily seek independent verification of non-financial disclosures if they wish.
  • Current practice in electronic reporting – The Government will clarify legislation concerning sending annual reports electronically and will continue to work with the FRC to encourage innovative digital reporting.
  • Gender reporting – The consultation sought views on how the definition of senior manager in the gender reporting requirement in section 414C(8) Companies Act 2006 could be improved and respondents favoured two approaches. The first suggested dividing “senior managers” into three separate categories (employees who are members of the executive committee, employees who are direct reports to members of the executive committee, and employees in all other management grades). The second approach uses the description of Key Management Personnel set out in international accounting standard IAS 24 which could be used to define a senior manager as a person who “has significant influence over the entity or is a member of the key management personnel of the entity”. The Government will explore these options with business and other stakeholders to consider how best to help companies make high quality disclosure to fulfil this requirement.

Implementing Regulations

In December 2016, the Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016 were published in their final form. The Regulations insert two new sections, 414CA and 414CB, into the CA 2006 in order to implement articles 1(1) and (3) of the Directive. Articles 1(1) and (3) also amend the Accounting Directive, and insert a new requirement for some companies to disclose certain non-financial information in a statement as part of the entity’s management report.

Section 414CA sets out the requirement for certain companies and groups which are not small or medium-sized and which have more than 500 employees to include a non-financial information statement in their strategic report. The companies to which section 414CA relates are traded companies, banking companies, authorised insurance companies and companies carrying out insurance market activities (public interest entities under the Directive).

Section 414CB provides that the non-financial information statement must contain information to the extent necessary for an understanding of the company’s development, performance and position and the impact of its activity, relating to, as a minimum: environmental, social and employee-related matters, respect for human rights and anti-corruption and bribery matters (together "non-financial matters"). The information must include a brief description of the company's business model, a description of the policies pursued by the company in relation to such non-financial matters, the outcome of these policies, a description of the principal risks relating to such non-financial matters and how the company manages such risks. If the company does not pursue policies in relation to one or more of the non-financial matters, it must give a clear and reasoned explanation for not doing so. If a non-financial information statement complies with subsections (1) to (5) of section 414CB, it will be deemed to fulfil some of the requirements for non-financial information which are already contained in section 414C CA 2006 so as to prevent duplication. Section 414CB does not require disclosure of information about impending developments or matters in the course of negotiation if the disclosure would, in the opinion of the directors, be seriously prejudicial to the commercial interests of the company, provided that such non-disclosure does not prevent a fair and balanced understanding of the company's development, performance or position or the impact of the company's activity.

The Regulations remedy a gap in the transposition of article 23(1) of the Accounting Directive. The amendments ensure that the parent company of a small group cannot benefit from an exemption from the requirement to produce group accounts under section 399 CA 2006 if a member of the group is established in an EEA State and is a public interest entity.

The Regulations will come into force on the seventh day after they are made and apply to financial years of companies and qualifying partnerships commencing on or after January 1, 2017.

Duty to report on payment practices and performance

In December 2016, the Department for Business, Energy and Industrial Strategy (BEIS) published a response document explaining how the Government will implement the duty on large businesses to report on their payment practices, policies and performance, as required by section 3 of the Small Business, Enterprise and Employment Act 2015. Proposals for implementing the reporting requirement and draft secondary legislation were published in November 2014 and the summary of responses was published in March 2015. Following consideration of the written consultation responses and additional views received through ongoing stakeholder discussions and research, BEIS published a new, revised set of draft regulations, together with draft regulations relating to limited liability partnerships (LLPs) with its response document. Final versions of the company and LLP regulations were published in March 2017 and are due to come into force on April 6, 2017.

In January 2017, BEIS published the final version of its guidance on the duty to report on payment practices and performance (the Guidance). The Guidance discusses which entities need to report, what needs to be reported, where the information needs to be reported, when the information needs to be reported and what period it needs to cover.

Who needs to report

The reporting requirement applies to large companies and large LLPs which exceed certain size criteria. Qualifying companies will exceed two or all of the thresholds, which are: £36 million annual turnover; £18 million balance sheet total; and 250 employees. The companies and LLPs in scope of the requirement are referred to in the Regulations as “qualifying companies” and “qualifying LLPs”. In the context of the reporting requirement, ‘company’ means a company formed and registered under the Companies Act 2006 (CA 2006) or previous legislation and ‘LLP’ means a limited liability partnership registered under the Limited Liability Partnerships Act 2000. Entities which are not companies or LLPs under these definitions are not required to report. Businesses incorporated outside the UK are also not required to report.

The information for the reporting requirement should be prepared on an individual company or individual LLP basis, not at a group level. The reporting requirement is not met if the information is provided on a group basis.

What needs to be reported

Businesses in scope of the reporting requirement must prepare and publish information about their payment practices and performance in relation to qualifying contracts (and the Guidance considers what qualifying contracts are), for each reporting period in the financial year. The information for each reporting period must reflect the policies and practices which have applied during that period, and the business’s performance for that period.

The report must be published on a web-based service provided by or on behalf of the Government within 30 days of the end of the reporting period. It must contain the information required by the Regulations and must be approved by a named company director or (for LLPs) a designated member.

A business and its directors (or designated members of an LLP) could be prosecuted if it fails to provide a report within the required timescale or if that report includes misleading, false or deceptive statements.

The Guidance summarises the information to be reported on which comprises certain narrative descriptions, statistics and statements and it considers the detail required in each case.

When the information needs to be reported and what period it covers

Businesses in scope must prepare and publish information about the payment practices and policies which they have applied during a reporting period, and their payment performance in that reporting period. In a financial year there will normally be two reporting periods. The first is the six calendar months starting on the first day of the business’ financial year, so if a financial year started on the 5th of a month, the last day of that reporting period would be the 4th of the month, six months later. The second reporting period starts on the day after the first period ends, and runs until the end of the financial year.

Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 – Draft

In December 2016, the draft Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 were published, following the Government Equalities Office’s consultation in February 2016 which included a draft version of the Regulations. The Regulations have been amended significantly since that draft.

The Regulations impose obligations on employers with 250 or more employees to publish information relating to the gender pay gap in their organisation. This information must be published within 12 months beginning with the “snapshot date” of April 5 each year, so the first information will need to be published before April 5, 2018 in respect of 2017. In particular, employers will be required to publish:

  • the difference between both the mean and median average hourly rates of pay paid to male and female employees (Regulations 8 and 9);
  • the difference between both the mean and median average bonus paid to male and female employees (Regulations 10 and 11);
  • the proportions of male and of female employees who receive bonuses (Regulation 12); and
  • the relative proportions of male and female employees in each quartile pay band of the workforce (Regulation 13).

Additionally, Regulation 14 requires the employer to make and sign an accompanying written statement to confirm that this information is accurate. Both the information and written statement must be published on the employer’s website for at least three years from the date of publication and on a website designated by the Secretary of State (Regulation 15).

The Regulations are due to come into force on April 6, 2017.

Amendments to accounting framework

Amendments to FRS 101 and FRS 102 – Notification of shareholders requirements

In December 2016, the Financial Reporting Council published amendments to FRS 101 (Reduced Disclosure Framework) and FRS 102 (The Financial Reporting Standard applicable in the UK and Republic of Ireland). The amendments remove the requirement for a qualifying entity to notify its shareholders in writing that it intends to take advantage of the disclosure exemptions in FRS 101 and FRS 102 and have not changed significantly from the draft amendments published in July 2016. The amendments apply to accounting periods beginning on or after January 1, 2016.

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