Directors' knowhow is a monthly article, which highlights key rule changes, proposed changes and market updates so that you know what is coming down the track.
OECD cites QCA Code in its report on flexibility and proportionality in corporate governance
The Organisation for Economic Co-operation and Development (OECD) has published its report on flexibility and proportionality in corporate governance, which surveyed the corporate governance regulations of 39 countries from across the globe including the UK, the United States, France, Germany and Japan.
We are delighted to report that cites QCA Corporate Governance Code on both pages 14 and 80. There is also a case study on the UK's approach to the creation and governance of companies on pages 62 – 79.
Overall, the report found that company size and the listing status of a firm were the most common reasons for allowing flexibility and proportionality. This generally manifested itself in more flexible criteria regarding a company’s ownership and control structures, board composition and the general disclosure of information.
FRC publish review of smaller listed and AIM company corporate reporting
The FRC has published its review of smaller listed and AIM company corporate reporting.
It reviewed the reports and accounts of 40 smaller listed and AIM quoted companies. Overall, the FRC observed that the biggest improvements in disclosures related to APMs, and judgements and estimates. Furthermore, some companies enhanced their strategic reports by providing commentary on all significant matters.
Nonetheless, the FRC has provided recommendations on five topics:
Alternative performance measures (APMs) and strategic reports
- Clearly define and reconcile APMs to the relevant IFRS numbers, accurately labelled and explained, and not given greater prominence than IFRS performance measures.
- Ensure their business model explains how they make money and is consistent with other information contained in the annual report and accounts.
- Discuss all material aspects of the business’s performance and financial position in the strategic report, including an explanation of relevant trends in balance sheet amounts such as pensions, and cash flows.
- Tailor principal risks and uncertainties and ensuring they are reviewed and updated as circumstances change.
- Disaggregate information on the assets held by the pension plan, including the bases of valuation.
- Explain the basis on which the company is expected to benefit, where net pension assets have to be considered.
- Avoid boiler-plate accounting policies. Only relevant, tailored policies should be included.
- Disclose revenue policies in sufficient detail so that users of the accounts are able to link them to, and articulate, the business model.
- Focus on estimates with a significant risk of a material change to the carrying value of assets and liabilities within the next year, identifying the specific amounts at risk of material adjustment.
Cash flow statements
- Provide high-quality cash flow information.
- Identify investing and financing cash flows correctly, consistent with the IAS 7 definitions.
- Be aware of the classification of unusual or one-off items in the cash flow statement.
- Provide useful disclosures concerning financing and the impact of non-cash transactions on their liabilities.
- Provide sufficient information to help stakeholders understand the company’s effective tax rate and the factors likely to affect it in the future.
- Explain both large differences between the tax charge and tax paid, and significant changes in the prior year assessment of tax liabilities.
- Disclose the tax issues that could have a material effect on the accounts, and quantify any material uncertain tax provisions.
- Discuss the tax effect of exceptional or non-recurring items, such as the effect of an acquisition of a subsidiary with its own deferred tax assets and liabilities.
FRC encourages companies to improve quality of their reporting
The FRC has also published its annual review of corporate governance and reporting for 2017/18.
With respect to the strategic report. the review advised companies to:
- Include a fair review of the company’s business that is balanced and comprehensive; and
- Clearly present alternative performance measures, ensuring that they are reconciled to International Financial Reporting Standards (IFRS) and explained as required by ESMA’s guidelines which the FRC considers best practice for all companies.
Corporate governance and stewardship
The review noted that compliance with the UK Corporate Governance Code remains high: 95% of FTSE 350 companies report that they comply with all but one or two of the 55 provisions. However, companies need to improve their reporting on how the Code’s principles have been applied and not overly rely on the Code provisions. Explanations must be thoughtful and provide a clear rationale for the action the company is taking.
Companies should also disclose more detail about the nature of their board evaluations, findings and follow-up action.
Risk reporting and viability statement
The review encouraged companies to:
- Enhance their viability statements by more clearly expressing how they have assessed their prospects and viability;
- Select a viability period that reflects the nature of its business and be specific about why the period is appropriate; and
With respect to Brexit, provide disclosure which distinguishes between the specific and direct challenges to their business model and operations, from broader economic uncertainties.
The review emphasised the importance of companies being more transparent. For example, they should explain how they engage with their stakeholders to understand and have regard to their interests or how they allocate capital resources for different purposes such as paying dividends and tax, and funding workforce pay and capital investment.
To support the review's findings, Paul George, the FRC’s Executive Director for Corporate Governance and Reporting, has also written an open letter to audit committee chairs and finance directors encouraging them to make improvements in key areas of corporate reporting, including key accounting judgements and estimates, eliminating basic errors and how companies have applied the Principles of the UK Corporate Governance Code.
Harvey Nash and Alumni publish fifth Board Report
Harvey Nash and Alumni have published the fifth edition of their International Board Research Report created in partnership with the London Business School’s Leadership Institute.
