Essential Corporate News – Week ending October 26, 2018

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

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. These are as follows:

• 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)

On October 24, 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)

On October 22, 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:

• Judgements and Estimates
• Alternative Performance Measures (APMs)
• Strategic Report
• Income Taxes
• Revenue
• Business Combinations
• Impairment of Assets
• Pensions
• Statement of Cash Flows
• Provisions and Contingencies.

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)

On October 22, 2018, HM Treasury published a draft of The Central Securities Depositories (Amendment) (EU Exit) Regulations 2018 (draft Regulations) together with an explanatory memorandum. The draft Regulations have been published as part of a series of draft statutory instruments related to contingency planning for a no-deal Brexit scenario.

The draft Regulations, among other things:

• make technical changes to the current Central Securities Depositories Regulations issued in 2014 and 2017 (CSDR) to ensure that the UK retains an operative regulatory framework for central securities depositories (CSDs) in the event that the UK leaves the EU without a deal;
• transfer the power to make equivalence decisions from the European Commission to HM Treasury; transfer powers from the European Securities and Markets Authority to the Bank of England, enabling the Bank of England to recognise third country CSDs post exit; and
• make amendments to the CSDR transitional regime so that third country CSDs can continue to provide services relating to the UK after exit.

The Bank of England and the Prudential Regulation Authority (PRA) as appropriate, will be updating the CSDR Binding Technical Standards (BTS) to reflect the changes introduced by the draft Regulations. The Bank of England will consult on the changes in Autumn 2018. The FCA will review the BTS and report back to the Bank of England and the PRA where appropriate.

(The Central Securities Depositories (Amendment) (EU Exit) Regulations 2018 – 22.101.8)

(The Central Securities Depositories (Amendment) (EU Exit) Regulations 2018 Explanatory memorandum – 22.10.18)