GC100: Guidance on directors’ duties – Section 172 and stakeholder considerations
On October 22, 2018 the GC100 published guidance on the practical interpretation of the duty on directors in section 172 Companies Act 2006 (CA 2006). The guidance aims to provide practical help to directors on the performance of their section 172 duty and it supplements earlier guidance the GC100 published in 2007 when the statutory duties of directors in the CA 2006 came into force.
The guidance sets out five specific steps directors can take to help them embed section 172 in their company’s decision making and it also considers the issue of the company’s culture:
Strategy – The section 172 duty should be reflected when the company’s strategy is set and updated. Stakeholder and other factors which will contribute to the company’s success or be affected by its activities should be considered, and the company’s key stakeholders assessed. Companies should also consider whether or not to explicitly recognise the company’s dependence on, for example, customers, suppliers and its workforce.
Training – Induction training for new directors and ongoing training for all directors should include training on section 172 and other directors’ duties. Companies should consider what training on section 172 is appropriate for subsidiary directors and management and directors should be provided with guidance on their section 172 and other duties.
Information – Information flows to the board should support achieving success for the benefit of shareholders as a whole and support the consideration of stakeholder factors. The metrics and reports received by the board should be reviewed to determine whether they are broad enough to address the section 172 duty, whether too much information is being received so that things that really matter for the company’s success are being obscured, and whether directors should consider what information is available to others in the company which may be inconsistent (or different) from that seen by the board.
Policies and processes – The guidance recommends that companies put in place policies and processes appropriate to support the company’s operating strategy and to support its goals in light of the section 172 duty. It considers possible policies and processes at board level and at management level, and in relation to directors of UK subsidiary and UK joint venture companies.
Engaging with stakeholders – The guidance urges companies to consider their approach to engagement with employees and other stakeholders, and the means of securing that engagement, as well as the experience of engagement that stakeholders will have with the board, management and employees.
Culture – The guidance notes that a company’s culture can develop so it is automatic that relevant stakeholder factors are built into the conduct of the company’s business. Directors are advised to consider how they propose to embed in the habits and behaviours of the board, management and employees a culture which, in its pursuit of success for the benefit of shareholders as a while, is consistent with the company’s goals in relation to stakeholders, whether employees, customers, suppliers, local communities, the environment or others affected by or engaging with the company’s activities.
The guidance also includes an example scenario of how directors in a specific business situation (the scaling back of a production line) could discharge their duties under section 172.
(GC100: Guidance on directors’ duties – Section 172 and Shareholder considerations – October 2018)
FRC: Revised FRC strategic report guidance
In July 2018, the Financial Reporting Council (FRC) published revised guidance on the strategic report (2018 SR Guidance) which encourages companies to consider wider stakeholders and broader matters that impact performance over the longer term. The SR Guidance is aimed at directors and is intended as best practice for all entities preparing strategic reports.
At the same time, the FRC published a statement summarising feedback received on the related consultation paper issued in August 2017. The feedback was generally positive and showed that the original 2014 strategic report guidance was helpful. As a result, the FRC has not undertaken a fundamental review, but just made a small number of amendments to the 2014 guidance.
The 2018 SR Guidance places a greater focus on the directors’ section 172 Companies Act 2006 duty to promote the success of the company. As a result, the 2018 SR Guidance:
Encourages best practice reporting with the inclusion of both financial and non-financial information in the strategic report. The FRC believes that the strategic report should be a cohesive document containing all relevant information.
Clarifies throughout that the primary audience of a strategic report remains the shareholders. The FRC, nevertheless, continues to encourage companies to consider the interests of wider stakeholders when running their businesses as part of their section 172 duty.
Encourages boards to give due consideration to their duty in section 172 and to report on relevant matters relating to that duty. The 2018 SR Guidance addresses some key issues with reporting including assessing the long-term consequences of board decisions, identifying key stakeholder relationships and disclosing principal board decisions. The FRC’s intention is to improve the effectiveness of section 172 and to encourage board discussions on how companies are considering key shareholders.
(FRC: Guidance on the Strategic Report – 31.07.2018)
(FRC: Feedback Statement – Amendments to Guidance on the Strategic Report – 31.07.2018)
New reporting requirements
Updated Companies (Miscellaneous Reporting) Regulations 2018 Q&A published
In November 2018, the Department for Business, Energy and Industrial Strategy (BEIS) published an updated version of the Companies (Miscellaneous Reporting) Regulations 2018 Q&A which was originally published in June 2018.
Changes in the updated Q&As include the following:
If the directors of a company knowingly do not comply with any of the Companies (Miscellaneous Reporting) Regulations 2018 (2018 Regulations) requirements, or are reckless as to their compliance, they will be committing an offence.
