The Financial Reporting Council (FRC) has published an updated version of its Guidance on the Strategic Report.
The disclosures required in strategic reports are governed by the nature of the reporting entity. The Guidance therefore aims to assist companies in determining which provisions of the Companies Act 2006 on the content of the strategic report apply to them. Appendix 2 to the Guidance includes a table summarising the application of the various disclosure requirements.
The FRC’s Guidance on this area of corporate reporting was substantially overhauled in 2018 (see our corporate update 2018/16). The changes which have been made in the 2022 edition are much more limited.
The Guidance has been updated to:
- reflect the introduction of the regulations which require publicly quoted companies, large private companies and large limited liability partnerships to include climate-related disclosures in their strategic reports (see our corporate update 2022/2);
- reflect the fact that the requirement to produce a strategic report also applies to traded LLPs and banking LLPs; and
- align the definition of public interest entities (PIEs) in the Guidance with the definition in legislation.
The Department of Business, Energy and Industrial Strategy has published the response to its March 2021 consultation on audit and corporate governance reform, Restoring trust in audit and corporate governance (for further details, see our corporate update from March 2021). Most of the proposals contained in the consultation will be implemented, a number in modified form following feedback received.
The reforms will see the creation of the Audit, Reporting and Governance Authority (ARGA) as the successor regulator to the Financial Reporting Council (FRC). The ARGA will have a broader remit and significantly expanded powers as compared to the FRC.
The majority of the changes will impact public interest entities (PIEs), a concept derived from the EU Audit Directive (as implemented into UK law). The reforms expand the current UK definition of PIEs to include all UK incorporated companies (and groups) with both 750 or more employees and an annual turnover of £750 million or more (the 750:750 threshold). AIM companies and LLPs which meet the 750:750 threshold will also be PIEs under the reforms.
The wide-ranging reforms will introduce a number of fundamental changes to the corporate governance and reporting landscape. These include:
- Directors’ duties – The ARGA will be given the power to enforce breaches by directors of their duties in relation to audit and corporate reporting. All directors of PIEs (and in exceptional cases, directors of their subsidiaries) will be within the scope of this new enforcement power.
- Internal controls – The FRC will amend the UK Corporate Governance Code to require an explicit board statement on the effectiveness of the company’s internal control systems and the basis for that statement. This was one of the three options the Government consulted on to strengthen the requirements in relation to internal control systems – another of the options that is not being taken forward was a statutory reporting and assurance regime similar to the US Sarbanes Oxley regime.
- Dividends – PIEs meeting the 750:750 threshold will be required to explain their long-term approach to the return of value to shareholders and how that policy has been applied in the reporting year. Directors of these PIEs will also need to confirm the legality of any dividend proposed or paid in year. They will not need to provide a two year solvency statement prior to payment of any dividend, as had been proposed.
- Reporting – A number of changes are being introduced in relation to corporate reporting. These new reporting requirements will apply to PIEs meeting the 750:750 threshold. They include:
- replacing the existing UK Corporate Governance Code viability and going concern statements with a new statutory resilience statement, which will form part of the strategic report;
- requiring the publication every three years of an audit and assurance policy (AAP), and an annual report on the implementation of the AAP; and
- requiring directors to report on the steps taken to detect and protect against material fraud.
The Government has also confirmed a number of measures to reform the audit market and to amend the regulation of auditors.
The reforms will be implemented through primary and secondary legislation and amendments to the UK Corporate Governance Code. As a result, and in order to give companies time to prepare for the new regime, the reforms will be implemented over a number of years.
An easy snapshot of the reforms can be found here. We have also produced a more detailed briefing on the reforms, which can be found here.
The Financial Reporting Council (FRC) has published its first review of the application of the Wates Corporate Governance Principles by large private companies.
Under the Large & Medium-Sized Companies and Groups (Accounts & Report) Regulations 2008, for accounting years beginning on or after 1 January 2019 in-scope companies are required to include a statement in their directors’ report on their corporate governance arrangements (if they are not already required to report against a specific corporate governance code, for example under the Listing Rules). The requirement applies to companies which have: (i) more than 2,000 employees; and/or (ii) a turnover of more than £200 million and a balance sheet total of more than £2 billion. The Wates Principles were developed to provide private companies with a framework to comply with these requirements.
As companies were granted additional time to file accounts during the Covid-19 pandemic, the annual reports covered by the review were the first round that included the corporate governance statement required under the regulations. Of the annual reports reviewed, the FRC found that:
- around two thirds included a statement on their corporate governance arrangements; and
- of those that stated that they had applied a particular corporate governance code, over 75% used the Wates Principles.
