Regulations setting out new corporate reporting requirements published

On 16 October 2023, the Department for Business and Trade announced that the draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023, which were laid in Parliament on 19 July 2023, have been withdrawn.

Introduction

On 19 July 2023 the Department for Business and Trade (DBT) published the draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023 (Regulations) and associated explanatory memorandum. These have been laid before Parliament and will be debated there in due course. At the same time, the Department for Business and Trade published guidance to help companies understand the requirements set out in the Regulations (DBT guidance).

The Regulations reflect the Government’s final proposals on new corporate reporting requirements as set out in its 2022 response to the 2021 White Paper on restoring trust in audit and corporate governance¹. The explanatory memorandum notes that, following publication of the Government’s response to the White Paper, the detailed content of the reporting requirements in the Regulations has been developed and this has involved two phases of informal consultation with a “balanced set of impacted and expert stakeholders”.

The Financial Reporting Council (FRC) is also currently consulting on changes to the 2018 UK Corporate Governance Code (Code) in light of the White Paper consultation, as that identified areas of the Code that could be strengthened, particularly around directors' responsibilities for internal control, risk, audit and corporate reporting².

Further changes to the corporate reporting regime in the UK can be expected in due course as the DBT is currently working with the FRC on a review of the non-financial reporting requirements UK companies need to comply with to produce their annual report and to meet broader requirements that sit outside the Companies Act 2006 (CA 2006). A call for evidence in relation to this was launched in May 2023.

New reporting requirements for companies with high level of employees and turnover

The Regulations make amendments to Part 15 of the Companies Act 2006 (CA 2006) which sets out a reporting framework for companies. The amendments impose additional reporting requirements in a number of areas for companies with a high level of employees and turnover. These are defined, in summary, as those UK-incorporated companies and groups, whether private or public (including listed and AIM companies), with 750 or more employees and an annual turnover of at least £750m.³

The Regulations do not make any changes to the reporting requirements for limited liability partnerships and other entities that are not incorporated as companies under the CA 2006.

Timing of the introduction of the new reporting requirements

If approved by Parliament, the Regulations will come into effect on 1 January 2025. They will apply first to UK listed companies (those with shares admitted to trading on a UK regulated market) and such companies will need to comply with the new requirements in reporting on their first financial year commencing on or after 1 January 2025.

Other UK companies meeting the high level of employees and turnover threshold, so very large private companies, unlisted public companies and AIM companies for example, have another year before they need to meet the new reporting requirements. Such companies will not need to report against the new requirements until they report on their first financial year which commences on or after 1 January 2026.

It is worth noting that, unlike the position with certain other non-financial reporting requirements, the Regulations do not include any “smoothing provisions”. As a result, subject to the timing of the commencement of the provisions as discussed above, if a company comes within the high level of employees and turnover threshold for a financial year, then that company must meet the reporting requirements in the Regulations in its annual report and accounts (ARA) for that financial year.

Key reporting requirements introduced by the Regulations

In-scope companies will need to include extra information in their Strategic Report and Directors’ Report in the ARA, as well as extra notes in their accounts. The key new reporting requirements include the following:

Additional information about distributable profits

Companies will have to include a note in their accounts about the amount of their distributable profits and this will be subject to the statutory audit. The explanatory memorandum notes that, as companies are not currently required to disclose their distributable profits, investors and other readers of the accounts have no way of knowing whether companies have sufficient distributable reserves to pay a dividend, or what headroom exists between dividends paid (or proposed) and the amount available.

As a result, the information required in the note must include:

• the distributable profits at the beginning and end of the financial year;
• a summary of the changes to the distributable profits during the financial year (so information about dividends or other distributions paid and any purchases of own shares, as well as relevant profits/losses during the year which have added to/reduced distributable profits must be provided);
• public companies must disclose the impact of the net asset restriction test that applies to such companies in the CA 2006 on the amount available for distribution.

