Looking ahead: What you need to know Winter 2018 - The 100 Group
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
www.pwc.co.uk
Looking ahead:
What you need to
know
Winter 2018
The 100 Group
tbriefingknow Draft
The 100 Group briefing
Dear members of The 100 Group,
Welcome to the first edition of The 100 Group briefing for 2018. We have a number of topics
included you may wish to keep an eye on over the festive period, in preparation for the New
Year.
The deadline to apply a number of accounting standards - IFRS 9, and IFRS 15 in 2018
financial statements, and IFRS 16 in the following year - is approaching. The FRC has made
it clear it expects companies to have made a step change in the quality of their disclosures
this year, and to provide detailed quantitative disclosure regarding the effects of IFRSs 9 and
15. Group members will want to pay special attention to this area of the financial statements
before this year’s annual report is signed off, as there’ll be plenty of scrutiny later from the
regulator.
In the governance arena, we have just had the FRC’s consultation on the ‘fundamental
review’ of the UK Corporate Governance Code that was promised in connection with the
Government Green Paper on corporate governance reform. It’s intended to be a ‘shorter,
sharper Code’ which shifts the emphasis back to principles and away from the more box-
ticking approach that some companies have arguably slipped into over the years. It also
includes a number of potentially controversial proposals that you may well want to comment
on to the FRC.
We’ve set out in the Executive summary the other topics included in this edition. I hope you
find the briefing useful – please do let me know what you’d like to see more of and how we
can improve the publication.
Gilly Lord
Gilly Lord
Head of Audit Strategy and Transformation at PwC
T: +44 (0) 20 7804 8123
E: gillian.lord@pwc.com
Looking ahead
The 100 Group briefing, Looking ahead, is a quarterly briefing commissioned by
the 100 Group of Finance Directors. Its aim is to brief the Group on key
developments in the capital markets and proposed changes in regulation and
standards that might require response, lobbying, or which are important for
general awareness.
For further information, please contact Gilly Lord.
PwC ContentsThe 100 Group briefing
Executive summary
Page Action
Reporting
Disclosure of the impact of new standards 2 Investors and regulators will be keeping a keen eye on R
disclosure of the impact of new accounting standards
on revenue and financial instruments.
FRC thematic review on judgements and 3 FRC thematic review identifies specific areas where M
estimates companies can improve their compliance with
disclosure requirements.
FRC thematic review on Alternative 4 FRC thematic review flagged good practice and areas of M
Performance Measures improvement.
FRC thematic review of pension disclosures 5 Outcome of thematic review noted examples of good M
practice together with areas companies need to improve
disclosures.
Corporate governance
FRC Consultation on revised UK Corporate 7 FRC has issued a consultation on a ‘fundamental R
Governance Code review’ of the UK Corporate Governance Code and on a
revised version of its Guidance on board effectiveness.
Risk and viability reporting 11 The FRC Reporting Lab has issued its latest project R
report, this time on risk and viability reporting.
Independent review of Financial Reporting 13 Independent review of the Financial Reporting M
Council sanctions Council’s (FRC) enforcement sanctions makes a
number of key recommendations.
The stakeholder voice in board decision making 14 New guidance has been issued on one of the most R
important aspects of the recent debate on corporate
governance reform.
Investor engagement
PwC investor survey shows there is room for 16 Research finds investors value high quality reporting, M
improvement in reporting quality but there are a number of areas where companies could
improve.
Assurance
iXBRL for consolidated financial statements of 18 ESMA have drafted rules that require listed companies M
listed companies governed by EU regulation to prepare an iXBRL version
of the annual report.
Key: M – Monitor R – Respond/React L – Lobby
Winter 2018 PwC 1The 100 Group briefing Reporting Disclosure of the impact of new standards Disclosure of the impact of new accounting standards on revenue and financial instruments will be subject to sharp investor and regulatory focus this year. PwC’s Peter Hogarth has more. Companies reporting under IFRS are required to disclose information about the possible impact of applying new accounting standards. In most cases, this note to the financial statements contains little or no useful information – it is an example of what is often criticised as ‘boilerplate’ disclosure. But this year it might be one of the most closely scrutinised notes in the entire annual report. Many companies are grappling with the task of getting ready to apply IFRS 9, ‘Financial instruments’, and IFRS 15, ‘Revenue from contracts with customers’, in their 2018 financial statements. IFRS 16, ‘Leases’, will follow a year later, and in some cases is presenting even more of a challenge. For companies reporting quarterly, the point at which numbers need to be published on the basis of IFRSs 9 and 15 is approaching rapidly, but investors are asking questions about the potential impact now. Boards do need to think about investor expectations when considering when and how to announce the impact of the new standards, especially where that impact is expected to be material. But regardless of the approach taken to investor engagement, there are disclosures that must be made in the next financial statements. Specifically, IFRS requires disclosure of “known or reasonably estimable information relevant to assessing the possible impact that application of the new standards will have on the entity's financial statements in the period of initial application”. It is the reference to “known or reasonably estimable information” that seems to spawn most debate. Given the proximity to a first reporting date on the basis of the new standards, how much should be reasonably estimable when the 2017 financial statements are published? The Financial Reporting Council has expressed a clear view on the matter. In its 10 October letter to audit committee chairs and finance directors, the FRC stated that it expects companies to have made a step change in the quality of their disclosures this year, and to provide detailed quantitative disclosure regarding the effects of IFRSs 9 and 15. In a similar vein, last year the European Securities and Markets Authority made public statements that it expects companies’ next annual financial statements to provide a quantitative analysis of the potential impact of IFRSs 9 and 15. In each case, of course, this disclosure should be accompanied by clear explanations of the key changes to accounting policies and any significant judgements that will need to be made. So our regulators seem to have a clear view that the impact needs to be quantified. But what if the company simply isn’t ready? A company cannot disclose what it does not know, but IFRS is clear that there should be disclosure of what is known or reasonably estimable. So in the absence of quantification, there will inevitably be greater focus on the quality of narrative disclosure. In addition, for those reporting into the US, the SEC has remarked that it expects effective internal controls to be in Winter 2018 PwC 2
The 100 Group briefing
place to enable timely disclosure. So questions might be asked if such a company
reveals that it cannot reasonably estimate the impact.