The review also considers the adherence to the “apply and explain” approach set out in the Wates Principles and the quality of the disclosures made as against the guidance provided. The FRC acknowledges that whilst there are positive aspects in relation to the application of the Wates Principles, there is room for improvement.
We have published our half-yearly update briefing which summarises the major developments in UK corporate law and regulation that have occurred over the last six months, that is from July to December 2021, and which are of relevance to UK listed companies.
The briefing is available here.
The Financial Reporting Council (FRC) has published a report on creating positive culture. It aims to promote good practice amongst companies by looking at how companies develop, embed, monitor and assess culture across their organisations.
The report follows the FRC’s 2016 report on corporate culture and the role of boards, the findings of which informed the 2018 UK Corporate Governance Code and the accompanying Guidance on Board Effectiveness. Under the Code, the board is responsible for ensuring that the company’s purpose, values and strategy are aligned (Principle B) and for monitoring and assessing culture (Provision 2).
The report notes that the pandemic has forced some companies to adapt their strategies and business model quickly and has led to an increased emphasis on environmental, social and governance matters amongst investors and stakeholders alike. The report emphasises that positive culture should be attained through honest conversations and by building trust, and that leadership should come from the top.
The FRC also noted in its recent Review of Corporate Governance Reporting (see our blog post here) that disclosures around culture could be improved. The FRC intends to continue monitoring this area and to produce additional guidance for companies in due course.
Institutional Shareholder Services (ISS) has published its UK proxy voting guidelines updates for 2022 and Glass Lewis has updated its Approach to Executive Compensation in the Context of the Covid-19 Pandemic.
ISS Proxy Voting Guidelines
The key changes to the current ISS UK proxy voting guidelines are set out in an executive summary document and include:
- Board diversity – In addition to its expectations on gender diversity (see our blog post from last year here), ISS has created a new policy on ethnic diversity based on the recommendations of the Parker Review (see our blog post here). For FTSE 100 companies, ISS will generally recommend a vote against the (re-)election of the chair of the nomination committee if the company has not appointed at least one director from an ethnic minority background.
- Board accountability on climate-related issues – In 2022, for companies that are currently featured on the Climate Action 100+ Focus Group list, ISS will recommend a vote against the (re-)election of the chair of the board where a company does not have both detailed disclosure on climate-related issues, such as reporting in line with the Task Force on Climate-related Financial Disclosures, and quantitative greenhouse gas emission reduction targets covering at least a significant portion of the company’s direct emissions.
- Non-financial ESG performance conditions in executive remuneration packages – ISS has confirmed that environmental, social and governance (ESG) metrics can be included as performance measures for executive remuneration, provided that the metrics are clearly linked to the company’s long-term strategy, material to the business and quantifiable.
The 2022 proxy voting guidelines apply to shareholder meetings taking place on or after 1 February 2022, save where otherwise noted.
Glass Lewis approach to executive compensation
Glass Lewis’s Approach to Executive Compensation document is designed to provide guidance on the application of its policy on executive remuneration in the context of the ongoing Covid-19 pandemic. Glass Lewis has updated the document to remove references to specific fiscal years, noting that the guidance will continue to apply throughout the course of the pandemic.
The Financial Reporting Council (FRC) has published its Annual Review of the UK Corporate Governance Code. The report discusses the quality of reporting against the UK Corporate Governance Code in 2021 and the FRC’s expectations for companies reporting in 2022.
The FRC notes that reporting has improved overall since last year (see our blog post on last year’s annual review here), in particular where companies have been reporting on environmental and social issues.
Other key messages from the report include:
- Compliance with the Code – Further to last year’s report, which raised concerns about companies reporting, but not demonstrating, full compliance with the Code, the FRC found an increase in declarations of non-compliance this year. The report reiterates that companies should be clear about any departures from the provisions of the Code and give a full explanation for any deviation (see our blog post on the FRC’s report on improving ‘comply or explain’ reporting here).
- Focus on impact and outcomes of engagement – The report welcomes improved reporting on stakeholder engagement and now encourages companies to focus on the outcomes of this engagement. The report also offers specific guidance on how to improve reporting around suppliers, communities and modern slavery.
- Effectiveness of risk management and internal control systems – The report notes that it is not sufficient for companies to confirm in the annual report that the board or audit committee has reviewed the effectiveness of the company’s risk management and internal control systems. Instead, the report should set out a detailed description of the review process and identify any actions that will be taken as a result.