The requirements for insurance and investment companies are modified in light of the different rules around distributions in the CA 2006 that apply to them. Similarly, the rules for UK groups are modified, with UK parent companies being required to disclose only their own distributable profits and not those of other companies within the group. In addition, a UK subsidiary which meets the high level of turnover and employee threshold in its own right will not need to disclose its own distributable profits if its UK parent is required to make its own disclosure, but an in-scope UK subsidiary with an overseas parent will not be able to avail itself of this exemption.

The Regulations do allow a company to disclose a minimum or “not less than” figure where an exact figure cannot be calculated without unreasonable expense or delay. It will be for the directors to decide whether this is the case, but they will have to explain their reasoning in the notes to the accounts. The DBT guidance notes that “it is not anticipated that directors will need to make use of this provision for distributable profits generated after the coming into force of the regulations and that, in practice, it will be used mainly in respect of historical trading activity”.

Distribution policy statement

Companies will need to include a distribution policy statement in their Directors’ Report. The aim of this is to provide readers of the ARA with a better understanding of the sustainability of the company’s distribution policy, the risks and legal constraints affecting it and how it relates to the distributable profits disclosed in the notes to the accounts (see above).

Amongst other things, companies will need to set out their policy on the amount and timing of distributions to shareholders over the short and medium-term as defined in the resilience statement (see below), including through purchases of own shares, to consider the risks and constraints relevant to implementing and sustaining the distribution policy (including the availability of distributable profits within the wider group, not just at the parent company level), and to describe how the policy has been implemented in the relevant financial year.

If the Directors’ Report is a group report, then the distribution policy statement should be a consolidated statement relating to the companies in the consolidation. The DBT guidance points out that while distributable profits and distributions exist only for a company, not for a group, the intention of new section 416C(1)(c) CA 2006 (as set out in the Regulations) is that the distribution policy statement should comment on the availability of distributable profits not just at the parent company level, but within the wider group. This will then give readers of the accounts information about the availability or future availability of distributable profits within the group which could be paid up to the parent company.

Resilience statement

A resilience statement will need to be included in the Strategic Report to help readers of the ARA understand how the company is managing risk and building or maintaining business resilience. This will be required (amongst other things) to summarise the company’s strategic approach to managing risk and building or maintaining resilience over the short, medium and long-term and its internal governance processes covering risk management.

Companies will need to define the short, medium and long-term periods. The short-term must be the same period over which the directors have assessed the company’s ability to continue to operate as a going concern (so at least 12 months from the date the directors approved the annual accounts for the relevant financial year). Companies can determine the medium-term period but must explain in the resilience statement how that period aligns with the company’s strategy, its business planning and investment cycle. The long-term period need not be defined but the DBT guidance points out that it must cover matters envisaged to occur or be relevant beyond the medium-term period.

There is also a requirement for the company to carry out an annual “reverse stress test” (in which it tests a scenario in which the business plan could fail) and to summarise this and any mitigating action taken as a result. However, there is an exemption from the disclosure of elements of reverse stress testing that directors consider could be seriously prejudicial to the company’s interests.

Companies are already required to include in their Strategic Report a description of the principal risks and uncertainties they face⁴, and the Regulations make it clear that this requirement will be met by referring to material included in the resilience statement. The FRC, in the current Code consultation, is also proposing that a company that applies the Code on a “comply or explain” basis will be regarded as having complied with the proposed updated Code provisions on going concern if it has published a resilience statement.

A group Strategic Report should include a consolidated resilience statement relating to the companies in the consolidation. A subsidiary within the high level of employees and turnover threshold will not need to produce its own resilience statement if it is included in its parent company’s group Strategic Report and that includes a compliant consolidated resilience statement.

Audit and assurance policy statement

In-scope companies will need to prepare an audit and assurance policy (AAP) statement for inclusion in their Directors’ Report for the first financial year in which the reporting requirement applies and every three financial years thereafter. There should then be an annual update in the Directors’ Report on the implementation of the existing AAP statement over the relevant financial year, which should also highlight any changes made to it during that year.