The new requirements will apply to company reporting on financial years starting on or after January 1, 2019 so, with one exception, reporting on the new requirements will begin in 2020. The exception is that the requirement for companies to illustrate the impact of share price increases on executive pay outcomes applies to any new remuneration policies introduced by companies from January 1, 2019.
Depending on the circumstances, it may be acceptable for a subsidiary to provide less information in its own section 172(1) statement where policies are set by the parent company and applied throughout the group. However, judgement will be needed in deciding what is appropriate. For example, where reference can be made to accessible parent company statements, the subsidiary may be able to include less detail in its report.
The requirement to make the corporate governance statement available on a website can be discharged by publishing the complete annual report or the whole directors’ report (or strategic report if it is included there).
The Government hopes that the corporate governance principles for large private companies currently being developed by James Wates and a coalition group will be widely adopted, however, companies can choose the most appropriate code for them, or none. If a company does not apply a code, however, it must explain why that is the case and what corporate governance arrangements have been made.
Companies are able to choose a foreign corporate governance code but if they do so, they should ensure that an English language version of it is available and that this version is easily accessible online and free of charge.
The requirement to prepare a corporate governance statement applies to UK subsidiaries of listed overseas parents.
The employee threshold and the turnover and balance sheet thresholds should be calculated at an individual company level only. No consolidation across a group is required for these thresholds.
If a UK-incorporated and quoted company is a subsidiary of a non-UK incorporated parent, it must still report its pay ratio. However, in such a case the pay ratio reporting would relate to the pay and benefits of the CEO of the UK-incorporated and quoted subsidiary, rather than to the pay and benefits of the CEO of the non-UK incorporated parent and cover only UK employee pay and benefits at the UK incorporated and quoted subsidiary and any subsidiaries beneath it.
If an existing company has 250 or fewer UK employees in the financial year before the 2018 Regulations come into force, it will not have to report its pay ratios for the first financial year in which the rules apply, even if it has more than 250 UK employees in that year.
(Companies (Miscellaneous Reporting) Regulations 2018 updated Q&A, 09.11.18)
BEIS: Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018
On November 9, 2018 the Department for Business, Energy and Industrial Strategy (BEIS) published the Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018 and an accompanying explanatory memorandum.
The published Regulations remain unchanged from the draft Regulations published on July 18, 2018. They make changes to reporting requirements for quoted companies and introduce new reporting requirements for large unquoted companies and large limited liability partnerships (LLPs) to annually report on emissions, energy consumption and energy efficiency action as follows:
- Quoted companies - will be required to disclose energy use from activities for which the company is responsible and from purchases of electricity, heat, steam or cooling for its own use. They must also describe the principal measures, if any, taken to increase their energy efficiency.
Large unquoted companies - will be required to disclose greenhouse gas emissions, energy use from activities for which the company is responsible and action taken to increase energy efficiency.
Large LLPs - will be required to prepare an energy and carbon report, equivalent to the directors' report for each financial year. The contents requirements of this report mirror the disclosure requirements that apply to large unquoted companies.
The Regulations will come into force on April 1, 2019 and will have effect on financial years beginning on or after this date.
(The Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018, 09.11.18)
(The Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018 explanatory memorandum, 09.11.18)
Review of corporate reporting
FRC: Corporate reporting thematic review – Reporting by smaller listed and AIM quoted companies
On November 6, 2018 the Financial Reporting Council (FRC) published a report setting out findings from its thematic review of smaller listed and AIM company disclosures in their annual reports and accounts. The review, which was conducted by the FRC’s Corporate Reporting Review, considered the annual reports and accounts of 22 listed companies outside the FTSE 350 and 18 AIM quoted companies with year ends ranging from December 31, 2017 to March 31, 21018.
The main objective of the report is to encourage better quality reporting that better enables users to assess the quality of management’s decisions and to provide preparers with examples of better disclosure. The report covers the following topics:
Alternative performance measures (APMs) and strategic reports
The FRC has noted improvements in the presentation of APMs but most of the improvements identified involved incremental changes to existing disclosures (for example, clarifying narrative elements, providing a better balance between APMs and IFRS measures and explaining the calculation of APMs), rather than major redrafting of the report and accounts. However, it has also noted several inconsistencies with the reporting requirements and comments that companies should not use labels that are likely to be confused with terminology defined by IFRS or normally used in the context of IFRS reporting. In addition, only a few companies provided specific, rather than general disclosures to explain their rationale for excluding certain items from an APM. The FRC does expect companies to explain why individual items have been excluded from an APM.
In considering the overall comprehensiveness of strategic reports, the FRC notes that the quality of the discussion in relation to cash flow matters varied significantly, with weaker narrative failing to present a comprehensive view of the cash position or showing inconsistencies with the financial statement. Better examples specifically address the effect on cash flows of individually significant transactions separately from ongoing trends and provide supplemental information to support the analysis where required.