Given the regulatory focus, and the investor interest in the subject, Group members
ought to examine this note to the financial statements carefully as this year’s annual
report is prepared and finalised.
FRC thematic review on judgements and
estimates
Late last year the FRC announced a thematic review into the
disclosure of significant accounting judgments and sources of
estimation uncertainty. PwC’s Margaret Heneghan looks at the
outcome.
The FRC reviewed the disclosures made by a sample of 20 companies (three FTSE
100, 12 FTSE 250, 4 smaller listed and one AIM-listed) and published a report
summarising its findings and setting out broader observations from its regular
reviews. The report also includes some good practice examples. The advance
notification of the reviews led most sample companies to improve their disclosures
but the level of improvement was not as significant as that noted in other thematic
reviews.
IAS 1 requires disclosure of judgements, apart from those involving
estimations, made by management in applying the entity’s accounting policies that
have the most significant effect on the amounts recognised in the financial
statements (‘judgements’). It has a separate requirement to disclose sources of
estimation uncertainty that have a significant risk of resulting in a material
adjustment in the carrying amounts of assets and liabilities within the next
financial year (‘estimates’). Of the three thematic reviews recently conducted by the
FRC, it is in compliance with these requirements that the FRC has expressed most
disappointment.
The FRC has identified specific areas where companies can improve how they meet
these disclosure requirements and expects the following:
Differentiation between judgements and estimates. The distinction is important
because, for example, companies are required to disclose, for estimates,
sensitivities and the range of reasonably possible outcomes.
Detailed description of the specific, material judgements made in applying
accounting policies. To avoid clutter, companies should make disclosures only in
respect of judgements that have a significant effect on the financial statements.
They should avoid boilerplate disclosure.
Estimate disclosures should focus on those estimates with a significant risk of a
material change to the carrying values of assets and liabilities in the next financial
year. Companies should reassess each year whether the previous year’s
disclosures are still relevant. If management believe there is a significant risk of a
material adjustment in the longer term, it might be helpful to disclose that fact
but such disclosure should be clearly differentiated from disclosures related to
estimates that could result in adjustment in the next financial year.
Estimate disclosures should be clear and entity-specific, pinpointing the precise
sources of estimation uncertainty and should avoid boilerplate language.
Estimate disclosures should include details of the specific amounts at risk of
material adjustment. It is not sufficient to disclose only the value of the line item
Winter 2018 PwC 3The 100 Group briefing
within which those amounts are included (for example, a significant uncertainty
might relate to one particular provision, not to all provisions).
Assumptions underlying estimates should be quantified if investors need this
information to understand their effect. This is particularly relevant where certain
matters are likely to be significant sources of estimation uncertainty for all
companies in the same industry.
Disclosure should be made of the sensitivity of carrying amounts to assumptions
and estimates and/or the range of reasonably possible outcomes within the next
financial year. Many companies are failing to disclose these matters except when
required to do so by an accounting standard other than IAS 1.
Changes to past assumptions in making estimates should be explained if the
uncertainty remains unresolved.
The FRC’s Corporate Reporting Review Team will continue to have disclosure of
judgements and estimates within its sights. Group members should examine their
own disclosure in light of the recent findings.
FRC thematic review on Alternative
Performance Measures
The FRC issued the results of their second thematic review on
Alternative Performance Measures (APMs) in November 2017. PwC’s
Gurpreet Kaur has more.
Following on from the November 2016 thematic review on the use of APMs in interim
statements, the FRC recently released the results of a second thematic review of this
area, covering 20 companies in total (8 FTSE 100, 9 FTSE 250, 2 smaller listed and 1
AIM company). The aim was to follow up on the earlier findings, focusing on the
extent to which companies were consistent in their annual reports with the ESMA
Guidelines that came into effect from 3 July 2016, having had more time to consider
them fully.
The FRC found that APMs were used by all companies in the sample and that
compliance with the ESMA Guidelines was generally good. In particular:
Definitions of APMs were given in all cases.
Most gave explanations for the use of APMs.
Reconciliations for at least some APMs were given by all companies.
Most gave equal prominence to IFRS numbers and APMs.
Furthermore, a range of good practice examples are presented in the report, including
on topics such as definition and labels, explanations for the use of APMs and
reconciliations to IFRS numbers.
In terms of areas where there was scope for improvement, the FRC flagged:
A number of issues around common exclusions from profit, including:
◦ Terms such as ‘non-recurring’, ‘unusual’, ‘infrequent’ and ‘one off’
being used to describe common activities such as restructuring
and impairment charges. The report states that “for larger
companies in particular, there will be few occasions when there is
only one event in a period of years which drives such charges” and
recommends that “in general, companies remove such
descriptions as ‘non-recurring’ from their definitions of APMs and
select more accurate labels.”
