Essential Corporate News – Week ending October 2, 2015

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

On September 29, 2015 the Financial Reporting Council (FRC) published a consultation paper providing and requesting responses to proposed amendments to the UK Corporate Governance Code (the Code), the FRC’s Guidance on Audit Committees, Auditing Standards and Ethical Standards for Auditors. The consultation was prepared in response to Regulation EU/537/2014 (the Statutory Audit Regulation) which covers specific requirements regarding statutory audits of public interest entities, and Directive 2014/56/EU (the Statutory Audit Directive) which covers the statutory audit of annual accounts and consolidated accounts. Both will apply with effect from June 17, 2016.

The UK Corporate Governance Code

The FRC proposes minimal changes to the Code to align it with the Statutory Audit Directive and to limit the regulatory burden. The proposed changes are as follows:

• The requirement in Code Provision C.3.1 for the board to “satisfy itself that at least one member of the audit committee has recent and relevant financial experience” has been amended to reflect the wording in Article 39 of the Statutory Audit Directive that at least one member has “competence in accounting and/or auditing”. Additionally, this Provision now includes reference to the requirement in Article 39 that the audit committee as a whole should have competence relevant to the sector in which the company operates.
• Having reviewed Code Provision C.3.2, the FRC considers that the requirements in Article 39 are satisfied, particularly the audit committee’s responsibility for the appointment of the external auditor, and the management of the external audit process and its effectiveness.
• The FRC is satisfied that Code Provision C.3.8 covers Article 39 Sections 6 (e) and (f) which require the audit committee to, among other things, monitor the integrity of the company’s financial statements.
• The FRC refers to the Competition and Markets Authority’s (CMA) 2013 report and subsequent Orders relating to the audit services market where the CMA identified adverse effects on competition including a lack of switching of auditors and auditors being too close to management. In order to address this the report identified seven remedies, of which the FRC addresses three in the consultation paper:
  • Remedy 1 required FTSE 350 companies to put their audit engagement out to competitive tender at least every ten years. This requirement has been superseded to an extent by the Statutory Audit Regulation and Statutory Audit Directive. As the Code includes a similar requirement, which is now considered redundant, Code Provision C.3.7 has been amended to remove this reference. However, Code Provision C.3.8 is being amended to add a requirement that shareholders are informed about future audit tendering plans and a footnote about the retendering rules is being included.
  • Remedy 4 related to increasing shareholder engagement on audit matters through changes to both the Code and the UK Stewardship Code. The FRC considers that sufficient coverage is already given to this topic in both the Code and the Stewardship Code and that it is not appropriate for the Code to place emphasis on a particular topic over any other.
  • Remedy 4 also included a recommendation to introduce an advisory vote for shareholders to indicate their satisfaction with the audit committee’s annual report,. However, the FRC considers that shareholders already have sufficient rights to express their opinion on the audit committee report either by the annual re-election of the directors, which includes the audit committee chairman, or by tabling a specific shareholder resolution.
  • Remedy 5 made suggestions to increase audit committee oversight of the external audit. The FRC considers it unnecessary to amend the Code as it already contains provisions for the audit committee’s oversight of the external auditor that are consistent with the Order, however it does address additional requirements in its discussion on the revised Guidance on Audit Committees.

Guidance on Audit Committees

The FRC proposes several changes to its Guidance on Audit Committees to take account of proposed amendments to the Code. The principal changes relate to:

