In this podcast, we discuss the UK Government’s long awaited consultation paper on audit and governance reform with the Financial Reporting Council’s Kate O’Neill, Director of Stakeholder Engagement and Corporate Affairs, and Miranda Craig, Director of Strategy and Change. The consultation paper proposes some fundamental reforms in a number of areas in relation to audit, corporate governance and corporate reporting. In this podcast we consider some of the key issues for corporates including in relation to director liability and accountability, risk management and internal control process and procedures and audit and assurance.
The Department of Business, Energy and Industrial Strategy has today published its long awaited consultation paper on audit and governance reform, Restoring trust in audit and corporate governance.
The consultation paper follows three separate reviews into audit and the audit market over the last few years:
- the Kingman Review on the operation of the Financial Reporting Council (FRC), in December 2018 (see our corporate update 2019/1);
- the Competition and Markets Authority’s update to its statutory audit paper on competition in the audit sector, in April 2019 (see our corporate update 2019/8); and
- the Brydon Review on the quality and effectiveness of the audit process and product, in December 2019 (see our corporate update 2020/1).
Together, these reviews made over 150 recommendations for reform. The consultation paper states that the government is planning to takes forward the vast majority of the recommendations.
Under the government’s proposals:
- Director accountability – The Audit, Reporting and Governance Authority (ARGA), the successor regulator to the FRC, will have power to sanction directors of all large companies for breach of their duties under the Companies Act 2006 in respect of reports and accounts, including the duty to approve accounts only if they give a true and fair view, and the duty to provide information to auditors.
- Audit process – There will be new reporting obligations on both auditors and directors around internal controls and detecting/preventing fraud. It is consulting on different options, including a regime similar in scope to the US’s Sarbanes-Oxley Act on auditor assurance on internal controls.
- Annual accounts – The current mandatory going concern statement and viability statement will be replaced with a ‘resilience statement’, requiring directors to focus their minds on short term survival, medium term reliance and long term threats to resilience.
- Audit market – In order to increase the number of firms participating in the audit market, FTSE 350 companies will be required to use a smaller “challenger” firm to conduct a meaningful portion of their annual audit (e.g. one or more subsidiaries would be audited solely by a challenger firm), referred to as a managed shared audit.
Corporate governance proposals
The consultation paper also proposes a wider range of governance reforms, including in relation to:
- Executive pay – Under the UK Corporate Governance Code, listed companies will be expected to be able to recover bonuses or share awards from executive directors if they have failed to protect customers’ and employees’ interests; and
- Dividends – Directors will be required to make a formal statement about the legality and affordability of any proposed dividend.
The consultation period will close on 8 July 2021. Subject to the outcome of the consultation, the government will bring forward primary legislation to implement the proposed reforms when parliamentary time allows.
We will publish a fuller briefing on the detailed proposals in due course.
The Investment Association (IA) has published a document discussing its listed company shareholder priorities for 2021.
The IA first published its shareholder priorities in January 2020. It focused on four key areas: climate change, audit quality, stakeholder engagement and employee voice and diversity (see our earlier blog post). The 2021 priorities document provides insights into the progress made by companies on these issues in 2020 and investors’ expectations for 2021. It also sets out how the Institutional Voting Information Service (IVIS), which is part of the IA, will analyse these issues for companies with year-ends on or after 31 December 2020.
- Climate change – All companies in a high-risk sector (being financials, energy, transportation, materials and buildings, and agriculture, food and forest products) that do not address all four pillars of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) (being governance, risk management, strategy, and metrics and targets) will receive an amber top from IVIS. IVIS will also highlight to investors those FTSE companies that include a statement in their annual report that the directors have considered the relevance of material climate-related matters when preparing and signing off the company’s accounts.
- Audit quality – The IA says that the quality and robustness of the audit is essential for investors but notes that, in practice, audit committee reports do not adequately demonstrate how the audit committee has challenged management’s judgments and do not describe how the audit committee has assessed the quality of the audit. IVIS will continue to focus on these issues in 2021.
- Stakeholder engagement and employee voice – The IA notes that the Covid-19 pandemic has significantly impacted companies and their stakeholders. It says that investors expect companies to make quality disclosures outlining the approach taken to engaging, communicating and supporting the company’s stakeholders during the disruption caused by the pandemic and that this should include how the board reflected the views of their stakeholders in key decision making.