Winter 2018 PwC 4The 100 Group briefing
◦ The lack of symmetry between excluding the costs associated with
acquired intangible assets (such as amortisation), without
excluding the benefits (such as additional revenue).
◦ The exclusion of share based payment charges which, in the FRC’s
view, “appear to be a valid cost of the business and relieve
companies of an alternative cash expense”.
◦ It was also noted that 85% of companies in the thematic review
had adjusted profit measures that were higher than the IFRS
equivalent, demonstrating why it is important to have clear
explanations of these exclusions.
Reconciliations to IFRS numbers not being provided for all APMs, the most
frequently omitted being ratios such as return on capital and cash conversion.
IFRS numbers not being given equal prominence in sections such as Chairman’s
statement and Chief Executive’s review.
Finally, whilst not an issue specifically picked up within the thematic review,
from FRC regular reviews, there were instances where it was not always clear
whether a measure used was an APM or an IFRS measure.
APMs will therefore continue to be a focus for the FRC’s Corporate Reporting Review
Team. As well as the matters set out above they have flagged that they will continue to
challenge companies where:
Definitions are not given for all APMs used.
Good explanations for the use of APMs are not provided.
There is no discussion of either the IFRS results themselves or of the adjustments
made to those results to arrive at adjusted profit.
The IFRS results are not highlighted at an early point in the narrative section of
the report and accounts.
No explanation is given for changes made in the APMs used.
A company uses APMs incorporating adjustments not usually made by its peers
without appropriate explanation.
Group members may wish to look at the good practice examples included in the
report, as well as considering their APMs against the common issues flagged by the
FRC.
FRC thematic review of pension disclosures
The FRC recently published the outcome from its thematic review of
companies’ pension disclosures. PwC’s Mike Simpson has the details.
The FRC reviewed the disclosures made by a sample of 20 companies (four FTSE 100,
one FTSE 250, 13 smaller listed, one listed bond issuer and one unlisted company)
and published a report summarising its findings. It noted examples of good practice,
together with a number of areas where it would like to see companies improve their
disclosures.
A key message from the findings was that companies don’t necessarily need to include
‘more words’. Disclosures could be made more useful by simply using plain language
and avoiding references to paragraphs from the standard. The FRC also encourages
companies to be imaginative in how they convey information to users, noting good
examples such as the use of graphs and tables to illustrate the maturity profile of the
pension obligations and future funding obligations.
Winter 2018 PwC 5The 100 Group briefing The FRC noted that many entities disclosed the basis on which they recognised a pension asset or, where a scheme was in deficit, the policy they would apply to any potential asset. However, there is room for companies to improve the disclosures in this area by explaining any significant judgements they’ve made when determining whether the company has the right to a refund of a plan surplus, for example about pensions trustees’ rights to enhance benefits or to wind-up a scheme. The FRC considers that information about future funding of the scheme is critical to a user’s understanding of the timing of cash flows from the company to the scheme, and noted that most companies did disclose their future funding obligations to the scheme. The better disclosures explained in simple terms why the accounting deficit or surplus is different to the funding deficit or surplus, and explained that the funding obligation is driven by the most recent triennial valuation and so could change after the next valuation. Where companies have agreed funding obligations linked to payment of future dividends, it is appropriate to explain such arrangements, even though they might not strictly represent a minimum funding requirement. Disclosures of pension assets by classes that distinguish their nature and risk were of mixed quality in the FRC’s view, with a few companies providing very little analysis, with clear room for improvement. The FRC found that most companies gave clear disclosures of the investment strategy and the associated risks. But where schemes use liability-driven investments (LDIs), such as longevity swaps and insurance policies, there is scope for improvement by making clearer to users the nature of the instruments (which can vary widely) and which scheme risks the instruments do, and do not, mitigate. Also, the fair value of LDIs will often derive from unobservable inputs; while the basis of valuation of insurance policies was usually well explained, this was often not the case for other LDIs. The FRC observed that the linkage between significant actuarial assumptions and the corresponding sensitivity analysis could also be improved. The FRC welcomed mention of the pension liabilities in companies’ strategic reports, where the associated potential impact, risks and mitigations were explained. Some companies considered this to be a principal risk, and a few companies included pension scheme funding as a key assumption in their projections for the viability statement. Group members may wish to look at disclosures made in respect of strategies, risks and exposures relating to pension plans in light of FRC’s calls for improvement. Winter 2018 PwC 6
The 100 Group briefing Corporate governance FRC Consultation on revised UK Corporate Governance Code The FRC has issued a consultation on a ‘fundamental review’ of the UK Corporate Governance Code (‘the Code’) and on a revised version of its Guidance on board effectiveness (‘the GBE’ or ‘the Guidance’). PwC’s John Patterson takes a look at the details. The proposed new Code and GBE are important parts of the overall response to the ongoing debate around corporate governance reform and include proposals in relation to how companies and boards relate to their major stakeholders as well as on the work of the remuneration committee and directors’ pay. But the FRC’s review has been wider in its scope than the issues identified in the Government’s response to the November 2016 Green Paper and in particular they have looked to shorten the Code, emphasise the principles over the detailed provisions and generally give it a more commercial focus. There is, however, no change to the unitary board structure or the flexibility connected with the comply-or-explain reporting mechanism. The consultation document also includes preliminary questions in connection with the FRC’s planned review of the Stewardship Code for asset managers and owners which