While there were improvements in previously reported information, and most companies, for example, disclosed key pension valuation assumptions, they did not always provide the required sensitivity analyses. The FRC also expects companies to explain any judgement made when assessing pension trustees’ rights and this assessment should be made both when there is a pension surplus, as well as when total committed contributions under a minimum funding requirement exceed the net defined benefit liability.
Accounting policies, including critical judgements and estimates
The FRC notes that there were markedly fewer judgements than estimates reported. It comments that companies should differentiate between judgements that do not involve estimation uncertainty and those that do, as there are different reporting requirements. It also notes that there were cases where the auditor’s report included commentary on matters involving significant judgement or estimation by management that had not been disclosed as such in the accounts.
Cash flow statements
The FRC notes that companies should explain key cash flows and their cash position in the strategic report. In some cases, the classification of cash flows appear to be inconsistent with IAS 7 requirements and while the FRC understands that reverse factoring/supplier financing arrangements are common, these were only referred to by one company reviewed.
A number of the companies reviewed presented their effective tax rate reconciliation clearly. However, the FRC did challenge companies where significant movements in the tax charge were labelled “other”, potentially reducing the usefulness of the analysis of the charge, or credit, for the period or the reconciliation to a standard applicable rate. The FRC comments that better tax disclosures provide a clear explanation of the matters requiring estimation, the amounts in question and sources of uncertainty affecting them.
Table of reminders
A table in section 8 of the report sets out the FRC’s expectations in each of the areas above and provides guidance on what should be included so as to assist companies in considering the requirements of the Companies Act 2006 and relevant IFRSs.
(FRC: Corporate reporting publications - Small Listed and AIM Quoted Companies, 06.11.18)
FRC: Future of corporate reporting – Call for participation
On October 30, 2018 the Financial Reporting Council (FRC) launched a project to challenge existing thinking about corporate reporting and consider how companies should better meet the information needs of shareholders and other stakeholders.
As part of the project, the FRC will review current financial and non-financial reporting practices, consider the information investors and stakeholders require, consider the purpose of corporate reporting and the role of the annual report and other types of corporate communications, and look at how technology can assist companies in delivering information to stakeholders. The FRC expects the project to lead to a series of calls for action for changes to regulation and practice. The FRC will publish a thought leadership paper consolidating the outcomes of the project later in 2019.
The FRC are looking for up to fifteen participants to join an advisory group to support the project, and is accepting nominations for participants until November 15, 2018.
(FRC: Future of Corporate Reporting – Call for participation – 30.10.18)
FRC: Annual Review of Corporate Governance and Reporting 2017/18
In October 2018 the Financial Reporting Council (FRC) published a report on its review of corporate reporting in the UK following its review of 220 reports and accounts, predominantly December 2016 year ends. One aim of the report is to help companies improve the quality of their reporting.
Key findings include the following:
Financial statements – The reporting of significant judgements and estimates is an area needing improvement, with the FRC still seeing instances of poor disclosure of the sensitivy of assets and liabilities to the assumptions and estimates on which they were based. The FRC will continue to press for more informative disclosures. There has also been a rise in basic errors and non-compliance in certain areas, including misclassification of cash flows in the primary statement.
Strategic reports –
Companies should ensure their strategic report includes a fair review of the company’s business that is balanced and comprehensive and Alternative Performance Measures (APMs) should be clearly presented, reconciled to IFRS and explained as required by the European Securities and Markets Authority’s Guidelines on APMs
which the FRC views as best practice for all companies.
UK Corporate Governance Code – While reporting on compliance with this was high, the FRC does not consider this to necessarily be an indication of high governance standards as an excessive focus on formulaic compliance with the Provisions can mean reporting on the application of the Principles is overlooked. Non-compliance with the UK Corporate Governance Code is often not fully explained and explanations should be thoughtful and provide a clear rationale for the company’s action. More information about the nature of board evaluations, their findings and any follow-up actions should also be disclosed.
Viability statements – While some companies have enhanced their disclosures, others should explain the processes undertaken to prepare their viability statement, including the stress and scenario testing they have carried out. The FRC recommends a two-stage process in assessing viability (first describing the company’s long-term prospects and then selecting a shorter viability period), with companies being expected to select a viability period that reflects the nature of their business and being specific in explaining why that period is appropriate.
Non- financial reporting – The FRC believes companies can be more transparent in this area, for example by explaining how they engage with their shareholders to understand and have regard to their interests or how they allocate capital resources for different purposes.
