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Essential Corporate News – Week ending October 21, 2016

Publication October 21, 2016


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

FCA: Final report on investment and corporate banking market study

In April 2016 the Financial Conduct Authority (FCA) published an interim report on its investment and corporate banking market study, which focused on primary market activities in the UK (equity capital market, debt capital market and merger and acquisition services). The FCA consulted on the interim findings and proposed remedies with a range of stakeholders including investment banks, clients, corporate finance advisers, innovators, buy-side investors and league table providers. Having considered the consultation feedback and carried out further work, the FCA has now confirmed its interim findings as final.

The final findings are that there is a wide range of banks and advisers active in primary market activities. While many clients, particularly large corporate clients, feel the universal banking model of cross-selling and cross-subsidisation from lending and corporate broking services to primary market services works well for them, there are some practices that could have a negative impact on competition, particularly for smaller clients.

The FCA has developed a targeted package of remedies to address these concerns and to ensure competition takes place on the merits:

  • A ban on restrictive contractual clauses – Banks at times use contractual clauses that restrict a client’s choice in future transactions. The FCA has published a separate consultation paper alongside this final report setting out its proposals for banning such clauses. Depending on the responses to the consultation paper, the FCA expects to publish the final rules in early 2017.
  • Ending league table misrepresentation in banks’ pitches to clients – Banks routinely present league tables to clients in a way that inflates their own position. The FCA is working with the BBA and the Association for Financial Markets in Europe (AFME) so that they can develop and adopt industry guidelines to improve the way in which banks present such information to clients.
  • Removing incentives for loss-making trades to climb league tables – League tables that rank investment banks can be misleading because some banks carry out loss-making transactions purely to generate a higher position in such tables. The FCA has asked league table providers to review their recognition criteria so as to reduce the incentives for banks to undertake such league table trades.
  • Supervisory programme for initial public offering (IPO) allocations – The FCA comments that allocations of shares in IPOs are at times skewed towards buy-side investors from whom banks derive greater revenues from other business lines (for example, trading commission). In the run up to the implementation of MiFID II, the FCA will carry out supervisory work with those firms where it has identified shortcomings in their allocation policies or a skew in their allocation practices. The FCA also sets out in this report where it has found allocation policies and practices are potentially not consistent with existing guidance in SYSC 10 or the relevant requirements in the MiFID II delegated regulations.
  • Revised IPO process – There is a blackout period in the UK IPO process between publication of ‘connected research’ by syndicate banks and the circulation of the ‘pathfinder’ prospectus so both the pathfinder and approved prospectuses are made available late in the process. Together with a lack of access to the issuer’s management, this means that non-syndicate banks’ analysts and independent research providers lack information from which to produce IPO research. This leaves connected research as the only source of information available to investors during a crucial stage of the process. In a discussion paper published at the same time as the interim report the FCA suggested changes to the IPO process to address these concerns. The FCA is continuing to consult on and develop these changes and expects to publish a separate consultation paper with policy proposals in winter 2016/17.

(FCA, Market Study MS15/1.3: Investment and corporate banking market study – Final report, 18.10.16)

FCA: Consultation paper on the prohibition of restrictive contractual clauses in investment and corporate banking

On October 18, 2016 the Financial Conduct Authority (FCA) published a consultation paper following its investment and corporate banking market study, which focused on primary market activities in the UK (equity capital market, debt capital market and merger and acquisition services). It published an interim report on this market study in April 2016. One of the practices that the FCA found could hinder competition, especially for smaller clients, is the use by banks of clauses in contracts, mandates or engagement letters that oblige clients to award or offer future services to that bank. The FCA found that these clauses can restrict a client’s choice in future transactions. It considered a range of interventions and proposed in its interim report that these restrictive contractual clauses should be prohibited.

The consultation paper proposes to introduce a restriction in the FCA’s Conduct of Business Sourcebook (COBS), which applies to corporate finance businesses, which will prohibit two types of contractual clauses that restrict competition without being clearly beneficial to clients:

  • “Right of first refusal” clauses – These prevent clients from accepting a third party offer to provide future services unless they have first offered the mandate to the bank or broker on the terms proposed by the third party.
  • “Right to act” clauses – These prevent clients from sourcing future services from third parties, regardless of any potential third party offers.

The FCA has excluded from the prohibition future service restrictions in bridging loans. This type of loan is provided on the basis that the client will replace it with longer term financing, typically a bond issue, equity issue or term loan. The FCA notes that the bank would be unlikely to provide the bridging loan at all or on the same terms if it did not also know that it would be mandated on the subsequent longer term financing.

The FCA has requested comments on this consultation paper by December 16, 2016 and it is intended that the rules will be ready for firms to apply from early 2017.

(FCA, Consultation Paper CP16/31: Investment and corporate banking – prohibition of restrictive contractual clauses, 18.10.16)

FRC: Annual review of corporate reporting 2015/2016

On October 21, 2016 the Financial Reporting Council (FRC) published its annual review of corporate reporting for 2015/2016. This report provides the FRC’s assessment of corporate reporting in the UK based on broad outreach and evidence, including that obtained from the FRC’s own monitoring work, performed by its Corporate Reporting Review (CRR) team, on cases opened in the year to March 31, 2016, and from more recently performed thematic reviews.