is planned for late 2018. The consultation period closes on 28 February 2018 and the FRC plans to issue the final version of the Code and GBE by early summer 2018. The Code would then apply for periods beginning on or after 1 January 2019. Below are the key areas of change and emphasis that the FRC is proposing. Changes to structure and length The ‘supporting principles’ that used to expand on the ‘main principles’ of the Code have now been removed; each of the sections now contains only principles and provisions. In some cases the supporting principles have been incorporated into new principles or provisions, and others have been moved to the revised GBE. The sections themselves have been revised and are now: Section 1 – Leadership and purpose Section 2 – Division of responsibilities Section 3 – Composition, succession and evaluation Section 4 – Audit, risk and internal control Section 5 – Remuneration The FRC had originally planned to reduce the number of provisions by a third; in the version of the Code being consulted on there has been a reduction of a quarter from 55 to 41 provisions. Winter 2018 PwC 7
The 100 Group briefing Reporting As before, it is the provisions of the Code to which the comply-or-explain reporting mechanism relates; partly because of the reduction in the number of provisions (there are now several principles with no associated provisions) the FRC is clear that it will not be sufficient for companies to report on how they have complied with these. There is a significant shift of emphasis towards the principles and the requirement (under the Listing Rules) to report on how these have been applied, which will mean that companies and boards need to think again about whether their reporting achieves this. Our view for some years has been that the best way to do this is to work from the main developments in the business back to the governance processes and procedures and the FRC is now advocating this kind of approach too: “It is important to report meaningfully when discussing the application of the Principles and to avoid boiler-plate reporting. Instead, focus on how these have been applied, articulating what action has been taken and the resulting outcomes.” [Proposed revised Code > Introduction, page 2] PwC comment: we think this change of emphasis will mean that many companies need to revisit their reporting to show how governance was applied as opposed to listing board and committee responsibilities, processes and procedures. Stakeholder engagement Engagement with stakeholders is dealt with in section 1 of the proposed revised Code, which also deals with company purpose and culture. As the consultation document notes, the new Code “makes it clear that the board should consider the culture of the company and wider stakeholder interests to achieve long-term sustainability”. Provision 3 of the proposed Code includes the three mechanisms through which boards might engage with the workforce that were suggested in the Green Paper: a director appointed from the workforce; a formal workforce advisory panel; or a designated non-executive director. No preference is expressed and other methods could be used on a comply-or-explain basis. Provision 4 requires the board to explain in the annual report “how it has engaged with the workforce and other stakeholders, and how their interests and the matters set out in Section 172 of the Companies Act 2006 influenced the board’s decision- making”. In the consultation document the FRC notes that it will keep the exact wording of this provision under review, pending the secondary reporting legislation that the Government promised in its response to the Green Paper, and also any subsequent changes to the FRC’s own Guidance on the Strategic Report. Shareholder engagement The new section 1 also addresses shareholder engagement, now alongside stakeholder engagement. Provision 6 includes more specific requirements around the actions companies need to take in the event of a significant (i.e. more than 20%) vote against a resolution at a general meeting. In addition to the current requirement to make a statement when announcing the voting results, there is a new requirement to provide an update no later than six months after the relevant vote on the company’s understanding of the reasons for the dissent. A final summary should be provided in the annual report or in the explanatory notes to resolutions at the next general meeting. Winter 2018 PwC 8
The 100 Group briefing
The consultation document states that the public register of significant votes against
AGM resolutions which the Investment Association will be maintaining from the end
of 2017 “will be available for reviewing these updates”.
Remuneration committees and directors’ pay
The main changes in section 5 of the proposed revised Code include:
The expansion of the remit of the remuneration committee to include the setting
of the remuneration of the whole board and of senior management. Senior
management is defined as the executive committee or the next tier of
management below board (including the company secretary) for the purposes of
the Code. The remuneration committee is also expected to have oversight of
workforce policies and practices.
Remuneration committee chairs should now have at least twelve months’
experience on a remuneration committee prior to their appointment.
A minimum five year period (from grant to realisation) for long-term incentives
and longer periods (including post-employment) where appropriate.
A new Code provision requiring remuneration schemes and policies to provide
boards with discretion to override formulaic outcomes.
There are also a number of additional disclosure requirements for the annual
remuneration report; these largely bring the Code into line with the remuneration
reporting regulations.
Other significant changes
Independence criteria: These are carried over unchanged into provision 15 of the
proposed revised Code from provision B.1.1 of the existing Code (including the so-
called ‘nine year rule’ on tenure), but failing to meet any of them now means that the
relevant director is automatically regarded as non-independent. Previously the
criteria in B.1.1 were ‘indicators’ only. Companies can still use the comply-or-explain
mechanism to explain why they regard a director as independent notwithstanding the
criteria in provision 15, but this would now represent a departure from the Code.
Independence of the chairman: The proposed revised Code treats the chairman
in the same way as the other non-executive directors for the purposes of
independence. Previously, the chairman was not regarded as being independent from
the time of his or her appointment onwards, due to the extent of the involvement they
would have with the business. As a result, the chairman will now need to meet the
criteria for independence set out in provision 15 if they are to be in line with the Code.