- Diversity – IVIS will issue an amber top to any FTSE 350 companies that do not disclose either the ethnic diversity of their board or a credible action plan to achieve the Parker Review targets (see our earlier blog post). IVIS will also issue a red top to any FTSE 350 company that has female representation of 30% or less on their board, or female representation of 25% or less in their Executive Committee and its direct reports. FTSE Small Cap companies will receive an amber top in those circumstances.
The FCA has published guidance on the requirement for listed companies to publish accounts in the European Single Electronic Format (ESEF) and the Department for Business, Energy and Industrial Strategy (BEIS) has updated its policy paper on ESEF.
Under DTR 4.1.14, issuers will have to publish their annual reports in the ESEF (see our earlier blog post). The FCA recently confirmed that the ESEF requirements that were due to become effective for financial years beginning on or after 1 January 2020 would instead become effective for financial years beginning on or after 1 January 2021 (see our earlier blog post).
The FCA has published guidance for the preparation of annual reports in European single electronic format.
The guidance says that issuers should have regard to the ESEF reporting manual published by ESMA when preparing their reports in ESEF. It also sets out a small number of specific departures to the approach outlined in ESMA’s manual for UK issuers.
The FCA has confirmed that issuers will be able to voluntarily submit their annual report to the National Storage Mechanism (NSM) in ESEF from January 2021. The FCA’s ESEF webpage contains further information about the process for filing reports in ESEF.
Government guidance on auditor involvement
BEIS has updated its policy paper on ESEF to set out its view on the role of auditors. The Government first published the policy statement in June 2020 to set out its view on directors’ sign-off of accounts (see our earlier blog post).
The updated policy paper confirms that the Government will not require auditors to report on ESEF tagging of accounts at present but will consider this in the context of the recommendations on audit made by Sir Donald Brydon (see our earlier blog post).
The policy paper also notes that companies may wish to obtain assurance in relation to the preparation of accounts in accordance with the ESEF requirements in accordance with the Financial Reporting Council’s new ISAE 3000 standard.
The Financial Reporting Council (FRC) has published a consolidated and updated edition of its guidance for companies on corporate governance and reporting in light of Covid-19 and the Government has extended the temporary restrictions on winding up petitions.
Additional commentary contained in the new guidance note includes:
- Timing of publication of annual reports and accounts – The FRC encourages companies to make use of the extensions to the deadlines for the publication of the annual report and accounts. It notes that the FCA recently confirmed that listed companies with a year end up to and including 31 April 2021 will still have six (rather than four) months to publish their annual report and accounts (see our earlier blog post).
- Strategic report – The FRC notes that stakeholders are interested in how business models and strategies have evolved in response to the pandemic and, in particular, how companies intend to navigate the short and medium-term uncertainty posed as a result of Covid-19.
- Risk management and internal controls – The guidance notes that the risk of fraud may be elevated, given the changes to systems and procedures in light of Covid-19, and that boards should be alert to this risk.
The FRC has also published a consolidated and updated edition of its guidance for auditors in light of Covid-19.
Extension of insolvency restrictions
The temporary restrictions on winding up petitions that were introduced by the Corporate Insolvency and Governance Act 2020 (CIGA) have been extended until 31 March 2021.
The CIGA introduced restrictions on winding up petitions being presented if they were based on statutory demands dated between 1 March 2020 to 30 September 2020 (see our corporate update 2020/14). The restrictions were extended to 31 December 2020 in October (see our earlier blog post), and the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) (No.2) Regulations 2020 have now extended the restrictions again until 31 March 2021.
The FRC has published a thematic review on climate reporting.
The report follows a review by the FRC into climate-related issues as they affect governance, reporting and audit, and the roles of a range of market participants. It sets out the FRC’s views on current market practice and expectations for the future.
The key findings in the report include:
- Governance – The report considers how boards take into account climate-related challenges. It notes that, although more companies are disclosing their approach to climate governance, it is often unclear how consideration of climate-related issues informs key decisions or impacts business model and strategy. Investors are looking for boards to explain how they consider and assess climate-related matters.