The report includes:

  • an annual assessment of corporate reporting;
  • an overview of corporate reporting enforcement activity; and
  • current and future developments

Annual assessment of corporate reporting

The FRC concludes that although compliance with the accounting framework is generally good, particularly by larger public companies, certain areas of corporate reporting have, for several years, required general improvement. The profile of these issues has been raised through annual activity reports, discussions with audit firms and the use of generic press notices.

There have been improvements in some of these areas this year, for example in respect of the disclosure of principal risks and uncertainties (PRUs) and capital management policies. Fewer instances were in evidence this year of:

  • boilerplate PRUs;
  • lack of discussion of how risks are managed; and
  • capital management policies that failed to explain management’s approach in sufficient detail or provide the necessary quantified information.

In addition, there were fewer issues relating to cash flow statements, in particular relating to misclassifications between operating, investing and financing activities.

The review sets out the more significant findings from this year’s monitoring activity relating to the financial statements and the strategic report.

Corporate reporting enforcement activity

This section provides an overview of the disciplinary cases which have been concluded under the FRC Accountancy Scheme in the year to 31 March 2016. In April 2016 the FRC introduced changes to its enforcement and disciplinary arrangements in preparation for the implementation of the EU Audit Regulation and Directive. With effect from June 17, 2016 the FRC implemented a new Audit Enforcement Procedure for new statutory audit cases.

Current and future developments

In this section, the FRC provides an overview of current and future developments in corporate reporting and the expected impacts, including:

  • Implications of Brexit for corporate reporting – The legislation underpinning the preparation of financial statements in the UK is generally derived from European law. Therefore, the decision to leave the EU may have significant implications for the corporate reporting framework in the UK, subject to the form and content of the UK settlement with the EU. Over the coming months the FRC will carry out a review to identify potential risks to the reporting framework at, and subsequent to, the date of exit from the EU. The FRC will also consider opportunities for improvement to more closely meet the needs of UK stakeholders.
  • Current debates on the future of corporate reporting – The annual report focuses primarily on the information needs of investors, but increasingly there are calls for the provision of information to a more diverse set of stakeholders reflecting the wider societal impact of companies. Given developments in digital communication which are changing the ways people distribute, consume and analyse information and facilitating the reporting of some information outside the annual report, the annual report can be seen as one part of a wider framework of reporting by companies to their stakeholders. These two drivers, calls for greater accountability to stakeholders other than shareholders and new communication channels arising from technological developments, will continue to change the form and content of corporate reporting in the broadest sense.
  • New International Financial Reporting Standards (IFRS) and their adoption in Europe – Whilst the UK remains in the EU the legislative framework for the adoption of new IFRS will remain the same. New IFRS are reviewed and adopted on a standard-by-standard basis. IFRS requires disclosures in the financial statements on the future impact of standards before their effective date and as that date approaches the FRC expects those disclosures to become more detailed and descriptive.

(FRC, Annual Review of Corporate Reporting 2015/2016, 21.10.16)

FRC: Discussion paper on improving the statement of cash flows

On October 20, 2016 the Financial Reporting Council (FRC) published a discussion paper which presents ideas to improve the usefulness of the statement of cash flows. This is in the context of an IASB project on “Primary Financial Statements” which is examining the purpose, structure and content of the primary financial statements, including the statement of cash flows.

The statement of cash flow tells investors where their company’s cash has come from and where it has gone, providing an insight into the quality of earnings. The discussion paper suggests several ideas for improving the transparency and consistency of the statement, while providing the company’s own perspective on the management of liquid resources. These include the following:

  • Notional cash flows should not be reported in any section of the statement of cash flows but transparent disclosure of non-cash transactions should be required.
  • Operating activities should be positively defined or described (perhaps as including transactions with customers, employees and suppliers) rather than being a residual or default classification.
  • It should be clear that items should not be excluded from operating activities merely because they are unusual or non-recurring but these items should be separately disclosed and items that do not relate to operating activities (or another defined section of the cash flow statement) should be reported in a separate section of the cash flow statement.
  • Cash outflows to acquire property, plant and equipment should be reported as a cash outflow from operating activities. As such outflows are likely to be volatile, a sub-total of cash generated from operating activities before capital expenditure should be disclosed. Entities should be encouraged to disclose the extent to which expenditure on property, plant and equipment represents ‘replacement’ or ‘expansion’.
  • Cash flows on financing liabilities (including the payment of interest) should be reported in the financing category of the cash flow statement. Cash received from customers (including any amount treated as interest income in the statement of profit or loss) should be reported within cash flow from operating activities.
  • Cash flows relating to tax should be reported in a separate section of the statement of cash flows and the statement of cash flows should report inflows and outflows of cash, rather than cash and cash equivalents.
  • A separate section of the statement of cash flows should report cash flows relating to the management of liquid resources. Liquid resources should be limited to assets that are readily convertible into cash, but should otherwise not be restrictively defined. Entities should also be required to disclose their policy for the management of liquid resources, and the classes of instruments that are treated as such.
  • A reconciliation of profit and cash flow should be presented in all cases (including where a direct method cash flow statement is presented). Because the amounts reported in the reconciliation are not cash flows, the reconciliation should not be reported within the statement of cash flows itself, but as a supplementary note, perhaps immediately following the statement of cash flows.