- Diversity and succession planning – The FRC remains concerned about inadequate disclosures around succession planning. Many disclosures are focused on process, rather than demonstrating coherence between the company’s succession plans, diversity and inclusion policies, and strategy.
- Remuneration – Companies should explain how their remuneration arrangements support the company’s strategic objectives and promote its long-term sustainable success. Reporting should also demonstrate how remuneration aligns with the company’s purpose and values by referring to specific performance measures which incentivise executives in these areas. The report also provides specific guidance on workforce engagement.
The Financial Conduct Authority (FCA) has published the 36th edition of its Primary Market Bulletin (PMB), which is focused on climate-related disclosure requirements for listed companies.
The PMB follows the introduction of Listing Rule 9.8.6R(8) which requires premium listed companies to make disclosures in compliance with the Task Force on Climate-related Financial Disclosures (TCFD) Recommendations and Recommended Disclosures on a comply or explain basis for financial years beginning on or after 1 January 2021 (see our briefing here).
Key points from the PMB include the following:
- Consultation on technical note – The FCA is consulting on a new technical note to provide further guidance on the disclosure requirements. The note covers, amongst other things, expectations around explanations for non-compliance and the role of third party advisers in preparing disclosures
- Supervisory strategy on TCFD-aligned reporting – Whilst the FCA is responsible for monitoring and enforcing compliance with the Listing Rules that cover TCFD-aligned disclosures, the Financial Reporting Council (FRC) will also be heavily involved in monitoring disclosures by listed companies. If a company’s disclosures do not appear to meet the Listing Rule requirements, in the first instance the FRC may ask for corrective action to be taken, including seeking an undertaking that disclosures will be enhanced in the next reporting year.
- Sanctions for non-compliance – If a listed company fails to include TCFD-aligned disclosures in their annual report, the FCA will request that a company publish a separate TCFD statement via an RIS as soon as possible. The FCA may use its full range of powers to deal with any non-compliance, including imposing sanctions where appropriate.
The FCA is consultation on imposing the same disclosure requirements on standard listed companies under LR 14 has closed (see our blog post here) and the PMB confirms that the FCA expects to make rules in this area before the end of the year.
The FRC has published its annual review of corporate reporting for 2020/2021.
The FRC notes that the Covid-19 pandemic did not lead to a decline in reporting quality and that there is evidence of improvement in both the content of the strategic report and the use of alternative performance measures (see our blog post here). However, there remain multiple areas for improvement, with many FRC queries to companies resulting from apparent inconsistencies between the financial statements and other elements of the annual report.
Key findings from the report include:
- Section 172 statement and stakeholder engagement – Where section 172 statements and stakeholder engagement disclosures are combined, companies must take care to ensure that all requirements are met (for example, covering all six aspects of the section 172 duty). Companies should be aware that the FRC monitors media coverage and expects that any stakeholder engagement covered in the press will be reflected in formal corporate reporting.
- Cash flow statements – The FRC remains concerned about the number of cash flow statement errors it has identified in its reviews, often purely from critical analysis of line items appearing on the face of the balance sheet.
- 10 hot topics – The 10 topics most frequently raised by the FRC in the context of financial statements include issues relating to judgements and estimates; revenue recognition policies; impairment of assets; alternative performance measures; the use of financial instruments; provisions and contingencies; leases; and income taxes.
The FRC says that its monitoring in the coming year will include a focus on climate-related risks and disclosures, as well as judgements and uncertainties in light of the continued impact of Covid-19.
The Financial Reporting Lab of the Financial Reporting Council (FRC) has published a report on developing practice in TCFD-aligned corporate reporting. The report reiterates investor expectations in relation to climate-related reporting and includes examples of best practice.
Key recommendations from the report include:
- Governance mapping – Companies should provide an overview of how each group or committee contributes to the overall assessment and consideration of climate-related issues.
- Risks and opportunities – Investors are looking for more nuanced reporting around risks and opportunities, featuring more information on likelihood, impact, prioritisation and time horizons.
- Performance against targets – Investors want to understand performance against targets by the business as a whole, not just small portions that are doing well. Companies should distinguish between “aims” or “ambitions” and more concrete objectives and policies which are being actively pursued.
- Climate-related scenario analysis – Investors remain very interested in climate-related scenario planning, and encourage an integrated discussion of how different scenarios might impact the company’s customers and suppliers, as well as the company’s strategy and performance.