The UK leaving the EU –
The FRC has reviewed the effects of the UK leaving the EU in companies’ reporting in their strategic reports and associated disclosures. It encourages companies, in its accompanying open letter
to Audit Committee Chairs and Finance Directors, to provide disclosure which distinguishes between the specific and direct changes to their business model and operations from the broader economic uncertainties which may still attach to the UK’s position when they report. Particular threats, for example delays to their supply chain or the possible effect of changes in import/export taxes should be clearly identified and management should describe actions taken or to be taken to manage the potential impact. As the situation may change between the balance sheet date and the date of signing the accounts, companies are reminded in the open letter to incorporate a comprehensive balance sheet events review in their year-end reporting plan to identify adjusting and non-adjusting events and make the necessary disclosures required by IAS 10.
IFRS 15 (Revenue from contracts with customers), IFRS 9 (Financial investments) and IFRS 16 (Leases) – Both the FRC's review report and the open letter refer to these and the FRC sets out what it expects to see by the way of year end disclosures that explain the impact of these new standards.
The FRC’s report also includes an overview of future developments in relation to corporate governance and reporting.
(FRC: Annual review of corporate governance and reporting 2017/18 – October 2018)
(FRC: open letter to Finance Directors and Audit Committee Chairs - Summary of key developments for 2018/19 annual reports – 24.10.18)
FRC: Corporate Reporting Review – Technical findings 2017/18
In October, 2018 the Financial Reporting Council (FRC) published a document outlining the technical findings of their 2017/18 Corporate Reporting Review. The document highlights the matters most frequently flagged by the FRC’s corporate reporting monitoring activities.
The document identifies the top ten areas in which the FRC asked questions of preparers relating to reports reviewed in the financial year ending March 2018, and builds on themes highlighted in the Annual Review of Corporate Governance and Reporting 2017/18. These areas are:
Particular focus has been given to the top three of these areas, two of which, Judgements and Estimates, and the use of APMs, were the subject of thematic reviews published in 2017. These issues, along with issues in relation to the Strategic Report, equate to approximately one third of the total questions asked by the FRC’s corporate reporting review team throughout the year.
In light of the findings, the FRC encourages preparers to consider how to improve and develop their reporting.
(FRC: Corporate Reporting Review Technical findings 2017/18 – 22.10.18)
(BEIS: Committee report on gender pay gap reporting – 02.08.18)
Financial Reporting Lab reports
Financial Reporting Lab: Performance metrics – Principles and practice
On November 7, 2018, the Financial Reporting Council’s Financial Reporting Lab (Lab) published a report providing guidance for companies on the presentation of performance metrics in their reporting.
The Lab notes that performance metrics presented in a fair, balanced and understandable way are key to the communication between companies and investors. The report includes examples of how companies can apply the five principles outlined in the Lab’s June 2018 Report on performance metrics which focused on investors’ views. That report highlighted that when trying to understand performance, investors utilise whatever information they think is likely to be useful, regardless of its type. Investors will, however, be seeking different metrics, or using them in different ways, depending on their position in the investment chain and investment focus.
In relation to each of the five principles, the report sets out questions that the management and board should ask in relation to each principle and it provides examples of good practice:
Aligned to strategy - It is important for companies to report those metrics that are being monitored and managed internally, and explain how and why they are used, including how they link to the company’s strategy. Means of demonstrating that metrics are aligned to strategy include explaining what the metrics are and why they are important.
Transparent – Performance metrics must be meaningful, and users must be able to understand what the metric attempts to measure and how it does so. Providing an explanation for the use of metrics and a full breakdown of GAAP to no-GAAP metrics is one of the means listed of presenting metrics in a transparent way.
In context - In understanding performance, investors want to understand what is achieved in the context of the company’s aims. Companies can provide context by disclosing targets for metrics, showing whether performance has achieved its target or not, referencing a relevant industry benchmark and/or providing a market context that is linked to how that context affects the company.
Reliable - Investors require the metrics being disclosed to be calculated appropriately, and there must be sufficient governance and oversight over their use and reporting. Making governance and oversight over metrics clear and explaining the levels of scrutiny to which metrics have been subjected will help in the presentation of the reliability of metrics.
Consistent - Consistent reporting across time, and across reporting formats, helps build credibility, as investors feel that they are getting a consistent and solid view of the state of the company. A five year track record and performance with reference to industry benchmarks or standards will help companies show their reporting is consistent.
(Financial Reporting Lab: Performance metrics – Principles and practice, 7.11.18)
FRC: An update on business model reporting and risk and viability reporting
In October 2018, the Financial Reporting Lab (Lab) of the Financial Reporting Council published a report which considers how reporting practice in relation to both business model reporting and risk and viability reporting has changed since the Lab published its “Business model reporting” report in October 2016 and its Report on “Risk and viability reporting” in November 2017. The report also examines how companies have responded to suggestions for good practice disclosure that were presented in those reports and it highlights examples where companies have thought about and demonstrated how to enhance the value of their disclosures.