- Corporate reporting – Whilst many companies comply with the minimum reporting requirement in relation to climate issues, the report states that frequently this does not meet the needs of investors and other users of the annual report. In particular, the report notes that investors seek to understand the risks and opportunities presented by climate change, including their prioritisation, likelihood and impact, the timeframes over which they might crystallise and the resilience of the company’s business model and strategy. The report also notes that a growing number of companies report, or intend to report, against the Task Force on Climate-related Financial Disclosures (TCFD) framework. The FRC encourages the use of the TCFD framework but notes that these disclosures would benefit from greater detail in relation milestones, targets and metrics.
- Auditors – The report discusses how auditors take into account climate-related issues. It concludes that auditors need to improve their consideration of climate-related risks when planning and executing their audits.
The report is accompanied by five further reports containing more detailed findings on each of the five themes contained in the report: how boards are taking into account climate-related challenges; how companies are developing their reporting on climate-related challenges; what investors want to see; how auditors are taking into account climate-related challenges; and how professional bodies and regulators are taking account of climate change.
The Financial Reporting Council (FRC) has published its annual review of corporate reporting for 2019/2020.
The Review sets out the FRC Corporate Reporting Review team’s key findings following its review of annual reports and accounts for reporting periods to 31 October 2019.
In relation to narrative reporting, the FRC says that the topics most often raised with companies when reviewing annual reports include:
- Strategic reports – Issues that the Review highlights that could be improved are the comprehensiveness of the strategic report and whether it gives a fair review. Other areas for improvement include ensuring non-financial information reporting requirements are appropriately addressed and ensuring that the principal risks and uncertainties do not omit risks that merit inclusion (for example, climate change).
- Alternative performance measures (APMs) – Issues commonly raised include in relation to reconciliations, prominence and consistency. The Review also notes that the FRC expects issuers to continue to follow the ESMA Guidelines on APMs after the end of the Brexit transition period.
The FRC says that the topics most often raised with companies in the context of financial statements include issues in relation to judgements and estimates; impairment; revenue from contracts with customers; use of financial instruments; cash flow statements; provisions and contingencies; fair value measurement and business combinations.
In relation to the FRC’s monitoring priorities for the 2020/2021, it says that these are risks, judgements and uncertainties in light of the ongoing Covid-19 pandemic, the potential consequences of the UK’s exit from the EU, and climate-related risks.
The FRC has published a discussion paper, A Matter of Principles: The Future of Corporate Reporting.
The discussion paper explores ideas for fundamental changes to the corporate reporting framework in the UK, to make it more effective and engaging for a company’s stakeholders. It asks whether the traditional concept of the annual report remains fit for purpose, given the increasing importance of non-financial information and the digital channels available to companies to engage with their stakeholders.
The paper proposes a completely new approach to corporate reporting, replacing the current annual report with a network of interconnected reports. The network of reports would be centred around a “business review”, which would effectively be a more concise version of the current strategic report. The financial statements would be a separate standalone report. The network would also include a “public interest report”, which would be a broader, stakeholder-focused report.
The paper also discusses the opportunities available to improve the accessibility of corporate reporting through the use of technology.
The FRC says that these proposals are consistent with the themes in the Kingman Review and the Brydon Review (see our blog post at the time) on audit reform.
The FRC seeks comments on the discussion paper by 5 February 2021.
The Financial Conduct Authority (FCA) has announced that it has begun criminal proceedings against the former chief executive, the former chief financial officer and the former finance director of Redcentric Plc.
The company issued unaudited interim results in November 2015 and audited final year results in June 2016 which it is alleged materially misstated its net debt position and overstated its true asset position.
The individuals have been charged with making a false or misleading statement, contrary to section 89(1) of the Financial Services Act 2012. Between them they also face charges in relation to false accounting (contrary to section 17(1)(a) of the Theft Act 1968); making a false or misleading statement to an auditor (contrary to section 501 of the Companies Act 2006) and fraud by false representation (contrary to sections 1 and 2 of the Fraud Act 2006).
The FCA censured the company, Redcentric, for market abuse in connection with the issue in June 2020 and the company agreed to put in place a compensation scheme for affected purchasers of its shares (see our earlier post on the issue).
In light of the widespread impact of COVID-19, various pieces of guidance have been published which companies should be aware of.
