Corporate governance and narrative reporting developments – Summer 2017 | Global law firm

Global | Publication | July 2017

Content

Introduction
Corporate governance developments
Narrative reporting developments

Introduction

Since our Spring 2017 publication, there have continued to be a number of corporate governance and narrative reporting developments. This briefing summarises those developments and looks at future developments in a number of areas that companies need to start preparing for.

Corporate governance developments

Share issue and share buyback developments

Pre-Emption Group’s Monitoring Report 2017

In May 2017, the Pre-Emption Group published its latest Monitoring Report, looking at the implementation of the Statement of Principles for the disapplication of pre-emption rights published in March 2015 and the use of its template resolutions for authorities to disapply pre-emption rights published in May 2016, for meetings held between March 13, 2016 and February 1, 2017.

The Monitoring Report concludes that the template resolutions and Statement of Principles have generally been adhered to, but the Pre-Emption Group is aware of examples of poor consultation and disclosure in the monitoring period. It points out that discussions between companies and investors should address both the spirit and the letter of the Statement of Principles and notes that a request for a general disapplication is likely to be supported where it meets the criteria regarding size, duration and resolution format. However, it is still important for there to be effective dialogue and timely notification.

The Monitoring Report also notes that investors remain of the view that the allocation of the additional five per cent provided for in the Statement of Principles should not be applied for automatically by companies, but only when it is appropriate for their circumstances. If a company is to utilise the additional five per cent authority, then investors will expect it to be tied to an acquisition or specified capital investment and companies should disclose the circumstances that have led to its use and describe in detail the consultation process undertaken.

The Pre-Emption Group reminds companies that those that do not adhere to the Statement of Principles are less likely to receive ongoing shareholder support and investors are likely to raise questions about specific issuances that appear to be contrary to the Statement of Principles. It also reminds companies that if they do not use the template resolutions, this may form part of an adviser’s rating analysis.

In an Appendix to the Monitoring Report, the Pre-Emption Group set out best practice in engagement and disclosure, covering applications for disapplication authority, proposed share issues on a non-pre-emptive basis and disclosures in the subsequent report and accounts.

The Pre-Emption Group is to continue monitoring the Statement of Principles on an ongoing basis, particularly in light of regulatory changes surrounding implementation of the Prospectus Regulation.

ICGN - Use of share buybacks and their governance implications: Viewpoint Report

In May 2017, the International Corporate Governance Network (ICGN) published a Viewpoint Report on the use of share buybacks and their governance implications. The report examines the arguments for and against the use of share buybacks as a tool for managing capital. It identifies some key issues that need to be addressed by shareholders and boards around buybacks, particularly in relation to capital allocation, determining the appropriate price for the buyback, calculation of net present value and the methodology for calculating this and the impact of buybacks on executive remuneration.

While the report does not take a view as to whether companies should or should not engage in share buybacks, it raises issues about potential abuses and suggests the need for healthy scepticism on the part of both boards and shareholders. It sets out a number of critical questions that should be asked by both shareholders and boards, including the following:

What is the board’s approach to capital management and the objective of buybacks? Is there an informed discussion involving the whole board? Was there a conscious discussion within the board about alternatives?
How much of what the company earns should be re-invested into the business?
How much should be returned to shareholders through dividends or buybacks and how much should be retained by the management as a reward?
How far did the board discuss the price at which buybacks were made and what is the buyback programme’s impact on the company’s creditors and credit quality?

Developments in institutional investor/proxy adviser guidelines

PIRC’s UK Shareowner Voting Guidelines 2017

Pensions and Investment Research Consultants Ltd (PIRC) published the 24th edition of its UK Shareowner Voting Guidelines in April 2017. These can be purchased from PIRC.

PIRC has made several key changes in the 2017 Guidelines, including:

The board

PIRC believes the combination of roles of chairman and chief executive at a listed company can only be justified on a temporary basis under exceptional circumstances and where a clear, cogent and compelling rationale has been provided for the combination. PIRC will also oppose the re-election of an executive chairman except in exceptional circumstances.
In the 2016 Guidelines, PIRC stated that it is important for both company boards and shareholders to take account of a director's track record, qualifications, sector-based experience, transactional experience and overall competency when contemplating his or her suitability for re-election. PIRC now states that this principle should also apply for a director’s election to the board.
Where there are serious concerns over the conduct of a director, PIRC will be unlikely to support a director's nomination unless fully justified by the board.
PIRC now believe it should be seen as normal practice for vacant executive director posts to be formally advertised.
PIRC supports the recommendations of the final Lord Davies review and the Hampton-Alexander review and will not support the re-election of a nomination committee chairman of a FTSE 350 company where current female representation on its board falls below the expectations of those reviews with no clear and credible proposals for reaching their objectives.
PIRC has removed guidance stating that it does not consider the appointment of alternate directors to be acceptable owing to the lack of accountability to shareowners and certain guidance on company secretaries.

Report and accounts, audit and financial controls

PIRC regards the provision of non-audit services as a significant material risk factor that can compromise auditors' ability to confront directors on difficult issues. Accordingly PIRC will normally recommend abstention in relation to the vote on the auditor’s re-appointment where non-audit fees are between 25 per cent and 50 per cent of audit fees, and oppose re-appointment if non-audit fees exceed 50 per cent of audit fees for either the year under review or over the previous three years. In its 2017 Guidelines PIRC clarifies that, in its view, tax compliance fees charged by auditors are to be regarded as non-audit fees for the purpose of calculating these percentages, since they cannot be fully separated from tax advisory services.

Shareowner rights, capital stewardship and corporate actions

PIRC maintains that where a company has received a significant proportion of votes cast against a management proposed resolution, it should provide a statement within its RNS announcement. The 2017 Guidelines also state that the company should disclose in its subsequent annual report steps taken to engage with shareowners on the substantive concerns represented by any ‘significant’ votes.

Directors' remuneration

PIRC now calls on companies to disclose the remuneration consultants they have used and their fees on an annual basis. PIRC also notes that it has become more common for audit firms to provide remuneration consultancy, which PIRC considers wholly unacceptable.

Sustainability and corporate responsibility reporting

PIRC states that the November 2016 BEIS Green Paper on Corporate Governance Reform is consistent with PIRC’s interpretation of the law regarding directors’ duties and the strategic report. It notes that the legislation enacting the strategic report requires directors to explain how they have fulfilled their duties under the Companies Act 2006 including the non-exhaustive list of items included in section 172. PIRC notes that some industry guidance, including the FRC Guidance on the Strategic Reports, has not done this, leading to evidence being presented to Parliament in 2016 which was indicative of wide spread non-compliance with the law.

Best Practice Principles Group: Consultation to review Principles

In April 2017, the Best Practice Principles Group for Shareholder Voting Research and Analysis (BPP Group) announced a review of its Best Practice Principles by the end of 2017.

In 2014 the BPP Group developed the Principles which signatories are expected to adopt on a comply-or-explain basis, (Proxy advisors: Best Practice Principles for Shareholder Voting Research 2014). In publishing its new review, the BPP Group aims to achieve its original objectives and seeks to improve practice and transparency in the market. The aim is to ensure that the Principles should be able to be applied in all markets for which voting research and analysis is provided, and by all providers of such services. The update will also address the transparency requirements for proxy advisers outlined in the amendments to the revised EU Shareholder Rights Directive adopted on April 3, 2017.