The report makes a number of points, including the following:
Business model reporting - The report notes that investors do not expect key information about the business model to always reside within the business model disclosure itself, as they appreciate the need for flexibility and for companies to structure their communications in a way that best meets their stakeholders’ needs. However, investors do seek clear disclosure that builds understanding either directly or through cross-referencing and coherent, meaningful linkage. There are concerns that many disclosures of business models are falling short in that they add neither broad understanding nor company specific detail, and lack connections to wider information within the annual report. As a result, the report includes some questions for boards on business model disclosure.
Risk reporting - So far as risk reporting is concerned, the report notes that there continues to be a lack of detail in certain areas, such as mitigating actions and links to the business model and key performance indicators, and this lack of detail is heightened by overall changes in the risk environment. By way of example, while many companies highlight that various Brexit scenarios create a principal risk, the report notes that investors expect more detail on the level of preparedness, the current state of implementation of mitigating activities and numerical breakdowns to help them assess the impact.
Viability reporting - In relation to viability reporting, the report notes that there are some promising developments with companies separating the viability statement into an assessment of prospects, then an assessment of viability, providing more disclosure on both. However, investors would like to see more disclosure on scenario and sensitivity analysis that supports the statement, and reasoning behind the period selected.
The report includes questions for boards on both principal risks and the viability statement.
(FRC, Financial Report Lab Report – Business model reporting; Risk and viability reporting – Where are we now? - 18.10.18)
FRC: Participants in new climate and workforce reporting project sought
In September 2018, the Financial Reporting Lab (Lab) of the Financial Reporting Council invited investors and companies to participate in a new project regarding how the disclosure of climate change and workforce information can be reported effectively.
The scope of the project is likely to explore, among other things, how companies understand, measure and report on climate change and workforce issues, especially in the context of new reporting requirements, and examine how investors use this information. The project will consider how the recommendations identified in the Lab’s previous reports on business model reporting, risk and viability and performance metrics apply to companies’ reporting on climate change and their workforce.
A final report is likely to be published in Autumn 2019.
(FRC: Financial Reporting Lab Call for Participants in new project - Climate and workforce reporting – 12.09.18)
Audit and accounting developments
BEIS Committee inquiry into the future of audit
In November 2018, the Department for Business, Energy and Industrial Strategy Committee (BEIS Committee) launched an inquiry into the future of audit. The enquiry follows a similar study by the Competition and Markets Authority (CMA) on the statutory audit market and the Government’s independent review of the Financial Reporting Council (FRC) led by Sir John Kingman.
The inquiry will focus on the likely impact of the CMA market study and the review of the FRC in improving quality and competition in the audit market and reducing conflicts of interest. The Committee intends to feed into the CMA study and ensure audit reform is linked to coherent reform of the wider corporate governance agenda. As part of this inquiry, the BEIS Committee will consider the published submissions from the CMA’s market study of the audit sector.
Submissions are requested by January 11, 2019. The BEIS Committee intends to begin evidence hearings in January 2019, as soon as possible after the Kingman and initial CMA reports are published.
(BEIS Committee Inquiry: future of audit, 12.11.18)
(BEIS Committee Inquiry: future of audit press release, 12.11.18)
FRC: Developments in audit 2018
In October 2018, the Financial Reporting Council (FRC) published a report setting out the work the FRC has undertaken in the last year to drive the delivery of consistent, high-quality audits by UK firms and address specific risks and issues. In line with the FRC’s aim to promote transparency and integrity in business, the report considers auditor independence, audit quality, the future needs of investors and corporate viability.
The report highlights several key themes, including:
Auditor independence – Confidence in the independence of the auditor influences public confidence in audits and so the FRC plans to review the effectiveness of the rules on auditor independence. Specifically, the FRC is looking into whether consulting work performed by an auditor on a company it is auditing should be banned to prevent auditor independence being compromised. The FRC will work closely with the Competition and Markets Authority in this area.
Viability – Taking lessons from recent company failures, the FRC will look to develop proposals to strengthen requirements on auditors when considering whether an organisation is a going concern. This includes matters concerning the responsibilities of auditors in assessing companies’ statements on their longer-term viability and whether auditors should report publicly on their views of the realism of assessments made by companies.
Investor needs – The FRC will be conducting a review of the work auditors do on the front half of the annual report to assess whether auditors are undertaking enough work to conclude it is not materially misstated. In addition to this, the FRC will soon launch a major review of stakeholders’ needs for information in corporate reports and will consider to what extent such information needs to be assured.
Audit quality – The FRC has implemented an enhanced programme of audit firm monitoring. In addition, the FRC has improved its enforcement capacity to ensure that cases are concluded faster and has amended the sanctions framework to ensure that penalties issued reflect the gravity of the issue in question.