• Statutory Audit Regulation and Statutory Audit Directive. The main amendments involve changes to take into account the requirements of the Statutory Audit Regulation and Statutory Audit Directive. This includes expanding on changes relevant to the composition of the audit committee covering sectoral competence; removal of the references to audit retendering; changes covering the new rules around the prohibition of non-audit services; and consequential changes reflecting amendments to the Ethical and Auditing Standards for Auditors.
• Recommendations of the CMA. The FRC addresses Remedies 1, 5, and 6 as outlined in CMA’s 2013 report, in the proposed changes to the Guidance:
  • Remedy 1 required FTSE 350 companies to put their audit engagement out to competitive tender at least every ten years. To address this remedy the FRC has removed references to audit retendering in the Guidance as these have been overtaken, however the Code and Guidance have been amended to provide that shareholders should be informed about future audit tendering plans.
  • In Remedy 5 the CMA recommended that the Code align with the Order relating to an audit committee’s oversight of the external auditor and the provision of non-audit services. The FRC does not wish to override the ‘comply or explain’ nature of the Code by requiring certain items, but has included suggested clarifications in the Guidance.
  • Remedy 6 recommended the disclosure of the FRC’s Audit Quality Review (AQR) team inspection findings in audit committee reports and the Guidance has been amended to include this kind of reporting.
• Audit Quality Review and Corporate Reporting Review transparency.
  • Guidance has been included requiring the audit committee to discuss with their auditors the findings of the FRC's AQR team (if such a review has been undertaken). The audit committee should consider whether any findings are significant and, if so, make disclosures about those findings and the action they and the auditors plan to take.
  • The nature and extent of interaction (if any) with the FRC's Corporate Reporting Review (CRR) team should be disclosed in the audit committee section of the annual report. Since changing its policy in 2014, which included encouraging boards to refer voluntarily to their exchanges with the CRR team in their reports, the FRC's Conduct Committee has found that relatively few audit committees have provided clear disclosure of the nature and extent of interaction with the CRR team. As a result, the FRC will continue to monitor how audit committees report the outcomes of CRR reviews (and AQR team reviews) in their annual reports.
• Ensuring consistency and minimising overlap. The Guidance has been amended to reduce duplication with elements of the Code. The Guidance should be read in conjunction with section C.3 of the Code.
• Internal Audit. The section on internal audit has been updated to reflect recent reviews of best practice in this area. A number of the elements around internal audit were already included in the Guidance, but they have been expanded upon to provide an indication of best practice.

Ethical Standards for Auditors

The FRC proposes to replace existing Ethical Standards for Auditors (other than the Standard for small entities) with a single consolidated standard that includes changes to reflect the FRC's approach to member state options, as set out in the Statutory Audit Regulation and the Statutory Audit Directive.

In particular, the FRC suggests neither extending the EU's blacklist of prohibited non-audit services for public interest entities nor creating a white list of permitted non-audit services. The FRC does not wish to impose a lower cap for non-audit fees than is set out in the Statutory Audit Regulation, although it would seek to make changes relating to the calculation of that cap.

The FRC recommends a maximum period of five years for an audit partner engagement, but would retain flexibility to extend that period in exceptional circumstances. It would also retain its existing definition of a 'listed entity', despite it being wider than the EU definition.

Auditing Standards

The FRC intends to reverse its position on auditing standards on the form and content of the auditor's report by adopting ISA 700 and ISA 701, making additions specific to UK audits.

Furthermore, the FRC suggests amendments to the Auditing Standards including an obligation for auditors to keep audit working papers for a period of six years from the date of the auditor's report, changes reflecting the UK's implementation of the Accounting Directive and, especially, an option for small companies to file abridged accounts that do not require the filing of a special auditor's report.

The consultation closes on December 11, 2015.

(FRC, Enhancing Confidence in Audit: proposed Revisions to the Ethical Standards, UK Corporate Governance Code and Guidance on Audit Committees, 29.09.15)

On September 28, 2015 the European Securities and Markets Authority (ESMA) published its final Technical Standards in relation to the Market Abuse Regulation which came into force on July 2, 2014.  The final Technical Standards follow a consultation paper published by ESMA in July 2014 and the Technical Standards have now been sent to the European Commission for endorsement. The European Commission has three months to consider the Technical Standards.

The final report is divided into nine sections dealing with each of the topics on which mandates were given to ESMA to develop Technical Standards and cover the following:

• the content of the notifications of financial instruments and the manner and conditions of the compilation, publication and maintenance of the list of financial instruments and the timing, format and template of submission of the notifications of financial instruments;
• the conditions, restrictions, disclosure and reporting obligations for buyback programmes and stabilisation measures;
• the arrangements, procedures and record keeping requirements for persons conducting market soundings, and systems and notification templates to be used in market soundings and the technical means for appropriate communication;
• the establishment, maintenance and termination of accepted market practices;
• the arrangements, systems, procedures and notification templates to report suspicious orders and transactions;
• the technical means for the public disclosure of inside information and its delay;
• the precise format of insider lists and the format to update them;
• the format and template for the notification of PDMR transactions; and
• the technical arrangements for the objective presentation of investment recommendations or other information recommending or suggesting an investment strategy and for disclosure of particular interests or indications of conflicts of interest.

(ESMA, Draft technical standards on the Market Abuse Regulation, 28.09.15)

On September 25, 2015 the European Securities and Markets Authority (ESMA) launched a public consultation on draft Regulatory Technical Standards on the European Single Electronic Format (ESEF). The Transparency Directive as amended requires issuers listed on regulated markets to prepare their annual financial reports in an ESEF from January 1, 2020 with the aim of making submission easier for issuers and facilitating accessibility, analysis and comparability for investors and regulators. This consultation paper includes an assessment of current electronic reporting and explores the way forward with regard to the establishment of an ESEF.