A public consultation on the Principles will be held in the summer of 2017 and the Principles will be reviewed by the end of the year. An advisory stakeholder panel, comprised of members from companies, asset owners, asset managers, and other constituencies, will be established to provide input to the preparation of the consultation and any subsequent revisions to the Principles.

Developments in relation to directors

Tomorrow’s Company: NEDs – Monitors to Partners

Tomorrow’s Company announced publication of a new report “NEDS – Monitors to Partners” in June 2017. Tomorrow’s Company, an independent non-profit think tank, has consulted with chairmen, non-executive directors (NEDs) and executives from a number of UK companies. The report concludes that there are shortcomings in the current approach to the role of non-executive directors (NEDs) and to corporate governance generally and it analyses the changes that need to be made in corporate governance to allow companies to focus upon long-term, sustainable business growth. This includes innovation in governance structures and greater alignment between NEDs and executives.

Many boards have found themselves focused on risk mitigation in recent years following a series of scandals and consequent reforms. While NEDs have occupied themselves with minimising risk and monitoring processes, executives have fallen short with record high dividends and low investment. The report considers that the following reasons have negatively impacted on board effectiveness:

shortage of time for the topics that drive long-term value;
unrealistic expectations that have created a lack of clarity on the role of NEDs;
a focus on acting as monitor rather than partner or adviser;
a focus on backward-looking financial information; and
too little variation in the role of NEDs.

The report addresses the need for change, critiques the current ‘focus on form over substance’ and lists a number of actions and questions that should be considered. The report also includes a series of perspectives from business leaders, intellectuals and its own members.

Corporate governance review

House of Commons BEIS Committee’s report on corporate governance

In April 2017, the House of Commons Business, Energy and Industrial Strategy (BEIS) Committee published a report on its inquiry into corporate governance. This inquiry was announced in September 2016. The inquiry examined whether the UK corporate governance framework is still fit for purpose, whether it provides the right structures to assist businesses in making high quality decisions for the long term, taking fully into account the wider interests of society, and how good behaviour can be embedded in business through cultural change and persuasion.

The BEIS Committee believes that the system of corporate governance in the UK is still strong and remains an asset to the country’s reputation for doing business. It does not believe that there is a case for a radical overhaul of corporate governance in the UK, but that there is scope for significant improvements in order to address the changing nature of company ownership in a globalised economy, and its report contains a number of recommendations, including the following:

Promoting good corporate governance

More effective measures are required to ensure that directors demonstrably take seriously their duties to have regard to other stakeholders and the long-term consequences of decisions. As such, it recommends that the Financial Reporting Council (FRC) amends the UK Corporate Governance Code (the Code) to require informative narrative reporting on the fulfilment of directors’ duties under section 172 Companies Act 2006. Boards must be required to explain precisely how they have considered each of the different stakeholder interests, including employees, customers and suppliers, and how this has been reflected in financial decisions. They should also explain how they have pursued the objectives of the company and had regard to the consequences of their decisions for the long term, however they choose to define this. Where there have been failures to have due regard to any one of these interests, these should be addressed directly and explained.
The FRC should encourage companies to be more imaginative and agile in communicating digitally with stakeholders throughout the year and should actively push back on the use of boilerplate statements in annual reports. The FRC should work with business organisations to develop appropriate metrics to inform an annual rating exercise. This should publicise examples of good and bad practice in an easy to digest red, yellow and green assessment. Companies should be obliged to include reference to this rating in their annual reports.
The Government should bring forward legislation to give the FRC the additional powers it needs to engage and hold to account company directors in respect of the full range of their duties. If engagement is unsuccessful, the FRC should report publicly to shareholders on collective board or individual failings and the FRC should be able to initiate legal action for breach of section 172 duties.
The Secretary of State should be more prepared than is presently the case to use existing powers where there is any suspicion of serious wrongdoing that may be in breach of the law.
The Investor Forum should seek to become a more pro-active facilitator of a dialogue between boards and investors by engaging in regular routine dialogue in order to pick up on any widespread concerns, for example those identified by the new FRC rating system.
Companies should consider establishing stakeholder advisory bodies and the BEIS Committee recommends that the Code should be revised to require a section in annual reports detailing how companies are conducting engagement with stakeholders.
The FRC should review the UK Stewardship Code with a view to providing more explicit guidelines on what high quality engagement would entail; a greater level of detail in terms of requirements; and an undertaking to call out poor performance on an annual basis.
The Government should consult on new requirements on listed and large private companies to provide full information on advisers engaged in transactions above a reasonable threshold, including on the amount and basis of payments and on their method of engagement.
Increased transparency and accountability are the best routes to promoting better stewardship, high quality engagement and public trust and as such, the BEIS Committee recommends that the FRC includes in its revised Stewardship Code stronger provisions to require the disclosure of voting records by asset managers and undertakes to name those that subsequently do not vote.
The FRC should include best practice guidance on professional support for non-executive directors when it updates the Code and that companies include training of board members as part of reporting on their people or human resources policy.
The FRC should update the Code to provide guidance on how companies should identify clearly and transparently the roles of non-executive directors where they have particular responsibilities and how they should be held to account for their performance. Further, non-executive directors should be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.

Private companies

The FRC, Institute of Directors and Institute for Family Business should develop, with private equity and venture capital interests, an appropriate code with which the largest privately-held companies would be expected to comply. They should contribute to the establishment of a new body to oversee and report on compliance with that code. Further, the new code should include a complaint mechanism, under which the overseeing body could pursue with the company any complaints raised about compliance with the code. The scheme should be funded by a small levy on members. Should this voluntary regime fail to raise standards after a three year period, or reveal high rates of unacceptable non-compliance, then a mandatory regulatory regime should be introduced.

Pay

Companies should make it their policy to align bonuses with broader corporate responsibilities and company objectives and take steps to ensure that they are genuinely stretching. Policy in this respect would be considered by the FRC in their corporate governance rating system.
Long-term incentive plans (LTIPs) should be phased out as soon as possible. No new LTIPs should be agreed from the start of 2018 and existing agreements should not be renewed.
The FRC should consult with stakeholders with a view to amending the Code to establish deferred stock rather than LTIPs as best practice in terms of incentivising long-term decision-making. This consultation should develop guidelines for the structure of executive pay which should be simpler based on long-term equity, a limited use of short-term performance-related cash bonuses and clear criteria for bonuses.
The FRC should revise the Code to include a requirement for a binding vote on executive pay awards the following year in the event of there being a vote of over 25 per cent of votes cast against the remuneration report in any year. This requirement should be included in legislation at the next opportunity.
Employee representation on remuneration committees would represent a powerful signal on company culture and commitment to fair pay. This option should be included in the Code and leading companies should adopt this approach.
Any chair of a remuneration committee should normally have served on the committee for at least one year previously. To further incentivise strong engagement, the chair of a remuneration committee should be expected to resign if the remuneration committee’s proposals do not receive the backing of 75 per cent of voting shareholders.
Companies should set out clearly their people policy, including the rationale for the employment model used, their overall approach to investing in and rewarding employees at all levels throughout the company, as well as reporting clearly on remuneration levels on a consistent basis. The FRC should consult with relevant bodies to work up guidance on implementing this recommendation for inclusion in the Code.
The FRC should work with other relevant stakeholders on the detail and amend the Code to require the publication of pay ratios between the CEO and both senior executives and all UK employees. Further, the Government should require that equivalent pay ratios be published by public sector and third sector bodies above a specified size.