(Financial Reporting Council: Developments in Audit, October 2018 – 08.10.18)
Competition and Markets Authority: Statutory audit market study launched
In October 2018, the Competition and Markets Authority (CMA) launched a market study into the statutory audit market in the UK to determine whether it is working as well as it should. As part of its review, the CMA will investigate whether the sector is competitive and resilient enough to determine whether it is working as it should to maintain high quality standards. The review focuses on three sets of issues, namely choice and switching of auditors, the long-term resilience of the sector, and the incentives between audited companies, audit firms and investors.
The CMA will focus on what might be the most effective and proportionate remedies but will look particularly at ideas to improve incentives, further separating audit and non-audit services, and reducing barriers to entry and expansion of non-Big Four firms.
(CMA: Statutory audit market – invitation to comment – 09.10.18)
(CMA: Statutory audit market – market study notice – 09.10.18)
BEIS: Accounting and audit if there is no Brexit deal – Notice
In October 2018, the Department for Business, Energy and Industrial Strategy published a notice explaining the implications for accounting, corporate reporting and audit if the UK leaves the EU in March 2019 with no Brexit agreement in place.
The notice states that if after March 2019 there is no deal, the Government will ensure that the UK continues to have a functioning regulatory framework for companies and that, as far as possible, the same laws and rules that are currently in place continue to apply, but certain changes will be necessary to reflect that the UK is no longer an EU Member State.
A number of points, including the following, are made:
The rules relating to audits of UK companies operating solely within the UK will be unchanged but there will be additional requirements relating to the audits of UK companies operating cross-border and to the provision of audit services cross-border.
The UK will provide individual auditors with EU qualifications with a transitional period, from exit until the end of December 2020, during which they can apply to be recognised as auditors in the UK subject to passing an aptitude test. At the end of the transitional period EU auditors will cease to benefit from automatic recognition of their qualifications in the UK and may no longer be offered an aptitude test.
Audits of EU companies seeking to raise capital by issuing shares or debt securities on a regulated market in the UK will need to be undertaken by an auditor registered with the Financial Reporting Council (FRC). The audits will need to be included in a cycle of inspections, in which the FRC will visit the registered auditor in the EU Member State where the business is incorporated until that Member State is recognised in the UK as having an equivalent audit regulatory framework.
Audits of UK businesses seeking to raise capital by issuing shares or debt securities on a regulated market in the EU will need to be undertaken by an auditor registered as a ‘third country auditor’ in the EU Member State in which the market operates. The audit will then be in scope of a cycle of inspections by the recognised authority for that market.
EU businesses operating in the UK seeking to raise capital by issuing shares or debt securities on a regulated market in the UK may wish to consider securing the services of an auditor registered with the FRC and UK businesses who wish to raise capital by issuing shares or debt securities on a regulated market in the EU may wish to consider securing the services of a ‘third country auditor’ registered in the relevant Member State.
Accounting and corporate reporting
A number of points, including the following, are made:
- UK incorporated subsidiaries and parents of EU businesses will continue to be subject to the UK’s corporate reporting regime but certain exceptions in the Companies Act 2006 relating to the preparation of individual accounts will no longer be extended to companies with parents or subsidiaries incorporated in the EU. For example, a UK company is currently exempted from having to prepare individual accounts if it is dormant and part of a group of companies with an EU parent company that prepares group accounts. This exemption will only continue to apply after exit if the parent company is established in the UK.
- UK businesses with a branch operating in the EU will become third country businesses and will be required to comply with specific accounting and reporting requirements for such businesses in the Member State in which they operate.
- UK companies listed on an EU market may also be required to provide additional assurance to the relevant listing authority that their accounts comply with International Financial Reporting Standards as issued by the International Accounting Standard Board. This will need to be done in accordance with EU third country requirements.
- Subsidiaries and parents of EU companies established in the UK will need to make themselves familiar with the exemptions in the Companies Act 2006 relating to accounting and reporting requirements that will no longer be extended to UK companies with parents or subsidiaries incorporated in the UK.
- Branches of EU companies established in the UK will become subject to additional requirements under the overseas companies regime, and after exit will be subject to the same accounting and reporting requirements as non-EU companies that have a branch here.
(BEIS: Accounting and audit if there is no Brexit deal guidance – 12.10.18)
BEIS: Draft Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) Regulations 2018
in November 2018, the Department for Business, Energy and Industrial Strategy (BEIS) published the draft Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) Regulations 2018. The draft Regulations are intended to address deficiencies arising from the UK’s exit from the EU in relation to the regulatory oversight and professional recognition of statutory auditors and third country auditors in the UK.