“…in normal circumstances [we] would not expect either an independent director or
chair to be on the board for more than nine years in total”. [FRC consultation
document, para 54]
PwC comment: the fact that the clock does not restart when an independent non-
executive steps up to the chairman role could encourage the appointment of more
external candidates to chairman roles. There is also a more fundamental question
here as to what this says about the role of the chairman and the extent of their
involvement with the company – can they really do the job and remain independent
in the same way as other non-executive directors?
Board composition: Because the chairman can now be regarded as independent
the provision on board composition and independence has been changed from at
Winter 2018 PwC 9The 100 Group briefing
least half the board excluding the chairman to a majority of the board including the
chairman.
Small company exemptions: The existing Code includes relaxations for
companies outside the FTSE 350 in relation to a number of provisions, including: the
number of independent non-executive directors needed on the board and on the audit
and remuneration committees; externally facilitated board evaluations; and the
annual re-election of all directors. The FRC is now consulting on removing all these
differences.
PwC comment: There are many companies outside the FTSE 350 that have only two
independent non-executive directors. Although the chairman may now also be an
independent director this could still result in smaller companies needing to recruit
new board members, which has historically been a challenge for some. We believe
that the FRC’s view is that this could indirectly promote diversity by encouraging
boards to consider candidates from a wider range of backgrounds.
Diversity: There is a significant focus on diversity in section 3 of the proposed
revised Code. Principle J encourages boards to “promote diversity of gender, social
and ethnic backgrounds, cognitive and personal strengths”, and provision 23 requires
disclosure of actions taken to oversee the development of a diverse pipeline for board
and senior management appointments, as well as the gender balance in the senior
management team and their direct reports – aligning the Code with the recent
Hampton-Alexander focus on the levels below boards.
Guidance on board effectiveness
The proposed revised Guidance on board effectiveness takes as its starting point the
2011 version of the GBE and re-orders a significant amount of existing content into
five sections which mirror the sections of the proposed revised Code, as well as
incorporating some of what was previously in the existing Code. The consultation
document recognises that the draft may need to change to reflect the final form of the
Code.
Significant additions to the GBE include:
New content on relations with the workforce and wider stakeholders (which
refers to and reflects the recent ICSA/Investment Association publication The
Stakeholder Voice in Board Decision Making).
Suggested questions for boards to consider in relation to several areas, in
particular company purpose, the stakeholder agenda, and culture and values.
Encouragement of a ‘two stage’ approach to the viability statement, consistent
with the recent FRC Reporting Lab project report on risk and viability (the first
stage being a wider and longer term assessment of prospects and risks and the
second the – potentially more restricted and shorter-term – formal statement of
viability). See the separate piece on the Lab report.
As a reminder, FRC Guidance is not subject to the comply-or-explain reporting
mechanism but the FRC does expect companies to follow it to the extent applicable in
their circumstances. This will be particularly relevant where content has been moved
from the previous Code to the new Guidance.
Winter 2018 PwC 10The 100 Group briefing
Planned review of Stewardship Code
Almost half of the questions in the FRC consultation document relate to the
Stewardship Code, reflecting the in-depth nature of the review that the FRC is
considering.
Issues raised include:
Whether the Stewardship Code needs to be more relevant/tailored to the three
categories of signatory (asset owners, asset managers, and service providers).
The impact of the Shareholder Rights Directive on the Stewardship Code,
including how the specific requirements for proxy advisers might be taken into
account and the effect on the FRC’s ability to review the implementation of the
Code (the recent tiering exercise might not be repeatable).
Whether long-termism, ESG-related matters and responsible investment could be
more embedded in the Stewardship Code.
What the role of independent assurance should be.
Whether asset managers should be required to break their disclosures down to a
fund level.
The initial impression that the revised Code leaves is of a less fundamental review
than was trailed, notwithstanding the re-emphasis of the Code principles and the
need to report against them better. Relatively few specific procedural changes are
proposed (and we need to bear in mind that these are only proposals for now), but
those that are proposed could have quite significant and challenging impacts.
Smaller companies may find that they have issues with board and committee
composition. For FTSE 100 companies it’s the proposed change in the expectation
around the independence of the chairman that is likely to be a major source of
debate. Few chairmen would claim to be ‘independent’ in the same way as other
independent non-executives – the role just does not allow for that. The implication of
the proposed change of status must therefore be that ‘independence’ is now defined
simply by the objective criteria set out in provision 15 of the proposed Code without
any subjective judgement about the position and mindset of the chairman in
practice.
Risk and viability reporting
The FRC Reporting Lab has issued its latest project report, this time
on risk and viability reporting. PwC’s John Patterson thinks it may
help some companies overcome their concerns about providing
information in these areas beyond the relatively short term.
The FRC has published a Reporting Lab project report looking at both risk and
viability reporting. As always, the Lab’s report is based on discussions with both
companies and investors and focuses on the information that investors indicate is
valuable, taking into account what companies are willing and able to provide. The
report contains a range of good practice examples from annual reports.
Risk
In the section on risk reporting the focus is primarily on principal risks rather than
risk governance (though mitigation of risks is of course discussed as part of principal
risk disclosures). The priorities of investors are identified as being to understand:
Winter 2018 PwC 11The 100 Group briefing
How important a risk is – likelihood, impact and priority
The nature of the risk – categorisation
How it has changed – movement in the year
How the risk links to the company’s story – how it’s connected with the rest of the
annual report including the business model and risk appetite
What the company is doing about it – the mitigating actions and who is
responsible for them.