Composition of boards and diversity

The aims and targets of the Hampton-Alexander Review should go further and, in support of the Equality and Human Rights Commission’s objective, the Government should set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women. Companies should explain in their annual report the reasons why they have failed to meet this target, and what steps they are taking to rectify the gender inequality on their executive committees.
For companies seeking a competitive advantage, the directors and non-executives running them, and those setting the strategic context in which they operate, should be empathetic to the needs and requirements of all those involved, including employees, workers, suppliers and customers. The FRC should embed the promotion of the ethnic diversity of boards within its revised Code. At the very least, wherever there is a reference to gender, the FRC should include a reference to ethnicity, so that the issue of ethnic diversity on boards is made explicit in the revised Code, and is given as much prominence as gender diversity.
In accordance with the spirit of the McGregor Smith review, the Government should legislate to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and by pay band.
The more similar that individual directors think, act, and look, the more likely it is that they are not going to challenge each other, or innovate, or think imaginatively. Greater cognitive diversity promotes more effective challenge and more informed decision-making. The FRC should work with others to provide improved guidance on this aspect of diversity in the context of board membership.
The revised Code should have the issue of board diversity as a key priority and there should be a public explanation of the reasons why members are part of the board. The Code should require boards to cover in their annual reports information about diversity on their boards and in the workforce, covering diversity of gender, ethnicity, social mobility, and diversity of perspective. Annual reports should be required to include a narrative on the current position, and an emphasis on what steps the company has taken, and will continue to take to enhance the diversity of the executive pipeline, with agreed targets. This narrative should include how accurately the board mirrors the diversity of both the workforce and the customer base.
The detailed narrative of board diversity in annual reports should be a working document throughout the year, informing the board, the nomination committee, middle and senior managers, and the workforce and other stakeholders, about the seriousness with which companies are taking diversity and succession issues. The revised Code should make this requirement explicit.
Companies should be recruiting non-executive and executive directors from the widest possible net of suitable candidates, which should include recruiting internally. More companies should appoint workers on boards.
The revised Code should state explicitly that the procedure for the appointment of new directors to the board should be by open advertising, and by an external search consultancy, and detailed explanations should be given if one or both of these requirements is not met.
The FRC should be given the extra role of overseeing the rigour of the director evaluation process to ensure that it is genuinely independent, thorough and consistent across companies. The FRC should highlight best and worst practice among nomination committees.

Remuneration developments

ICAEW report on factors influencing remuneration consultants’ advice

In May 2017, the Institute of Chartered Accountants in England and Wales (ICAEW) published a report which examines the factors that influence how remuneration consultants advise non-executive directors (NEDs) on important decisions made within remuneration committees. The report’s findings are the result of a number of face-to-face interviews with consultants who advise FTSE 350 companies on executive pay.

The key findings presented in the report are as follows:

Often a fundamental change in business strategy or in the leadership team triggers changes in the remuneration plan which requires advice from consultants.
Consultants’ advice is subject to organisational context and therefore influenced by the company’s industry, business strategy and stage in its lifecycle.
Regulation policies and the company’s country of origin are other important factors to influence a consultant’s pay advice.
Quality of the chairmanship is paramount to ensuring a ‘good’ or a ‘bad’ remuneration committee but the calibre of the whole committee is still relevant. NEDs should be competent and committed and the chair must involve the whole remuneration committee in decisions, and encourage participation and debate.
Characteristics of a good remuneration committee are intellectual capability, good commercial judgement and the competence to understand the various parameters and complexities.
The relationship between consultants and the remuneration committee being advised matters; for instance, some companies have used the same trusted consultant for years and meetings are frequent while other companies have relatively new consultants that may only attend meetings once a year.
The degree of involvement of the CEO in the remuneration-setting process can lead to tensions. Therefore boundaries must be set to ensure that the remuneration committee is maintaining independence and control over the outcomes.
The quality of the remuneration consultants themselves, their independence and ability to advise will affect the remuneration committee being advised.

Human rights developments

House of Lords/Commons Joint Committee on Human Rights report on promoting responsibility and ensuring accountability

In April 2017 the House of Commons and House of Lords' Joint Committee on Human Rights published a report discussing human rights and business. The report follows the Joint Committee’s June 2016 announcement of an inquiry into human rights and business, to consider progress made by the UK Government in implementing the United Nations Guiding Principles on Business and Human Rights, by means of the National Action Plan that was published in 2013 and revised in May 2016. The Joint Committee then published an open call for evidence focussing on four main issues: the National Action Plan, Government engagement with business and human rights, monitoring transparency and compliance, and access to remedy.

The report notes the following:

The Modern Slavery Act 2015 has multiple shortcomings, including there being no requirement for a central list of companies required to report, which makes it difficult to hold companies to account.
The passage of the Modern Slavery (Transparency in Supply Chains) Bill should be facilitated as it seeks to amend the Modern Slavery Act not only so as to require the Secretary of State to compile a list of companies that should be in compliance, but also to include public bodies in the transparency in supply chains requirements of the Act and to prevent public bodies from procuring services from companies that have not conducted due diligence.
The Bill is a private member's bill that has been passed by the House of Lords but has not yet received a second reading in the House of Commons and the report recommends that if the Bill fails to be enacted in the present parliamentary session, the Government bring forward its own legislation in the next session to achieve a similar objective.
The Joint Committee recommends that the Government bring forward legislative proposals to make reporting on due diligence for all other relevant human rights, not just the prohibition of modern slavery, compulsory for large businesses, with a monitoring mechanism and an enforcement procedure.
Companies that have been found to have been responsible for abuses, either by the courts or by the National Contact Point, or where a settlement indicates that there have been human rights abuses, should also be excluded from public sector contracts for a defined and meaningful period.
The Joint Committee recommends that the Government bring forward legislation to impose a duty on all companies to prevent human rights abuses, as well as an offence of failure to prevent human rights abuses for all companies, including parent companies, along the lines of the relevant provisions of the Bribery Act 2010. The legislation should enable remedies against the parent company and other companies when abuses do occur, so civil remedies (as well as criminal remedies) must be provided. It should include a defence for companies where they had conducted effective human rights due diligence, and the burden of proof should fall on companies to demonstrate that this has been done.

Corporate Human Rights Benchmark - Key findings for 2017

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

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

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

Audit committee developments

ICSA revises terms of reference for the audit committee

In March 2017, the Institute of Chartered Secretaries and Administrators (ICSA) published a revised guidance note on the terms of reference for audit committees. It reflects the changes to the UK Corporate Governance Code (Code) published in April 2016 and to the Guidance on Audit Committees published by the Financial Reporting Council (FRC) in April 2016.