The purpose of the AAP statement is to help users of the company’s ARA understand the following:

• how information in the ARA is assured internally by the company, including how management conclusions and judgments, as disclosed in the ARA, may be challenged within the company;
• whether the company has plans to strengthen its internal audit and assurance capabilities over the three year span of the AAP statement; and
• whether the company has any plans for external (third party) assurance of any information in the ARA (including some or all of its resilience statement or of the effectiveness of the company’s internal controls over financial reporting) over the next three years, to the extent not already covered by the statutory audit⁵.

The explanatory memorandum notes that this requirement responds to concerns that the statutory audit is primarily concerned with assuring the reliability of the company’s financial statements and accounts but that other information in the ARA (such as risk, strategy and governance) is of increasing importance to investors and other stakeholders.

A group Directors’ Report should include a consolidated AAP statement relating to the companies in the consolidation. A subsidiary within the high level of employees and turnover threshold will not need to produce its own AAP statement if it is included in its parent company’s group Directors’ Report and that includes a compliant AAP statement.

Material fraud statement

The Regulations require the inclusion of a material fraud statement in the Directors’ Report. The DBT guidance points out that a company’s directors and management are primarily responsible for the prevention and detection of fraud in the company’s business operations, and the explanatory memorandum notes that this statement is intended to encourage boards to think carefully about this aspect of their responsibilities, as well as to provide reassurance to investors that the risk of material fraud is being properly considered and managed.

The material fraud statement must summarise the directors’ assessment of the risk of material fraud to the business (including how the directors have assessed the company’s susceptibility to material fraud and the types of material fraud considered), and describe the measures in place to prevent and detect fraud of this nature, as well as any new measures which the directors intend to put in place during the relevant financial year or the following financial year. There is an exception whereby the directors are not required to disclose information if they consider that the disclosure of that information would be seriously prejudicial to the interests of the company.

Fraud is defined as any behaviour that falls within sections 2 to 4 of the Fraud Act 2006 (i.e. fraud by false representation, fraud by failing to disclose information and fraud by abuse of position)⁶ and this covers fraud perpetuated by the company on external parties and fraud where the company is the victim of that fraud. “Material” fraud is defined in the Regulations as any fraud which by virtue of “its nature or magnitude could reasonably be expected to influence the decisions which a reasonable shareholder would take in connection with their shareholding in the company”.

A group Directors’ Report should include a consolidated material fraud statement relating to the companies in the consolidation. A subsidiary within the high level of employees and turnover threshold will not need to produce its own statement if it is included in its parent company’s group Directors’ Report and that includes a compliant consolidated material fraud statement.

Guidance on the new reporting requirements

The FRC will provide guidance on the new reporting requirements to help companies comply with them. This guidance, which will be consulted upon in draft, is expected to be published in final form before the reporting requirements come into effect. The DBT guidance states that the draft guidance should be published by the FRC for consultation by the end of 2023 or early 2024.

Actions for in-scope companies to take now

Despite the fact that the Regulations have not yet been approved by Parliament and the FRC’s guidance is not available, even in draft, there are steps that companies currently meeting the high level of employees and turnover threshold should be taking, including the following:

• Consider the wording of the new reporting requirements set out in the Regulations.
• Determine what steps need to be taken to meet the new reporting requirements.
• Consider how existing reporting need to be enhanced to meet the new requirements. Where are the gaps?
• Determine whether new or revised processes need to be put in place to collate the necessary information to meet the new requirements.
• Learn from companies that are already voluntarily providing some of the extra information in their ARA or are providing it to meet the Code’s existing requirements in relation to viability statements.
• Given the references to the views of shareholder, employees and other stakeholders in connection with the AAP statement in particular, early engagement with those groups to obtain their views should be considered.