Company meetings and other corporate actions
- Dividends – The London Stock Exchange (LSE) has published guidance in Market Notice N07/20 on payment dates under the 2020 Dividend Procedure Timetable. The Dividend Procedure Timetable says that issuers should pay cash dividends within 30 business days of the record date. However, from 25 March 2020, the LSE will permit a deferral period of up to 30 business days for payment of a dividend, but to no more than 60 business days after the record date. An issuer must notify the LSE of any deferral of a dividend payment without delay. After the deferral period has expired, the dividend must either be paid or cancelled. Issues to consider around the payment of dividends are also discussed in the FRC guidance referred to in the corporate reporting section below.
- Company meetings – The Government has announced that it will introduce legislation to ensure that companies required by law to hold annual general meetings (AGMs) will be able to do so in light of the restrictions on movement and gatherings. It says that companies will be given greater flexibility to hold AGMs online or to postpone the meetings but the detailed provisions are not yet available. ICSA: The Chartered Governance Institute has published an updated version of its guidance on holding AGMs and guidance on virtual board meetings.
- Proposed changes to insolvency law – The Government has announced that it will introduce a number of proposed changes to UK insolvency law in response to COVID-19. Whilst the detail of the changes is not yet available, the announcement indicates that they will enable companies undergoing a rescue or restructure process to continue trading, giving them breathing space that could help them avoid insolvency. They will also enable companies to continue buying supplies and will temporarily suspend wrongful trading provisions retrospectively from 1 March 2020. Our restructuring, turnaround and insolvency team has published a briefing on what form the changes may take.
- Share issues – The Pre-Emption Group has published a statement recommending that investors consider supporting, on a case by case basis, issuances by companies of up to 20% of their issued share capital (rather than the usual 5% for general corporate purposes, plus an additional 5% for acquisitions, that it usually recommends). The statement indicates that this is only a temporary relaxation and sets out steps for companies seeking to take advantage of this flexibility. For further information, see this briefing published by our ECM team.
- Stock transfer forms – HM Revenue & Customs (HMRC) has published details of a new process for stock transfer forms and payment of stamp duty, in light of COVID-19. Stock transfer forms should no longer be posted to HMRC but instead an electronic copy (e.g. a scanned PDF) of the stock transfer form, or in the case of purchase of own shares of Form SH03, should be emailed to HMRC. HMRC also says that it will accept e-signatures while COVID-19 measures are in place and that stamp duty must be paid before HMRC can process the form.
- Listed company annual report and accounts – The Financial Conduct Authority (FCA) has published a statement which, in effect, gives listed companies an additional two months to finalise their annual report and accounts as the FCA says that it will not suspend the listing of companies if they publish financial statements within six months of their year-end. The Q&A to accompany the FCA statement confirms that the FCA statement does not currently extend to half yearly financial reports. The FCA has published an updated version of its Primary Market Bulletin No. 27 to reflect this (see our blog post for more information on PMB No. 27).
- AIM company accounts – The LSE has said that AIM companies can apply for a three-month extension to the deadline for publication of their annual accounts.
- Filing accounts at Companies House – Companies House has said that it will grant a three month extension for companies to file their accounts. Companies must apply for the extension but those citing issues around COVID-19 will be automatically and immediately granted an extension.
- FRC guidance for companies preparing financial statements – The Financial Reporting Council (FRC) has published guidance for companies preparing financial statements. It highlights some key areas for boards in maintaining strong corporate governance as well as providing high-level guidance on preparation of annual reports and other corporate reporting matters.
- Gender pay gap reporting – The Government has suspended enforcement of the gender pay gap deadlines for this reporting year (2019/20) and there will be no expectation on employers to report their data.
- Preliminary results announcements – The FCA has asked listed companies to delay announcement of their preliminary results for a period of two weeks. Further details on the moratorium, which is voluntary, can be found in a Q&A published alongside the FCA statement.
Other relevant developments
- Managing liquidity – As both economic production and consumption contract rapidly, many businesses are facing cash flow difficulties. We have published a briefing in which we consider options open to companies to help manage liquidity.
- Job retention scheme – HMRC has published more details on the Coronavirus Job Retention Scheme. Our employment team has published a briefing on the new guidance.