Key changes to the model terms of reference include the following:

Where possible the audit committee should include a member of the remuneration committee so as to address the issue of board committees working independently while having some overlapping agenda items.
A provision permitting notices, agendas and supporting papers to be sent electronically to recipients who have agreed to electronic receipt is included.
In terms of financial reporting, it is made clear that the audit committee should review any other statements requiring board approval which contain financial information first, where to carry out a review prior to board approval would be practicable and consistent with any prompt reporting requirements under any law or regulation, including the Listing Rules and Disclosure Guidance and Transparency Rules.
In advising the board on whether the annual report and accounts is fair, balanced and understandable and provides shareholders with the information necessary to assess the company’s performance, business model and strategy, the audit committee should also advise whether it informs the board’s statement in the annual report on these matters as required under the Code.
As well as keeping under review the company’s internal financial controls, the audit committee should keep under review the systems that identify, assess, manage and monitor financial risks and the viability statement is added to the list of statements in the annual report that the audit committee should review and approve.
In terms of the internal audit, the audit committee should approve the internal audit charter annually, review and approve the annual internal audit plan, ensure internal audit has unrestricted scope and ensure there is open communication between different functions. It should also ensure it is satisfied that the quality, experience and expertise of internal audit is appropriate for the business, review management’s actions to implement internal audit’s recommendations and consider whether an independent third party review of internal audit processes is appropriate.
In relation to the external audit, the terms of reference refer to the FRC Ethical Standard published in June 2016. In relation to developing and recommending to the board a formal policy on the provision of non-audit services by the auditor, the terms of reference reflect the FRC’s 2016 Guidance on Audit Committees.
When the audit committee works and liaises with other board committees, it should take particular account of the impact of risk management and internal controls being delegated to different committees.

Diversity developments

FTSE 350 firms urged to improve gender transparency

In July 2017, Business Minister Margot James urged FTSE 350 chief executives to be more transparent about the number of women in their top positions. Chief executives have been asked to supply data for an independent review on increasing female representation in business, with FTSE 350 companies being requested to supply data on the number of men and women in the executive pipeline.

Margot James is expected to chair the first ever meeting of the Business Diversity and Inclusion Group in the forthcoming months, which will promote cooperation between the Government and industry leaders. The group will bring together Sir Phillip Hampton and Dame Helen Alexander of the Hampton-Alexander Review, Baroness McGregor-Smith, who led a review into Black and Minority Ethnic (BME) participation and progression in the workplace, Sir John Parker, leader of the review into diversity on boards and Jayne-Anne Gadhia, a champion for women in the finance sector.

The latest statistics on gender representation at the top of business are expected to be published later in 2017.

BEIS urges FTSE 350 chief executives to improve diversity and inclusion

In March 2017, the Department for Business, Energy and Industrial Strategy (BEIS) announced that Business Minister Margot James has written to the chief executives of all FTSE 350 companies urging them to improve diversity and inclusion in the workplace, and referring them to the key recommendations made in the McGregor-Smith Review of February 2017.

Companies are encouraged to:

publish a breakdown of their workforce by race and pay;
set aspirational targets; and
nominate a board member to deliver on those targets.

European developments

Directive amending Shareholder Rights Directive published in Official Journal

In May 2017, Directive (EU) 2017/828 (Directive), amending Directive 2007/36/EC on the exercise of certain rights of shareholders in listed companies (Shareholder Rights Directive) with a view to promoting long-term shareholder engagement, was published in the Official Journal of the European Union. The Directive comes into force 20 days after publication. Member states then have two years to bring into force laws, regulations and administrative provisions required to comply with the Directive (ie until June 10, 2019).

The Directive was approved by the European Parliament on March 2017, and by the Council of the European Union in April 2017. The Explanatory Memorandum to the Directive states that its overarching objective is to contribute to the long-term sustainability of EU companies, to create an attractive environment for shareholders and to enhance cross-border voting by improving the efficiency of the equity investment chain in order to contribute to growth, jobs creation and EU competitiveness.

The Directive includes the following measures.

Identification of shareholders and facilitating the exercise of shareholder rights: Article 3a of the Directive requires member states to ensure that companies have the right to identify their shareholders. Member states may provide for companies having a registered office in their territory to be only allowed to request the identification of shareholders holding more than a certain percentage of shares or voting rights (not exceeding 0.5%). Upon a company making such a request, intermediaries should provide certain information on the individual or legal entity concerned without delay. Article 3c of the Directive requires that member states ensure that intermediaries facilitate the exercise of shareholder rights, including rights to participate and vote in general meetings. Article 3c also requires companies to confirm, at least upon request, that shareholders’ votes have been validly recorded and counted by the company, unless that information is already available to them.
Engagement policy of institutional investors and asset managers: Article 3g of the Directive requires institutional investors and asset managers to develop and publicly disclose an engagement policy which describes how they integrate shareholder engagement in their investment strategy. Details of how the policy has been implemented, including a general description of voting behaviour, an explanation of the most significant votes and the use of proxy advisors, must be publicly disclosed on an annual basis. Where institutional investors or asset managers decide not to develop an engagement policy and disclose the implementation results, they must publicly provide a clear and reasoned explanation why they have chosen not to comply.
Strengthening the link between pay and performance of directors: The Directive aims to create more transparency in relation to remuneration policy and the actual remuneration awarded to directors and to create a better link between pay and performance by improving shareholder oversight of directors’ remuneration. Articles 9a and 9b require companies to publish detailed information on their remuneration policy and individual director remuneration. Article 9b states that the European Commission will provide guidelines for a standardised presentation of some of the information be included in the remuneration report. All benefits received by directors will need to be included in the remuneration policy and report. Shareholders will have the right to approve the remuneration policy in a binding vote whenever there is a material change to it and at least every four years, and will have an advisory vote on the remuneration report.
Transparency and approval of related party transactions: Article 9c of the Directive requires companies to submit any material transactions to shareholders for approval. The definition of a ‘material transaction’ is left to individual member states, however they must take into account (a) the influence that the information about the transaction may have on the economic decision of shareholders of the company; and (b) the risk that the transaction creates for the company and its shareholders who are not a related party, including minority shareholders. Member states must also ensure that companies publicly announce material transactions with related parties at the latest at the time of the conclusion of the transaction. Article 9c allows member states to provide that the announcement must be accompanied by a report, assessing whether the transaction is fair and reasonable. Transactions entered into with a group company that is a wholly owned subsidiary of the listed company will be excluded from this requirement, subject to certain conditions. Exclusions also exist for certain transactions entered into in the ordinary course of business and on normal market terms.
Transparency of proxy advisers: Article 3j of the Directive requires proxy advisers to adopt and report on a code of conduct which they apply. Where they do not apply such a code, they must provide a clear and reasoned explanation as to why. Annual public disclosure of key information related to the preparation of proxy votes is also required, as is disclosure of any actual or potential conflict of interest that might influence preparation of the voting instructions.

AGM developments

Companies split over value of AGMs – ICSA poll

In June 2017, the Institute of Chartered Secretaries and Administrators’ (ICSA) Governance Institute and The Core Partnership, a recruitment specialist, announced the results of a joint poll that found that only 36 per cent of companies surveyed considered the current system of annual general meetings (AGMs) to be still valuable for companies. Almost one-third (30 per cent) feel it is no longer valuable and a further 34 per cent of respondents were undecided.