In summary, the draft Regulations make amendments to the Statutory Auditors and Third Country Auditors Regulations 2016 (SI 2016/649), the legislation that implements the Audit Directive, and to the retained UK version of the Audit Regulation. The draft Regulations also transfer powers, previously held by the European Commission, to the Secretary of State and to the Financial Reporting Council (FRC).
The draft Regulations include amendments to the Companies Act 2006, the Companies (Audit Investigations and Community Enterprise) Act 2004, the Limited Liability Partnerships Act 2000 and the European Communities Act 1972 to provide:
new powers to the Secretary of State to determine the equivalence of the audit regulatory frameworks of "third countries" (which includes EEA member states and Gibraltar, as well as countries outside the EEA), and the adequacy of their competent authorities, as well as to set out the framework for future determinations of equivalence and adequacy;
that equivalence status is granted to any third countries that were granted equivalence in relation to the EU and that adequacy status is granted to any third country competent authorities that were granted adequacy in each case by the European Commission before exit day;
transitional arrangements on the equivalence of audit regulatory frameworks and the adequacy of audit competent authorities in EEA member states and Gibraltar for a transitional period ending on December 31 2020; and
for the recognition of EEA auditors and EEA audit firms as being eligible for appointment as statutory auditors after the UK's exit from the EU.
The draft Regulations also include amendments to the Statutory Auditors and Third Country Auditors Regulations 2016 to provide the FRC with further powers. These new powers supplement the FRC's existing powers to set standards in the UK and allow them to adopt International Standards on Auditing.
(Draft Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) Regulations 2018 draft statutory instrument, 6.11.18)
(Draft Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) Regulations 2018 draft explanatory memorandum, 6.11.18)
BEIS: The Accounts and Reports (Amendment) (EU Exit) Regulations 2018 – Draft
in October 2018, the Department for Business, Energy and Industrial Strategy published the Accounts and Reports (Amendment) (EU Exit) Regulations 2018. These make a number of amendments to Part 15 Companies Act 2006 (CA 2006) relating to the preparation and filing of accounts by companies in the UK. Part 15 CA 2006, with regulations made under Part 15, transposed into UK law the aspects of the EU Accounting Directive (Directive 2013/34/EU) which related to companies.
The draft Regulations address a number of minor inoperabilities arising from the UK’s exit from the EU, such as substituting references to the Accounting Directive with references to domestic legislation, as well as making changes which have more significant impacts, such as limiting the scope of certain exemptions so that they apply only to UK registered companies with UK parents.
The accompanying explanatory memorandum notes that the UK reporting framework derives heavily from EU law and in places it relies on reciprocal arrangements for company group structures. Once the UK leaves the EU, EEA states will be third countries in relation to the UK and the UK will be a third country in relation to EEA states. In the absence of a negotiated agreement about the economic relationship between the UK and the EU, it will be inappropriate to continue with preferential treatment for EEA entities or UK entities with parents or subsidiaries from EEA states, or entities listed on EEA regulated markets as this would amount to unreciprocated preferential treatment. Entities from, and listed on markets in, EEA states will be treated in the same way as entities from, and listed on markets in, other third countries. However, preferential treatment will continue for UK entities, UK entities with UK parents or subsidiaries and for those entities listed on UK markets.
In general, changes made by the draft Regulations which relate to financial years will apply to financial years beginning on or after the day the UK leaves the EU. However, for financial years that begin before, but end or on after, that date, the relevant UK law will apply as if the UK continued to be a member state.
Amendments are also being made to other legislation, including the Partnerships (Accounts) Regulations 2008, the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008, the Overseas Companies Regulations 2009 and the Reports on Payments to Governments Regulations 2014.
There will be another instrument which deals with the adoption of international accounting standards for the UK, and related consequential amendments, which will be published in due course.
(The Accounts and Reports (Amendment) (EU Exit) Regulations 2018 draft statutory instrument – 31.10.18)
(The Accounts and Reports (Amendment) (EU Exit) regulations 2018 explanatory memorandum – 31.10.18)
FRC: Board diversity reporting
In September, 2018, the Financial Reporting Council (FRC) published a report which assesses the current extent and manner of reporting by FTSE 350 companies on diversity at board and senior management levels in their annual reports.
Data was collected from the annual reports of FTSE 350 companies published as at March 1, 2018 and the report’s key findings include the following:
The quality of reporting on diversity of boards has improved since it was first included in the UK Corporate Governance Code in 2012. Then 56 FTSE 100 companies stated they had a broad diversity policy, all of which focussed on gender, whereas now 98 per cent of FTSE 100 and 88 per cent of FTSE 250 companies have one, with roughly 33 per cent referring to ethnicity as well as gender.
Only 15 per cent of FTSE 100 companies discussed all four elements in Provision B.2.4 of the 2016 UK Corporate Governance Code (this calls for a description of the nomination committee’s process in relation to board appointments, the board’s policy on diversity, including gender, measurable objectives set for implementing the policy and progress on achieving those objectives). Only 6 per cent of FTSE 250 companies discussed all four elements.