There is also a discussion on Brexit, which encourages companies to focus on how
they are preparing to address potential issues.
Viability
Although there is general agreement that the introduction of the viability statement
into the UK Corporate Governance Code has had a positive effect on how many
companies and boards think about risks to solvency and liquidity, the FRC’s Annual
Review of Corporate Reporting was clear that neither they nor investors are yet
satisfied with the related disclosures in annual reports: these rarely provide the sort
of long-term view of companies’ prospects and risks that the viability statement was
aimed at. As the Lab report puts the issue: “… current practice is often that viability
statements are prepared as longer term going concern statements with a focus on
liquidity rather than as a means to communicate how the company will remain
relevant and solvent in the long term and be able to adapt to emerging risks”.
To address this, the Lab report suggests that investors would be happy with a “two-
stage process” in relation to viability. Stage one of this process would be to give
broader and longer term information on the company’s “investment and planning
period” (which in many industries is significantly longer than the three to five year
horizon used in almost all existing viability statements). Stage two is then the formal
viability confirmation, for which the Lab and investors recognise that the ‘bar’ is
higher, in that the directors need to have financial forecasts which amount to a
‘reasonable expectation’ that the company will be able to meet its liabilities as they
fall due.
The Lab report also calls for more insight into the stress testing that companies carry
out, and provides a number of examples of leading disclosures in this area.
Our view is that the two-stage approach that the Lab report advocates has the
potential to allow companies to give longer term information on their risks and
prospects without the directors having to sign up to a quasi-working capital
statement that goes out beyond the period for which robust financial forecasts are
available (indeed this is a concept that we have been recommending since the early
days of the viability statement.) Having made this suggestion about giving longer
term information on companies’ prospects alongside the formal statement (but
without being part of it), it is surprising that the Lab report does not offer more
advice on what investors are looking for in relation to longer term and/or emerging
risks. Nevertheless Group members may well want to consider the Lab’s suggestions
in order to respond to the continuing pressure to make improvements in this area.
Winter 2018 PwC 12The 100 Group briefing Independent review of Financial Reporting Council sanctions On 21 November an independent review of the Financial Reporting Council’s (FRC) enforcement sanctions was published. PwC’s Deborah Karmel looks at what it included. The scope of the review, which was led by former Court of Appeal Judge Sir Christopher Clarke, included whether the FRC’s current reasons for imposing sanctions in its guidance and policies are appropriate; the fairness and the effectiveness of the range of sanctions available under the enforcement procedures; and whether the financial penalty sanctions, in particular, are adequate to safeguard the public interest and deter wrongdoing. The independent review made a number of key recommendations: 1. Sanctions guidance to include a focus on quality - enhancing the quality and reliability of future audits and accountancy work should be an objective in the FRC’s sanctions guidance and policies. The current focus on sanctions as a deterrence should be changed. 2. Cooperation with the FRC (or other authority) and impact of the investigation - cooperation by individuals/firms and impact of the investigation on them should be included in the FRC’s sanctions guidance and policies as factors to be considered by tribunals when assessing potential sanctions. 3. Previous sanctions not to be regarded as aggravating factor - tribunals to take account of the current record of the quality of the work of the individual/member firm when assessing factors relevant to potential sanctions. Previous sanctions imposed are not to be automatically regarded as significant aggravating factors. 4. Decision makers to determine sanctions by reference to principles/guidance - this reflects the complexity of the circumstances which come before tribunals. The panel do not recommend the use of a tariff or metrics to determine financial penalty but guidelines which set out guiding principles and factors for tribunals to consider. 5. Greater use of non-financial sanctions - tribunals should give greater attention to the use of non-financial penalties. 6. Dishonesty - where an individual has been found to have been dishonest the recommendation should normally be exclusion from the profession for at least 10 years. Suspension or expulsion is also appropriate in cases of intentional wrongdoing or recklessness but dishonesty destroys public confidence and so those guilty of it should be excluded for a substantial period. 7. Tribunals to consider sanctions likely to lead to improvement - tribunals to consider whether sanctions proposed are likely to lead to improvements in the quality of the work of the individual/member firm. Also whether a financial penalty is necessary if non-financial sanctions could lead to improved quality of work of the individual/member firm or of the profession as a whole. 8. Incentives to settle - a series of recommendations to improve incentives for early settlement of investigations. Winter 2018 PwC 13
The 100 Group briefing 9. On audit quality - there is recognition that the role of sanctions in promoting good behaviour is limited and that the FRC already carry out a range of activities to promote good quality audit work which include: education and training, standard setting and monitoring activity. 10. Availability of information on disciplinary outcomes - the FRC to make information readily available on its website about decisions of tribunals, other decision makers, settlement agreements and outcomes. 11. Precedent - tribunals should impose sanctions which they believe are appropriate based on the facts of each case and should not be restricted by decisions in past cases. 