When companies were asked to vote on whether the current AGM system was still valuable for shareholders however, 45 per cent of respondents said ‘yes’. A much lower percentage said ‘no’ (19 per cent) and 36 per cent remained undecided.

Companies then suggested ways in which to change the current AGM system:

ban proxy advisor input;
create a discussion forum to allow smaller shareholders a voice;
introduce virtual meetings;
hold meetings at a time when the majority of shareholders can attend;
apply a shareholding threshold for attendance;
remove the option of voting by a show of hands and encourage electronic voting; and
make meetings more interactive by using presentations about the business.

Narrative reporting developments

Developments in corporate reporting

ICAEW: What’s next for corporate reporting: Time to decide

In June 2017, the Financial Reporting Faculty of the Institute of Chartered Accountants of England and Wales (ICAEW) published a report which looks at where corporate reporting stands at present and identifies key decisions that need to be taken before a step change in the quality and usefulness of financial reports can be achieved, with particular reference to non-financial reporting.

A number of roundtable discussions have been held with stakeholders and the report sets out the main themes arising from those discussions. It sets out points of view that enjoyed substantial support and highlights major issues that were singled out as barriers to change in corporate reporting. The Financial Reporting Faculty believes stakeholders need to agree collectively a way forward in relation to these areas, which include the following:

Objectives of corporate reporting – who is the user?: The report points out that the definition of “corporate reporting” is uncertain, as is the definition of the users of corporate reports.
One report or many - the needs of investors v other stakeholder groups: The annual report is seen as the cornerstone of the corporate reporting process and most agree it needs to focus primarily on reporting to investors. However, this can result in short-termism and there are concerns that other stakeholders have different information needs. The report provides examples of disclosures required other than in the annual report (for example reports under the Modern Slavery Act 2015 and gender pay gap reporting) and there is a question as to whether the trend for separate reporting outside the annual report should be encouraged or whether a single comprehensive report is more effective for communicating with a wide range of stakeholders.
Consistency, credibility and the pace of change: The question is whether a concerted international effort to encourage adoption of a consistent approach to non-financial reporting is needed or whether it should be accepted that initiatives aimed at standardisation may inhibit experimentation and innovation.
The intangibles problem: Should standard-setters prioritise ways and means of bringing a wider range of intangibles onto the balance sheet or should attention be focused on a broader approach to reporting that looks beyond historical financial performance?
Data and technology: Should it be accepted that the pace of progress in the use of technology as a corporate reporting tool is likely to remain slow or should stakeholders make a concerted effort to accelerate and coordinate progress, requiring greater collaboration between technology specialists and those with an interest in better corporate reporting?

The Financial Reporting Faculty will consider comments on the report and expects to publish a follow up paper in 2018.

FRC: Approach to changes in IFRS

In June 2017, the Financial Reporting Council (FRC) published a Feedback Statement ‘Triennial review of UK and Ireland accounting standards: Approach to changes in IFRS’. The Feedback Statement summarises respondents’ comments to its consultation document on updating Financial Reporting Standards (FRS) 102 for changes in IFRS, published in September 2016.

The consultation document asked for views on whether FRS 102 should be kept up to date with IFRS as IFRS changes, particularly in relation to major new standards that have been issued. It outlined a timetable for the possible changes in relation to financial instruments, revenue and leases.

The Feedback Statement shows that almost all respondents agree with the proposed revised principles (set out in FRED 67: Draft amendments to FRS 102, March 2017). However questions were raised over the proposed timetable and implementation. Respondents felt that more IFRS implementation experience is needed before assessing if and how requirements based on these standards should be incorporated.

The FRC agrees that further evidence-gathering and analysis needs to be undertaken before a second FRED is issued. Currently there is no effective date for any changes to FRS 102 or FRS 103 and the FRC will consult on any detailed proposals in due course.

Investment Association’s long term reporting guidance

In May 2017, the Investment Association (IA) published new guidance on various aspects of long term reporting including the reporting of the long term drivers of value creation and productive enterprise. This guidance applies to companies whose shares are admitted to the Premium Segment of the Official List of the UK Listing Authority. Companies whose shares are admitted to the Standard Segment of the Official List, to trading on AIM or to the High Growth Segment of the London Stock Exchange’s Main Market are encouraged to adopt the guidance as best practice. Companies are urged to read the guidance in conjunction with the Financial Reporting Council’s (FRC) 2014 Guidance on the Strategic Report.

Expectations of future long term reporting include the following:

Business models and long term reporting

Quarterly reporting – IA members would prefer companies to stop issuing quarterly reports and quarterly earnings guidance, in favour of greater attention being given to longer term performance and strategic issues. If, however, a company continues to report quarterly, it should publicly explain this position and how it is relevant to the achievement of the company’s long term strategy. The IA also refers to its public position paper on quarterly reporting published in November 2016.
Business model disclosures – Companies should review their current approach to business model disclosures against the FRC Reporting Lab’s Business Model Reporting recommendations published in October 2016. The guidance highlights certain key findings in that publication.
Focusing on the longer term – Reporting should strive to provide insight into the significant strategic issues and potential risks that may face the company over the next three to five years – or longer time horizons wherever possible.

Productivity

The drivers of productivity – The Strategic Report should include a narrative discussion of how productivity is regularly assessed within the business and the main drivers of productivity should be described, together with their influence on operations and planned investments to improve productivity. Companies are urged also to outline both the significant opportunities and challenges that may affect productivity in the forthcoming year.
Measures of productivity – Companies are encouraged to provide evidence of the investments they are making, or are planning to make, in improving productivity. The IA suggest a series of Key Performance Indicators (KPI) such as infrastructure, innovation, skills and culture, which companies should use to enable improvements in productivity to be measured over time.

Capital management

Investors’ expectations of capital management – IA members are keen to understand a company’s capital position, how it manages its capital and measures the performance of its capital allocation decisions. Capital ought to be allocated efficiently, and open and effective dialogue on capital management issues between investors and companies would be welcomed.
Understanding a company’s capital management strategy – IA members expect the narrative discussion in the Strategic Report to set out the objectives and investment priorities of the company’s capital management strategy, the policies governing what it regards as capital, the process by which capital allocation decisions are made and the board’s role in setting the capital management strategy.
Capital allocation decisions in practice – A company should keep all capital allocation decisions under regular review and provide shareholders with updates on significant developments. The guidance sets out the types of disclosure on capital management to be included in the Strategic Report.
Supporting quantitative disclosures – Companies should work to develop financial metrics, suitable for each sector or market they operate in, that support a framework for long term growth. Results should be displayed either in a table or a clear signpost system with the following quantitative disclosures: working capital, investment capex, research and development, capital distribution (including debt servicing, dividends and buybacks) and investment in skills and training.
Merger and Acquisition transaction data – Disclosures on the rationale and performance of merger and acquisition activities should include the following: information on the full price paid, debt reconciliation, annualised sales, returns and margins, tax planning, and ROCE or ROI on the transaction.
Nature of funding – Information regarding a company’s funding arrangements and the nature of funding in relation to its capital management strategy should be provided. This should include: company policy and approach to leverage, a mix of funding approaches (such as bonds, bank loans and other funding sources), a net debt reconciliation, key maturity dates, impact of bonds/the state of bank covenants and actuarial assumptions.
Cost of capital – A company’s cost of capital (including an explanation of how this is calculated), its capital allocation decisions (including an explanation of how a discount rate is applied for risky or volatile activities) and the extent to which the expected return on investment will exceed the cost of capital should be made clear to shareholders in the annual report.
Demonstrating return on investment – Companies are expected to demonstrate the returns generated as a direct result of the capital allocation decisions made.