The report reviews the effectiveness of boards, diversity and digital enterprise transformation, and examines the causes and effects of informal discussions between board members.
It identified five themes:
- Board evaluations: Digital strategy and cyber security issues are dominating the agenda and boards are addressing their governance standards with more frequent evaluations as scrutiny in their behaviour grows. Yet, nearly one-third of boards have never completed an external board evaluation.
- Skills shortages: This remain a problem for the majority of respondents; 30% stated that a lack of technology skills was the biggest hurdle to digitisation.
- Consideration of environmental and social issues: To their detriment, boards are spending only minimal time discussing ‘good business’ issues such as climate change that could ultimately affect their entire supply chain. More than half of respondents have spent zero hours discussing environmental impact.
- Diversity: Ensuring you create an environment of acceptance, where diversity and points of difference are celebrated, ultimately stimulates innovation at every level in the business. Just under half of boards are concerned about diversity in the boardroom.
- Managing disagreement: Conflicting opinions in the boardroom are positive if handled correctly. Encouraging disparate viewpoints may well avoid necessitating unproductive offline conversations. 97% of respondents feel comfortable with raising questions of ethics.
Financial Reporting Lab issues guidance for companies on performance metrics reporting
The FRC’s Financial Reporting Lab has issued guidance for companies wishing to improve the presentation of performance metrics in their reporting.
The report highlights that investors use performance metrics to gain insights over a number of areas including, but not limited to, a company's value, its business model, strategy and risks, a forecast or assessment of future performance and the management team's credibility.
The Lab identifies five principles for performance reporting to provide the following recommendations:
1. Aligned to strategy
- Disclose the metrics used by management internally, including where and how they link to remuneration;
- Provide a combination of metrics linked to their strategic objectives, competitive advantage and business model, which may involve incorporating operational metrics alongside higher-level key performance indicators; and
- Explain which metrics are being used and why they are important.
- Provide an explanation for the use of metrics and a full break down of non-GAAP to GAAP metrics; and
- Maintain consistency by using the same, transparent format over a number of years.
3. In context
- Disclose targets for metrics, showing whether performance has achieved its target or not;
- Reference an industry benchmark when disclosing performance where relevant; and
- Provide a market context that is linked to how that context affects the company.
- Make the governance and oversight over metrics clear;
- Explain how metrics have been scrutinised; and
- Highlight relevant third party information in conjunction with internal information.
- Ensure that information across all reporting formats is consistent, even if it is presented differently for different audiences;
- Refer to industry benchmarks or standards where appropriate; and
- Build up a five-year track record using their chosen reporting formats.
Treasury Select Committee publishes report on SME finance
The House of Commons Treasury Select Committee has published a report on SME finance.
Although much of the report focusses on the inadequacy of bank lending, as well as a lack of competition in the SME banking sector, there was an interesting intervention regarding equity finance made by Philip Duffy, Director of Enterprise and Growth at HM Treasury, who remarked (on page 7) whilst given oral evidence that “[…] compared with comparator economies [such as] Australia, the United States and some of the European economies, we clearly have a problem [with equity finance]. We have a much lower proportion of our companies seeking equity. When they do seek equity, they do not do as well in later rounds of equity raising, and they exit the market sooner. There is a view from us that to fix some of these productivity problems we need to support that […]. That money is not reaching some of our start-up companies at the same speed that it does in other economies, and that is something that naturally really worries us."
Among the recommendations of the Committee was that HM Treasury should assess what can be done to improve the extent to which these companies benefit from the capital of the UK’s long-term investors.
FRC publishes thematic reviews on IFRS 9 and 15
The FRC has also published two thematic reviews to support companies improve the quality of their corporate reporting in relation to the new accounting standards which became effective on 1 January 2018 – IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers.
The review of IFRS 9 was generally targeted at smaller banks. Nonetheless, companies are encouraged to improve their disclosures by providing clearer disclosure of estimation uncertainty, particularly with respect to the quantification of sensitivities of expected credit losses to changes in assumptions.
Similarly, companies are advised to provide transitional disclosures analysing the principal differences between IFRS 9 and IAS 39, the standard it has replaced. Companies should also show that they have considered the potential impact of the new standard, even where it does not have a material effect.
With respect to IFRS 15, companies were advised to develop clearer explanations of the changes made to accounting policies, including the reasons for the changes and the judgements made by management in arriving at the new policies and disclose more information about performance obligations, including judgements made in determining these and the timing of their satisfaction.
Companies were also encouraged to clarify how the new standard had affected the balance sheet by including disclosure of accounting policies for new items such as contract assets and contract liabilities.
Stephen Haddrill to step down as FRC CEO in 2019
The FRC has announced that Stephen Haddrill will step down as Chief Executive of the FRC in late 2019. You can read the full press release here.