12. Delay - the panel recognise that any significant delay in disciplinary proceedings can prejudice the regulatory regime and cause harm. They recommend acceleration of the investigation process and that all parties (FRC, tribunals, the profession) should do what they can to reduce delay and to reach a resolution. Whilst the report concludes that it is not appropriate to set a tariff or range for financial sanctions, it does suggest that in certain circumstances a fine of £10 million or more could be appropriate for cases involving seriously poor audit work of a public company, carried out by a Big Four firm and leading to widespread loss (actual or potential) and that even greater fines may be appropriate in cases involving dishonesty. Our initial view is that the report provides helpful clarification in a number of areas. The next step is for the FRC to consider the report, following which there is likely to be consultation on changes to the FRC’s sanctions guidance and policies. As it is not yet clear what those changes will be, Group members are advised to keep an eye out for developments. The stakeholder voice in board decision making New guidance has been issued on one of the most important aspects of the recent debate on corporate governance reform. PwC’s John Patterson looks at what’s being suggested. The chartered secretaries’ institute (ICSA) and the Investment Association have issued their joint guidance on how boards can put themselves in the best position to consider major external stakeholders in their decision making - this was one of the items requested by the Government in its response to last autumn’s Green Paper on governance reform. It is advisory in status rather than having any specific force, but companies can take the guidance into account in their governance procedures and reporting with immediate effect. The guidance is divided into seven sections: directors’ duties; stakeholder identification; the composition of the board; induction and training of directors; taking account of the impact of board decisions on stakeholders; the mechanics of engagement; and reporting. The guidance notes that the Government response to the Green Paper asked the FRC to consult on bringing three potential engagement mechanisms into the UK Corporate Governance Code (stakeholder panels; designated NEDs to liaise with stakeholders; and/or stakeholder representatives on the board or committees). No Winter 2018 PwC 14
The 100 Group briefing preference is expressed between these mechanisms – boards are encouraged to choose whichever approach or approaches will be most effective in their circumstances. Consistent with this, it is noted that employees and customers will be important stakeholders for almost all companies but that the list will otherwise vary. The guidance does not therefore aim to be prescriptive or comprehensive but provides core principles in each of the seven sections of the report that are likely to be relevant in most cases. As indicated above, the guidance is significantly broader than simply engagement. Much of it is concerned with how the board can ensure it has the skills to understand the impact of the business on its stakeholders, encompassing everything from board appointments through to reviewing effectiveness. The section on reporting recommends that the annual report should cover the following three questions: Who are the key stakeholders? How does the board hear from its key stakeholders? What were the outcomes and what impact did that have on the board’s decisions? It also makes an important distinction between reporting to shareholders and reporting to other stakeholders and notes that “In the annual report, stakeholder identification and engagement should be put in the context of the company’s reporting on its business model and governance arrangements; to provide a picture to shareholders of how it contributes to the long-term success of the business and how directors have performed their duty under Section 172 to promote the success of the company”. Although the annual report will contain information which is relevant to them, reporting which is primarily for stakeholders is therefore likely to happen through other channels, such as CSR reports or websites. The questions that the guidance recommends for the annual report to cover are very similar to two of the encouraged content elements in the FRC’s recent consultation on revising its Guidance on the Strategic Report. We strongly recommend boards to consider addressing these issues in the upcoming reporting season in response to both the ICSA/Investment Association guidance and the underlying debate around how boards are implementing Section 172. Winter 2018 PwC 15
The 100 Group briefing Investor engagement PwC investor survey shows there is room for improvement in reporting quality PwC asked investment professionals globally about their views on the quality of a number of corporate reporting areas and how often they’d like to see companies report to the market. PwC’s Hilary Eastman looks at the UK survey results and what companies could do to improve the quality of their corporate reporting. In November, we published our latest investor survey, in which we analyse the views of 554 investment professionals globally, including the 275 that invest in or follow UK-based companies. We asked investors how well they think companies are doing in their reporting, whether they think companies are transparent enough and whether they have enough trust in the reported items. We also asked them how often they’d like to hear from companies about their financial performance and how often they’d like to receive updates on more qualitative aspects such as a company’s business model and strategic plans. Corporate reporting proved to be key to investment decisions 68% of UK investors told us they typically review the annual report of the companies they follow or invest in. But we’ve seen responses vary among role types. All credit ratings professionals said they review the annual report, compared to only 57% of private equity professionals. And 80% of sell-side analysts typically review the annual report, whereas only 67% of the buy-side analysts say they do. We understand from our discussions with those on the buy-side that because they follow so many companies (sometimes 50 or more), they don’t have enough time to review the annual reports for all of them and therefore rely more on the research provided by the sell-side analysts and data aggregators such as Bloomberg and refer to the annual report when needed. Despite not all investment professionals reviewing the annual report, 91% of UK investors surveyed state that reporting quality impacts their perception of the quality of management. In other words, if a company’s reporting quality is poor, it will reflect badly on management. Frequency of reporting We asked investment professionals to indicate their preferred reporting frequency for different information sets, whether annually, twice a year, quarterly, monthly, real- time or less than annually. A majority of investment professionals prefer companies to report at least quarterly on quantitative matters such as the financial statements, KPIs and management’s accompanying commentary. Conversely, they prefer companies to report less frequently on qualitative matters such as business model, strategy and risks. We have also seen different preferences depending on where investors are based. UK- based investors who invest in UK companies are in favour of less frequent reporting Winter 2018 PwC 16