Disclosure of material environmental and social risks

Importance of ESG issues – The IA supports increased disclosure on environmental, social and governance (ESG) matters in long term reporting.
Role of the board in addressing ESG issues – The annual report should state whether the board takes into account the significance of ESG matters to the company’s business, whether ESG risks that may affect the short and long term value of the company are assessed and whether there are effective systems for managing and mitigating those risks.
ESG disclosures in annual reports – With regards to policies, procedures and verification, annual reports should include information on ESG related risks and opportunities, how companies can combat such risks and ways to achieve a reasonable level of credibility in relation to verification of ESG disclosures.
ESG issues being considered by the remuneration committee – Companies are expected to state in their remuneration report whether the remuneration committee can include corporate performance on ESG issues when setting the remuneration of executive directors and if not, a reason should be provided for its absence.

Human capital and culture

Human capital and productivity – Annual disclosures on human capital management should be reported to improve the productivity of a company’s workforce over the longer term.
Understanding a company’s approach to human capital management – Companies should provide shareholders with narrative discussion in the Strategic Report on: significant investments a company has and will make to improve the productivity of its workforce; opportunities and principal risks that relate to human capital management; and how the workforce is incentivised to become more productive. Reporting on human capital management issues should demonstrate how it will improve the business’ long term strategy.
Metrics to support human capital disclosures – There should be an appropriate mix of quantitative and qualitative disclosures to explain human capital management to shareholders. Some key metrics that should be considered are: total headcount (broken down by full-time and part-time employees, gender and diversity); annual turnover; investment in training, skills and professional development; and a calculated employee engagement score.
Culture – Companies should review their current approach to corporate culture and consider how it is assessed and reported. The board should determine the purpose of the company and ensure that the company’s values, strategy and business model reflect this purpose.

Implementation and monitoring

Going forward, the IA encourages companies to adopt this guidance at the earliest possible opportunity. The IA’s Institutional Voting Information Service (IVIS) will monitor the implementation of this guidance by analysing annual reports for financial year-ends on or after September 30, 2017. IVIS will outline to its members those companies that continue to report on a short term basis and where companies are not making the desired disclosures.

ICAEW Technical Release – Guidance on realised and distributable profits under the Companies Act 2006 – TECH 02/17

In April 2017, the Institute of Chartered Accountants in England and Wales (ICAEW) published a Technical Release, TECH 02/17, which updates its guidance on realised and distributable profits. It is based on TECH 02/10 but has been updated as proposed in TECH 05/16, published in March 2016. The ICAEW has also published a mark-up of changes to the guidance to show the changes made to both TECH 02/10 and TECH 05/16.

The guidance provides advice on realised and distributable profits under the Companies Act 2006 (CA 2006) and all relevant statutory instruments made under the CA 2006. Its purpose is to identify, interpret and apply the principles relating to the determination of realised profits and losses for the purposes of making distributions under the CA 2006.

Changes made to the March 2016 draft TECH 05/16 include the following:

The use of footnotes makes it clear that the definition of a distribution for Part 23 of the CA 2006 reflects case law.
The ICAEW confirms that this guidance reflects accounting standards in issue at December 31, 2016 in relation to the meaning of realised profits. However, the additional guidance about the definition of a distribution in paragraphs 2.6A to 2.6D is based on legal advice and is not a question of generally accepted practice. Therefore, it is possible that some transactions previously entered into were distributions at the time they were entered into and would have been unlawful distributions in the absence of adequate distributable reserves. For example this may apply to some intragroup loans on off-market terms.
Further guidance is included on the definition of distributions in kind under sections 845 and 846 CA 2006.
A new paragraph has been included on the determination of the amount of a distribution in kind (paragraph 2.9FA). This states that a transfer of assets may be lawful in accordance with the statutory provisions of section 845 CA 2006, but nevertheless be an unlawful distribution of capital contrary to common law.
The paragraphs on intragroup loans have been redrafted to address comments received though not to change the overall conclusions.
Amendments have been made to address the consequences of the change in the law concerning distributable profits in relation to long-term insurance business made by The Companies Act 2006 (Distributions of Insurance Companies) Regulations 2016 (SI 2016/1194) which were made on December 7, 2016.
There is confirmation that there is no requirement under law or accounting standards for financial statements to distinguish between realised profits and unrealised profits, or between distributable profits and non-distributable profits.

FRC’s Discussion Paper on auditors and preliminary announcements

The Financial Reporting Council (FRC) published a Discussion Paper in April 2017 to stimulate discussion on the use and value of preliminary announcements and the role of the auditor in respect of such announcements. The Discussion Paper includes a number of possible options and views on those options will drive revisions to auditor guidance in Bulletin 2008/2, The Auditor’s association with Preliminary Announcements made in accordance with the requirements of the UK and Irish Listing Rules. This Bulletin, last updated in 2008, needs to be updated to reflect subsequent changes in law, regulation and applicable accounting standards.

The Discussion Paper summarises the key legislative and regulatory requirements relating to preliminary announcements, as set out in the Listing Rules and Companies Act 2006. It then analyses current practice among listed and AIM companies and evaluates the current guidance and options for change.

Current practice

The number of listed and AIM companies continuing to issue preliminary announcements remains high (though publication for listed companies has not been required since 2007).
FTSE 100 companies take on average 52 days from their year end to the results announcement, with AIM companies taking on average 98 days.
In most cases auditor’s reports have been signed on or before the date of preliminary announcements.
The average time to complete the audit after the preliminary results have been issued is 2-3 weeks for a listed company and just over a month for AIM companies.

Possible options for change

Bulletin 2008/2 could be converted into an engagement standard or regulators could establish a requirement that when preliminary results are disclosed, auditors should be aware of the relevant FRC guidance and be prepared to explain where they chose not to follow it in the conduct of an engagement. The guidance could also be extended to voluntary engagements by companies outside the main market so that, for example, AIM companies could be required to agree the release of preliminary announcements with their auditors.
Currently the auditor’s report on the statutory final statements does not have to be signed before auditors can agree to publication of preliminary results but this position could be changed.
An auditor’s report could be included with preliminary announcements confirming their agreement, describing the extent and scope of their work and/or setting out key information derived from the auditor’s report on the statutory financial statements.
The definition of a preliminary announcement in the Bulletin may need amending which could potentially change the scope of procedures required for an auditor to agree publication.
Auditors could be encouraged or required to assess whether the material in a preliminary announcement is “fair, balanced and understandable”, there could be specific guidance on the application of materiality, there could be more clarity on the auditor’s responsibilities in respect of “other information” (and more consistency with the approach in ISA (UK) 720) and the material on Alternative Performance Measures in the guidance could be updated.

Next steps

Comments on the Discussion Paper are due by June 2017. Bulletin 2008/2 will then be revised and there will be a formal consultation on any changes the FRC proposes to make.

