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Essential Corporate News – Week ending November 18, 2016

Publication November 18, 2016


Introduction

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

IA: Guidelines on Viability Statements

On November 16, 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 by Premium listed companies 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 as to the 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.

Stress testing

When directors assess a company’s prospects and viability the IA understands stress tests are likely to be undertaken to see whether the strategy is viable and evaluate any barriers to its execution. Investors are not always made aware of the extent of these stress tests and would welcome more transparency as to the specific scenarios considered and likely outcomes, specific mitigating or remedial actions, and any reverse stress testing.

Qualifications and assumptions

The Code expects directors to draw attention to any qualifications or assumptions as necessary and investors consider that qualifications should be differentiated from assumptions and be specific to the company.

(IA, Guidelines on Viability Statements, 16.11.16)

IA: Statement on quarterly reporting and quarterly earnings guidance

On November 17, 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.

When developing its Productivity Action Plan, published in March 2016, IA members widely referred to quarterly reporting as a distraction that shifted company resources away from long-term strategic considerations. In particular, members expressed concern at the potential for the practice to promote myopic behaviour by senior management by channelling its focus on short-term fluctuations in performance - resulting in the risk of it managing the market, rather than managing the business.

The IA notes that the Transparency Directive, which has removed mandatory quarterly reporting requirements, came into force in November 2013 and was enacted into UK law in May 2014. 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.

Additionally, in the coming months, the IA will host a series of round tables to discuss the benefits and challenges associated with ending quarterly reporting. Following these round tables, the IA will issue a guidance document on the issues raised.

(IA, Public Position Statement: Quarterly Reporting and Quarterly Earnings Guidance, 17.11.16)

FRC: Tiering of signatories to the UK Stewardship Code

On November 14, 2016 the Financial Reporting Council (FRC) published a press release advising 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.

(FRC, Tiering of signatories to the Stewardship Code, 14.11.16)

(FRC, UK Stewardship Code statements, 14.11.16)

Hermes Investment Management: Remuneration Principles - Clarifying Expectations

On November 14, 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.

In 2013 Hermes published a set of Remuneration Principles (which have been updated subsequently) in conjunction with the Pension and Lifetime Savings Association (PLSA), BT Pension Scheme, Railpen Investments and Universities Superannuation Scheme. The Remuneration Principles are as follows:

  • Shareholding – Executive management should make a material long-term investment in the company’s shares.
  • Alignment – Pay should be aligned to long-term success and the desired corporate culture.
  • Simplicity – Pay schemes should be clear and understandable for both investors and executives.
  • Accountability – Remuneration committees should use discretion to ensure that awards properly reflect business performance.
  • Stewardship – Companies and investors should regularly discuss strategy, long-term performance and the link to executive remuneration.

This 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 the Remuneration Principles.

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

(Hermes Investment Management, Remuneration Principles: clarifying expectations, 14.11.16)


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