The FRC has requested responses to the consultation by February 28, 2017.

(FRC, Improving the Statement of Cash Flows: A Discussion Paper prepared by staff of the UK Financial Reporting Council, 20.10.16)

ICGN: Updated Global Governance Principles

On October 18, 2016 the International Corporate Governance Network (ICGN) published an updated version of its Global Governance Principles (the Principles). There have been no significant changes from the previous version published in 2014.

The Principles describe the responsibilities of boards of directors and institutional investors respectively, and aim to enhance dialogue between the two parties. The Principles apply predominantly to publicly listed companies and set out expectations around corporate governance issues that are most likely to influence investment decision-making. They are also relevant to non-listed companies which aspire to adopt high standards of corporate governance practice. The Principles are relevant to all types of board structure, including one-tier and two-tier arrangements.

(ICGN, Global Governance Principles, 18.10.16)

ICGN: Guidance on Diversity on Boards

On October 18, 2016 the International Corporate Governance Network (ICGN) published Guidance on Diversity on Boards which builds upon the ICGN Guidance on Gender Diversity on Boards published in 2013. The original guidance identified the responsibilities of shareholders and companies alike to promote gender diversity on boards, ultimately to enhance corporate governance and the overall success of companies. The new Guidance recognises that a range of social and economic factors contribute to a fully diverse board, beyond gender diversity.

The Guidance identifies principles, policies and practices which promote board diversity in general, such as the adoption of robust board evaluation processes and shareholder engagement to promote good governance practices. As such, the Guidance aims to enhance dialogue on the subject between companies and investors. It also aims to provide a balanced view on the respective roles of companies and shareholders alike in promoting and supporting diversity on boards.

The ICGN encourages companies to develop and disclose board diversity objectives. Boards play a role in fostering diversity and inclusiveness within a company’s operations through overseeing recruitment and human capital management strategies. Boards should provide oversight on diversity measures and ensure that there is reporting across the organisation.

The ICGN also encourages shareholders to establish a dialogue with companies and, if necessary, hold the board accountable in instances of company non-compliance with market regulations or deficient disclosure with market protocols. Companies which do not meet such protocols should expect heightened shareholder interest. Shareholders may be able to facilitate greater board diversity by submitting their own nominees for consideration to the board. The ICGN notes that significant shareholders in some developed markets are increasingly able to nominate director candidates through equitable proxy access rules allowing them a voice in advocating for qualified, diverse nominees. Where proxy access is not assured, the ICGN notes that shareholders should consider petitioning their securities regulators for the right to have proxy access so as to facilitate boards that are more responsive to their shareholder base.

(ICGN, Guidance on Diversity on Boards, 18.10.16)

ICGN: Guidance on Executive Director Remuneration

On October 18, 2016 the International Corporate Governance Network (ICGN) published an updated version of its Guidance on Executive Director Remuneration. The Guidance on Executive Director Remuneration replaces guidance published in 2012 and aims to provide a consistent and global perspective focused on major aspects of remuneration policy and practice that will assist companies in better understanding long-term shareholders’ views, as well as serve as a tool for investors when engaging with companies.

The updated Guidance discusses the remuneration committee, remuneration structure and contractual provisions and includes four main changes from the previous edition:

  • Greater clarity has been provided on committee leadership.
  • Reference is made to the consideration of intrinsic motivational considerations beyond financial remuneration when determining effective remuneration structures.
  • It is made explicit that base salary is payment for achieving what is expected of the executive, and that variable remuneration is payment for out-performance.
  • Environmental, social and governance factors have been included in the assessment of performance to help achieve sustainable long-term value creation. The ICGN notes that this social sensitivity has particular relevance given public concerns about the high quantum of pay for executives in the context of building social awareness of the problems of economic inequality.

(ICGN, Guidance on Executive Director Remuneration, 18.10.16)

ICGN: Guidance on Non-executive Director Remuneration

On October 18, 2016 the International Corporate Governance Network (ICGN) published an updated version of its Guidance on Non-executive Director Remuneration. The Guidance replaces a previous version published in 2013 and sets out the ICGN’s position regarding remuneration structures for non-executive directors (NEDs), including board chairs. The updated Guidance discusses structure, accountability and transparency in NED remuneration and contains two main changes, specifically:

  • expectations on NEDs to attain a significant shareholding are more clearly defined; and
  • explicit reference is made to the remuneration of board chairs.

(ICGN, Guidance on Non-executive Director Remuneration, 18.10.16)

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