FRC’s letter to investors ahead of annual reporting season

In April 2017, the Financial Reporting Council (FRC) wrote to investors ahead of the 2017 shareholder meeting season to highlight some recent changes and developments in reporting which it hopes will be helpful. The letter encourages investors to engage with companies to provide a steer on what information they believe is relevant for inclusion in the annual report and to challenge where reporting falls short of expectations.

Business model reporting in the strategic report

The letter reminds investors about the Financial Reporting Lab report, published in October 2016, which identified room for improvement in the clarity with which many companies explain how they make money and what differentiates them from their peers.

Alternative performance measures in the strategic report

The FRC continues to monitor how alternative performance measures (‘APMs’ or ‘non-GAAP’ measures) are used to report performance. The letter comments that this year will be the first in which the European Securities and Markets Authority (ESMA) ‘Guidelines on Alternative Performance Measures’ apply to annual reports. Investors should expect to see disclosures that give a clear and complete understanding of the APMs presented, how they are calculated and why they are useful and, where relevant, reconciliation to amounts presented in the financial statements.

Risk reporting and viability statements in the strategic report

The letter notes that the FRC’s initial assessment of viability statements suggests that there is little variation in disclosures between business sectors. This year, the FRC has encouraged companies to provide clear disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company, what qualifications and assumptions were made, and how the underlying analysis was performed.

Brexit and the strategic report

Companies will need to consider the consequential risks and uncertainties in the political and economic environment and the impacts of those risks and uncertainties on their business. As the economic and political effects are developed and become more certain in the medium and longer term, the FRC would expect boards to provide increasingly company specific disclosures with, ultimately, quantification of the effects.

Governance reporting

The letter reminds investors that the UK Corporate Governance Code operates on a comply or explain basis. Where companies elect not to comply with key provisions of the Corporate Governance Code, they should provide specific explanations. This means setting out the background, providing a clear rationale for the action being taken and describing any mitigating activities. The FRC encourages investors to challenge companies where they do not believe that explanations given are sufficiently persuasive.

Audit committee report

In 2015, the FRC issued its ‘Audit Quality Practice Aid for Audit Committees’ to assist audit committees in evaluating and reporting on audit quality in their assessment of the effectiveness of the external audit process. The FRC notes that investors should expect to see this reporting in the context of the company’s business model and strategy, the business risks it faces, and it’s perception of the reasonable expectations of the company’s investors and other stakeholders.

Tax

The FRC’s thematic study of tax reporting identified areas for improved disclosure. More companies are expected to disclose the amount of their tax provisions than in previous years.

Dividends

In light of the 2015 Financial Reporting Lab report on best practice in dividend disclosures, the FRC has already noted examples of improved disclosure, and expects to see more over the coming reporting period. The FRC suggests investors may wish to challenge companies that provide insufficient information in this area.

Low interest rates

The FRC has reminded companies that they should consider the impact of low interest rates on the amounts reported in their financial statements. In particular, careful consideration should be given to the valuation of long term assets and liabilities and companies may need to provide sensitivity analysis to highlight the potential impacts.

Accounting policies, significant accounting judgements and estimates

Companies should explain significant judgements and accounting policy choices, particularly where there is diversity of treatment, in pension reporting, for example. However, the FRC notes that there continues to be room for improvement in the disclosure of accounting policies, particularly in relation to revenue recognition. Investors should be able to see a clear link between the sources of income described in the business model and revenue recognition policies. Companies should also identify the precise nature of the judgements they make rather than merely repeat the accounting standards so investors can assess the quality of management’s policy decisions. Clear descriptions of sources of estimation uncertainty should explain the extent to which the values of assets and liabilities have the potential to change materially in the next year.

Developments in IFRS

The FRC notes that the International Accounting Standards Board has published three major standards that will become effective in the next few years: IFRS 15 Revenue from Contracts with Customers (effective for periods beginning 1 January 2018), IFRS 9 Financial Instruments (effective 1 January 2018), and IFRS 16 Leases (effective 1 January 2019). It expects that most companies that apply IFRS will have made substantial progress in their implementation of these standards. Investors should expect to see companies provide information on this progress and disclose the likely impacts of each of the new standards once they can be reasonably estimated.

FRC Conduct Committee revises corporate reporting review procedures

In April 2017, the Financial Reporting Council (FRC) published revised operating procedures for reviewing company reporting together with a Feedback Statement and some revised Frequently Asked Questions (FAQs).

The revised operating procedures follow a consultation published by the FRC in October 2016, and no substantial changes have been made to the consultation draft. The changes implement new ways of working to address requests for more transparency about Corporate Reporting Reviews (CRRs) and their outcomes, and to enhance the efficiency of CRR procedures without compromising the quality of decision-making. Additional changes have resulted from requests for greater transparency in respect of the review process and clarity in the content of the operating procedures.

The FRC makes the following observations in the Feedback Statement:

Any interaction with CRR (including that the company’s accounts have been reviewed but no substantive issues have been raised) should be disclosed in the relevant company’s audit committee report, as it will enhance users’ understanding.
Respondents observed that the FRC’s Guidance to Audit Committees only applies to premium listed companies and there is no specific reference in the operating procedures to the reporting expected of other companies such as AIM companies. The FRC notes that guidance on this has been added to the FAQs, which clarifies that if any company, whether listed or not, has had its report and accounts reviewed, this is likely to be of general interest to any reader of the next year's accounts and so boards are encouraged to be transparent about the extent of any interaction with the FRC's CRR function in their subsequent reports and accounts.
The FRC’s Conduct Committee has committed to reviewing the effectiveness of the revised operating procedures once there is sufficient experience of their operation.
The FRC has concluded that it is for the company to explain its response to regulatory interventions to its shareholders and others, but that the FRC Board will monitor the quality of the disclosure provided by companies and the extent to which it is fair and balanced.
Paragraph 62 of the operating procedures has been amended to clarify that the list of companies whose reports have been previewed which is published by the FRC will indicate the type of approach made to the company and the specific report and accounts under issue.

Developments in non-financial reporting

European Commission’s guidelines on non-financial reporting

In June 2017, the European Commission published non-binding guidelines on the methodology for reporting non-financial information. The guidelines have been prepared in accordance with Article 2 of the EU Non-Financial Reporting Directive (Directive 2014/95/EU) which requires the disclosure of non-financial and diversity information by certain large undertakings and groups.

The guidelines are designed to help companies disclose non-financial information in a relevant, useful, consistent and more comparable manner. The guidelines are not mandatory and do not create new legal obligations, so companies may also rely on international, EU-based or national narrative reporting frameworks, according to their own characteristics or business environment.. The overall aim of the guidelines is to promote sustainable growth and provide greater transparency to shareholders. They include examples and key performance indicators (KPIs) throughout.