There is a range of approaches to diversity reporting, with some clearly understanding that diversity is the best utilisation of talent and a significant strategic issue, while others follow a “tick-box” approach.
20-30 per cent of the FTSE 100 and 10 per cent of the FTSE 250 are “best in class”, demonstrating maturity of approach to gender diversity and beginning to consider how best to increase ethnic diversity.
The majority of FTSE companies still need support to develop their approach to diversity.
Figures for reporting on diversity in the context of succession planning, diversity and board evaluations, ethnic diversity and initiatives aimed at senior management are substantially lower.
The report identifies examples of reporting that lead the way in terms of quality, in some cases providing real insight into the approach of companies concerned. The FRC notes in the report that it is considering the nature and scope of future monitoring against the 2018 UK Corporate Governance Code given that represents a significant increase in emphasis on succession planning and diversity in the management pipeline. It also encourages boards to think beyond gender diversity and to ensure appointment and succession planning practices are designed to promote diversity more broadly.
(FRC, Board diversity reporting - 17.09.18)
Government Equalities Office: Gender Pay Gap Information Regulations 2017 - Summary of reported data for 2017/18
In October 2018, the Government Equalities Office published a report on the Gender Pay Gap Information Regulations 2017.
Companies with 250 or more employees in England, Wales and Scotland are now legally required to report annually on the gender pay gap within their organisation, both on their own website and via a Governmental reporting portal. The report considers and summarises information reported by employers in the first year of the 2017 Regulations, along with findings from related research.
Key findings are as follows:
As of August 1, 2018, 100 per cent of identified organisations had complied with the 2017 Regulations, with 94 per cent of employers complying by the deadline date.
77 per cent of reported median gender pay gaps were positive, 14 per cent were negative, and 9 per cent of employers reported a median Gender Pay Gap of 0 per cent.
88 per cent of reported mean gender pay gap were positive, 12 per cent were negative, and 1 per cent of employers reported a mean gender pay gap of 0 per cent.
53 per cent of reported median bonus gaps were positive, 15 per cent were negative, and 33 per cent of employers reported a median bonus gap of 0 per cent.
62 per cent of reported mean gender pay gaps were positive, 14 per cent were negative, and 24 per cent of employers reported a median bonus gap of 0 per cent.
While 57 per cent of employers have more women than men among their lowest paid employees, only 33 per cent have more women than men among their highest paid employees.
As of May 2018, 48 per cent of in-scope employers had published an action plan outlining how they intend to tackle their gender pay gap.
Employers reported some difficulty collating the data required to make gender pay gap calculations in the first year, but the majority found it easy to register and input their data on the Gender Pay Gap Reporting Service.
(Government Equalities Office: Gender Pay Gap Information Regulations 2017 - Summary of reported data for 2017/18 – 24.10.18)
BEIS: Open consultation on ethnicity pay reporting launched
In October 2018, the Department for Business, Energy & Industrial Strategy (BEIS) and the Race Disparity Unit (RDU) launched a consultation on ethnicity pay reporting.
The consultation seeks views on ethnicity pay reporting by employers and asks a number of questions, including the following:
What ethnicity pay information should be reported by employers to allow for meaningful action?
Which companies should be expected to report?
What should the next steps be and what support can the Government give employers in this area?
The aim of the consultation is to provide the Government and employers with information which enables them to move forward in a consistent and transparent way. The consultation closes in January 2019 and responses received will contribute to future Government policy on ethnicity pay reporting.
(BEIS: Open consultation on ethnicity pay reporting – 11.10.18)
BEIS: Committee report on gender pay gap reporting
In August 2018, the House of Commons' Business, Energy and Industrial Strategy Committee (BEIS) published a report on gender pay gap reporting. This report follows responses to the BEIS Select Committee inquiry into aspects of pay in the private sector launched in March 2018.
The report’s recommendations include the following:
The Financial Reporting Council’s (FRC) proposals for a revised Stewardship Code should include reference to ensuring that gender diversity is properly reflected throughout the company, notably at board level.
Company boards should introduce Key Performance Indicators for reducing and eliminating their pay gaps and remuneration committees, when reporting on pay policy, should explain how the commitment to reducing the pay gap is being reflected in their decisions.
The FRC should monitor the quality of reporting on gender diversity and the pay gap in annual reports and press for improvements where necessary.
Businesses and organisations in the public and voluntary sectors should make it standard practice to include a tangible commitment to diversity in any tendering exercise or other provision of services.
The BEIS Committee will continue with its inquiry, examining the progress of reforms relating to executive pay.
(BEIS: Committee report on gender pay gap reporting – 02.08.18)