One of ESMA’s proposals is that initially the entire annual financial report should be provided in PDF format, but that certain financial statements should be provided in a structured data format, comprising machine-readable data with embedded coding, as follows:

• Consolidated accounts prepared in accordance with the IAS Regulation should be published in a structured format.
• Annual accounts of an issuer prepared under national law may be published in a structured format if this is permitted or required by the member state in which the issuer is incorporated.

The consultation closes on December 24, 2015. ESMA is required to submit the draft Regulatory Technical Standards to the European Commission by December 31, 2016.

(ESMA, Consultation Paper on the Regulatory Technical Standards on the European Single Electronic Format , 25.09.15)

On September 28, 2015 the European Securities and Markets Authority (ESMA) published its final report on draft Regulatory Technical Standards on the European Electronic Access Point (EEAP) as required by the directive amending the Transparency Directive. The EEAP is to be a web portal operated by ESMA and it will provide a single point of access at EU level to regulated information (including annual reports and major shareholding notifications) stored by officially appointed mechanisms in each member state.

ESMA consulted on the Regulatory Technical Standards in a consultation paper published in December 2014 and the final report notes that feedback to the consultation generally showed support for the functioning modalities of the EEAP, especially the search criteria and the technical infrastructure chosen by ESMA to ensure an easy access of end users to regulated information. ESMA has considered the responses received in order to improve the design system and ensure its compliance with the objectives set in the Transparency Directive. It has been decided that the EEAP will not replace existing officially appointed mechanisms in storing regulated information, but rather provide an additional way of access to the information that is already stored and enabled to end users by officially appointed mechanisms.

Since ESMA recognises that issuers and officially appointed mechanisms need sufficient time to adapt to legislative and technological changes in relation to the new classification of regulated information as set out in the Regulatory Technical Standards, ESMA proposes that these apply only to regulated information made available to officially appointed mechanisms by issuers after December 31, 2016 in order to enable the correct functioning of the EEAP on January 1, 2018.

The final report has been submitted to the European Commission which has three months to decide whether to endorse the draft Regulatory Technical Standards.

(ESMA, Draft Regulatory Technical Standards on European Electronic Access Point (EEAP), 28.09.15)

On September 28, 2015 the European Securities and Markets Authority (ESMA) published final draft Technical Standards on the Markets and Financial Instruments Directive II (MiFID II) and the Markets and Financial Instruments Regulation (MiFIR).

MiFID II and MiFIR require ESMA to develop a multitude of Regulatory Technical Standards and Implementing Technical Standards. These were consulted on in a discussion paper published in May 2014 and two consultation papers published in December 2014 and February 2015.

ESMA’s final report covers proposals for 28 final draft Technical Standards in the following areas: Transparency (Technical Standards 1-5), market microstructure (Technical Standards 6-12), data publication and access (Technical Standards 13-16), requirements applying on and to trading venues (Technical Standards 17-19), commodity derivatives (Technical Standards 20-21), market data reporting (Technical Standards 22-25), post-trading (Technical Standard 26) and investor protection (Technical Standards 27-28). The final report also discusses the feedback received to the previous consultations and the rationale behind ESMA’s final proposals.

Annex 1 to the final report sets out the final draft Technical Standards (Annex 1).  All of these Technical Standards are Regulatory Technical Standards except for one Implementing Technical Standard that relates to trading venues (covering the description of the functioning of multilateral trading facilities and organised trading facilities). A costs benefit analysis on the final draft Technical Standards is at Annex 2.

The European Commission has three months to approve the Regulatory Technical Standards. Once endorsed, both the European Parliament and the European Council have an objection period.

(ESMA, Draft Regulatory and Implementing Technical Standards MiFID II/MiFIR, 28.09.15)

On September 30, 2015 the European Commission (Commission) published an action plan on building a Capital Markets Union following its February 2015 Green Paper and consultation. The Commission believes that a Capital Markets Union will strengthen the markets, provide new sources of funding for business, help to increase options for savers and make the economy more resilient while supporting Europe’s ability to fund growth.

The Commission intends to focus on a number of key areas, specifically:

• providing more funding choices for Europe’s businesses and SMEs;
• ensuring an appropriate regulatory environment for long term and sustainable investment and financing of Europe’s infrastructure;
• increasing investment and choices for retail and institutional investors;
• enhancing the capacity of banks to lend; and
• bringing down cross-border barriers and developing capital markets for all 28 Member States.

(European Commission, Action Plan on Building a Capital Markets Union, 30.09.15)