The key principles of the guidance are:

To disclose material information so that it can be assessed regularly. Material disclosures should cover both positive or adverse impacts of a company’s activities in a clear and balanced way and the guidelines set out certain factors that may be relevant when assessing the materiality of information.
To be fair, balanced and understandable and presented in an unbiased way. Views and interpretations should be distinguished, plain language should be used, material information should be provided with appropriate context and the scope and boundaries of information disclosed should be explained.
Include comprehensive but concise material information on environmental, social and employee matters, human rights and anti-corruption and bribery matters. Companies should focus on providing the breadth and depth of information that will help stakeholders understand its development, performance, position and the impact of its activities.
To provide a strategic and forward-looking statement. Disclosures should provide insight into the strategic approach to relevant non-financial issues – what a company does, how and why it does it.
Ensure that all of the information is relevant and stakeholder orientated ie the information needs of stakeholders collectively should be considered rather than the needs or preferences of individual or atypical stakeholders.
The non-financial statement should be consistent and coherent with other elements of the management report.

In relation to the content of non-financial reports, the European Commission recommends the following:

Business model – Companies should consider using KPIs to explain their business model and main trends and highlight and explain any material changes to the business model during the reporting year. When describing their business model, companies may want to include the following: their business environment, their organisation and structure, the markets in which they operate, their objectives and strategies and finally any factors that may affect future developments.
Policies and due diligence – Companies should consider disclosures on their approaches to key non-financial aspects, their main objectives, and how they plan to deliver those objectives and implement those plans. They may want to explain the management and board’s responsibilities and make clear any changes to policies and processes.
Outcome – Companies should provide a useful, fair and balanced view of the outcome of their policies. The non-financial information disclosed by companies should help investors and other stakeholders understand and monitor the company’s performance.
Principal risks and their management – Companies are encouraged to disclose information that relates to principal risks and how they are managed and mitigated. A company should make such information on risks available to shareholders regardless of whether they stem from its own decisions or actions, or from external factors, and explain the processes used to identify and assess such risks. Companies should make clear any material changes to possible risks, or the way in which it intends to manage them in the reporting year.
KPIs – Companies are expected to report KPIs that are useful, taking into account their specific circumstances. KPIs should also be used consistently from one reporting period to the next to provide reliable information on progress and trends.
Thematic aspects – Material disclosures should provide a balanced and comprehensive view of a company’s development, performance, position, and the impact of its activities. The guidelines set out a list of thematic aspects that companies ae expected to consider when disclosing non-financial information in relation to: environmental matters, social and employee matters, respect for human rights, anti-corruption and bribery matters, information on supply chain matters that have significant implications for the company and, where relevant, responsible supply chains for minerals from conflict-affected and high risk areas.

The guidelines also address board diversity disclosure in a bid to help large listed companies prepare an appropriate description of their board diversity policy for inclusion in their corporate governance statement. The board diversity description does not, however, form a part of the non-financial statement, so this section of the guidelines is without prejudice to the need to disclose material diversity information. Companies should:

cover all aspects of diversity including age, gender, educational and/or professional backgrounds;
show how their diversity policy objectives are taken into consideration and the role of board committees in doing so;
disclose the status of the implementation and also the results from the last statement regarding diversity aspects of their policy;
if the diversity objectives are not met, the company should disclose how it intends to meet the objectives, including the expected timeframe within which these objectives are to be met.

Financial Reporting Lab reports

Financial Reporting Lab: Quarterly update

The Financial Reporting Lab (Lab) published its quarterly newsletter in June 2017. The newsletter highlights the Lab’s most recent activities over the last three months:

Lab Stakeholder survey – launched in April 2017, the survey asked for feedback on previous projects and sought views on topics the Lab might undertake going forward. The response was continued support for the Lab’s series of projects on the strategic report. The Lab plans to prioritise annual reports and remuneration reporting over the coming months.
Digital Future – in May 2017, the first in a series of reports on the Digital Future Project was released. It set out a framework of 12 characteristics which are important to consider in any future (or current) system of digitally enabled reporting. The Lab invites people with the relevant skills or experience in digital reporting to join their workshops over the summer and autumn in London.
Risk and viability reporting – the Lab is currently working on a project on risk and viability reporting, which follows its 2016 report on business models. The Lab is currently obtaining the views of members of the investment community in a private investor survey.
Improvements in dividend disclosures – in June 2017, the Lab decided to review developments in dividend disclosures following on from its implementation study which was released in December 2016.

Financial Reporting Lab’s report - A framework for future digital reporting

In May 2017, the Financial Reporting Lab (the Lab) published a report which sets out a framework for future digital reporting. The Lab has decided to undertake a Digital Future project and this is the first in a series of reports, following on from the Lab’s 2015 Digital Present Report. Written by a wide range of preparers, investors and others, the report expresses what they would like to see in any future (digitally enabled) system of corporate reporting.

The future digital reporting framework consists of twelve characteristics that are fundamental to the future of digital reporting and these are contained within three broad stages in the process of corporate reporting:

Production characteristics

Digital reporting must be cost efficient, easy to produce, timely and compatible with current reporting systems. Production characteristics are of most interest to companies and those supporting them. They focus on the collation, amalgamation, packaging and presentation of financial and non-financial information that a company or organisation will gather with the intention of releasing it externally.

Distribution characteristics

The distribution of such reporting must be free, prompt, compliant and easily accessible to find. This stage is focused on the dissemination of the information, meeting the regulatory requirements and communicating with external stakeholders. These characteristics interest both companies and those consuming the information.

Consumption characteristics

Successful future digital reporting will have certain consumption characteristics too; it shall be contextual, usable, credible and engaging. This final stage is focused on the analysis and the use of the distributed information. The consumption characteristics are of most interest to those bodies utilising the information.

Next steps

The Lab is keen to hear from technology experts and others with strong views on, or experience of, how technology might be used for corporate reporting. The next stage of the project will assess various reporting technologies and initiatives against the future digital reporting framework, to see how they might work together to meet the needs of preparers and users.

Financial Reporting Lab’s call for participants in risk and viability reporting

In March 2017, the Financial Reporting Lab published a lab project call for listed companies, investors and analysts to participate in a project on risk and viability reporting. This project follows the publication of the Lab report on business model reporting which was published in October 2016. The new report will explore how companies can develop effective principal risk reporting and viability statement reporting to meet the needs of investors.

While the scope of the project may evolve to explore the needs of companies and investors identified during the project, it is expected to examine characteristics including:

how companies identify their principal risks, the controls that mitigate the risks and how they are communicated;
the linkages to the business model, strategy and other parts of the annual report;
how companies develop the viability statement and how this links to the risk and control framework;
communication of key judgements made, including any qualifications and assumptions, and the rationale for the number of years the statement is covering;
communication of the approach to modelling and stress testing; and
how investors use principal risk disclosures and viability reporting to inform investment decisions and their stewardship of companies.

It is hoped that the results of the project will be published in time to assist those preparing December 2017 year-end annual reports.

Contacts

Raj Karia

Head of Corporate, M&A and Securities, Europe, Middle East and Asia

raj.karia@nortonrosefulbright.com

London

T: +44 (20) 74443374

Jo Chattle

Knowledge Of Counsel

jo.chattle@nortonrosefulbright.com

London

T: +44 20 7444 3356

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Corporate governance and narrative reporting developments – Summer 2017

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Introduction

Corporate governance developments

Share issue and share buyback developments

Developments in institutional investor/proxy adviser guidelines

Developments in relation to directors

Corporate governance review

Remuneration developments

Human rights developments

Audit committee developments

Diversity developments

European developments

AGM developments

Narrative reporting developments

Developments in corporate reporting

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