The 100 Group briefing than are those based in the US (see graph). This highlights the importance for companies to know their investors, know where they are based and understand their needs. Corporate reporting areas to improve The survey highlights a number of reporting areas that investment professionals think could be improved. For example, less than half (43%) of the respondents believe that companies do a good job of explaining their business model, only 40% of the investors surveyed have enough trust in the information companies report on strategic goals, risks and KPIs to be confident in their analysis and 36% think companies do a good job in linking these items to the financial statements. And only 27% of investors think management is sufficiently transparent about the metrics they use internally to plan and manage their business. This is consistent with the fact that investment professionals, when asked which area of reporting they think should be improved most urgently, highlighted non-GAAP reporting, ESG disclosures, and quality and clarity of disclosures most often in our interviews. This year’s research shows that investors value high quality reporting and that this impacts their perception of the quality of management. It also debunks the myth that investors and analysts don’t read company annual reports. The research identifies, however, a number of areas in which companies could improve the quality of reporting. Group members should reflect on the quality of their own reporting in these areas and the importance of knowing their investors, where they are based and what their needs are. Winter 2018 PwC 17
The 100 Group briefing Assurance iXBRL for consolidated financial statements of listed companies As part of the enactment of the Transparency Directive, ESMA have drafted rules that require listed companies governed by EU regulation to prepare an iXBRL version of the annual report, beginning with December 2020 year-end annual reports. PwC’s Jon Rowden has more. These rules, which are being termed “ESEF” (European Single Electronic Format) are due to be submitted by ESMA to the European Commission around the end of the calendar year and approved in the spring of 2018, at which point regulatory authorities in member states will begin to address their implementation. For at least the first two years the rules will be relatively light-touch. Whilst the entire document will be in iXBRL format, only the primary financial statements will need to be tagged, meaning that in a document that may currently consist of hundreds of pages, perhaps only five pages will involve machine-readable data. Nevertheless, for listed companies the processes, software, controls, responsibilities and potentially, independent assurance arrangements, will need to be in place for 2020 annual reports finalised in 2021. The scope of the iXBRL tagging can be expected to increase in later years to include notes to the financial statements and perhaps other required elements of the annual report. It’s possible that some companies might wish to perform full tagging from Year 1 and so regulators may need to clarify whether they will accept fully tagged consolidated financial statements from the outset. iXBRL, which combines familiar human-readable content with machine-readable data, is not new to the UK. Statutory financial statements prepared in iXBRL are submitted to HMRC as part of the annual corporation tax return process. However, there will be some significant differences between the two activities - in overview the ESMA rules are likely to mean that the choice of iXBRL tags will involve more judgement than is required for HMRC’s mandate. We have field-tested ESMA’s draft rules and found that on average 25% of the figures in the primary financial statements required judgement to be applied in the selection of the tag. We also expect that existing software will need to be adapted or new software developed to meet ESMA’s requirements. Listed companies that are US Foreign Private Issuers will be filing their first XBRL 20-Fs in 2018, a format where the electronic tags are provided in a separate document to the human-readable version of the 20-F, rather than being combined in one iXBRL document. For them, ESMA’s proposed taxonomy will be familiar, since it is based on the IASB’s IFRS taxonomy accepted by the SEC. However the ESMA rules differ from the SEC rules in some respects and at this stage it is unclear how much synergy will be available between the two processes. Winter 2018 PwC 18
The 100 Group briefing
There are five key issues around the proposed rules that will need to be resolved:
Brexit arrangements could mean that the ESMA rules do not apply to the UK in
2020. However, we know that UK regulators from the FCA, UKLA and FRC are
actively engaging with ESMA on the proposals. By doing so, they are not
predicting the outcome of Brexit, but rather they are taking a prudent approach
to maximise UK influence over rules which may apply here. Also, it is possible
that ESMA ESEF rules might be introduced to the UK irrespective of the Brexit
outcome, so that investors in the UK market have access to information in the
same format as other large capital markets.
The status of the iXBRL document is not entirely clear. For example the iXBRL
document may be a replacement for the current format for the annual report and
accounts. This could mean that it will no longer be permissible for directors to
sign a solely human-readable document purporting to be the annual report and
accounts, a radical change. Alternatively the iXBRL document may become a
“bolt-on” requirement to be prepared after an annual report and accounts
document in current human-readable format is finalised. The UKLA (and the
counterparts in other EU member states) will need to clarify which pathway the
new rules will permit or require listed companies to follow.
In November, a senior European Commission official signalled a Commission
view, backed by a legal opinion, that the iXBRL data should be addressed as part
of the audit. Assuming this is followed up with a written statement of the
position, then audit standard setters across Europe will be prompted to consider
how best to devise the professional standards necessary to bring iXBRL’s
machine-readable data into the scope of external audit.
How the machine-readable data will be made available to investors is currently
unclear. In the beginning this will be the responsibility of the UKLA and
equivalent regulators across Europe. Eventually the European Commission and
ESMA intend for the Europe-wide data to be commonly accessible through a
single access point, perhaps using distributed ledger technology or “Blockchain”.
A short video setting out the Commission’s vision can be viewed here.
National implementations across Europe will naturally differ in some respects,
for example each regulator will need to introduce their own software and
protocols for receiving iXBRL documents. However the extent of overall
difference is not yet clear. Whilst it is tempting to hope for a relatively consistent
implementation approach across the affected countries, the regulatory set-up
does not make this a certainty. Divergence in practice may create practical
difficulties, for example in the capacity of software companies and other solution
providers to tailor their solutions to national differences.
We expect UK listed companies will first hear directly from the UKLA after the ESMA
rules are approved by the European Commission in the spring of 2018, although there
is always some prospect that the Commission may require further changes, thus
delaying the implementation.
We recommend Group members keep a close eye on the emerging regulations as
events resolve the current uncertainties.
Winter 2018 PwC 19You can also read
