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 Government has announced that it does not currently intend to adopt any mandatory ethnic pay gap reporting measures. It will instead be publishing guidance for those employers wishing to publish this data voluntarily.
In 2018 the Government published a consultation paper on ethnicity pay reporting. It had proposed that there should be a mandatory duty to report ethnicity pay gap data as little voluntary progress had been made after the 2017 McGregor-Smith Review on race in the workplace (see corporate update 2018/21 for more details).
The guidance to be published by the Government is intended to enable employers to identify the causes of any pay disparities and take relevant steps to mitigate them. It will include case studies drawing on the experience of employers that have chosen to report on ethnicity pay issues, with the aim of establishing a benchmark for an effective action plan to tackle disparity.
For further information, see this post on our Employment Notes blog, which also has a link to our podcast where we discuss ethnicity pay gap reporting.
The Environment Act 2021, which received Royal Assent on 9 November 2021, sets out a new regime in relation to the use of “forest risk commodities” in UK commercial activity. Under the new regime, it will be illegal for larger businesses to use, in their UK commercial activities, forest risk commodities that have not been produced in accordance with local laws. Due diligence must be undertaken to mitigate the risk and companies will be required to report on the steps taken.
The aim of the provisions, which were consulted on in August 2020 with a response published in November 2020, is to protect rainforests and clamp down on illegal deforestation.
Much of the detail of the regime will be set out in regulations and the Department for Environment, Food and Rural Affairs has now published a consultation which will inform the drafting of secondary legislation and related guidance. The consultation, which closes on 11 March 2022, seeks views on a number of proposals including:
- In-scope commodities – The consultation proposes that the due diligence requirements apply, in a phased approach, to the following commodities: cattle (beef and leather), cocoa, coffee, maize, palm oil, rubber and soy. As and when evidence shows that other commodities are key drivers of deforestation they will be added to the list. (Timber and timber products are not included as they are already covered by separate regulations.)
- In-scope companies – The consultation proposes using UK turnover (as defined in the Companies Act 2006) as the relevant metric for determining which UK businesses are in-scope. For non-UK based businesses, the options are either to consider only turnover related to UK activity or to look at global turnover. The actual turnover threshold will be set between £50 million and £200 million on a commodity by commodity basis.
- Reports on due diligence systems – Under the proposals, in-scope companies will be required to eliminate, or reduce to as low as reasonably practicable, the risk of using any regulated commodity grown on land illegally used or occupied. There will also be guidance on establishing an effective due diligence system with an expectation that what is reasonably practicable to assess and mitigate risk will evolve over time. In-scope companies will be required to report annually on their due diligence exercise, including how they have assessed and mitigated risk.
- Enforcement and sanctions – Fines of up to £250,000 are proposed, with criminal sanctions for offenders who fail to comply with civil sanctions or fail to assist the enforcement authority.
For further information please see our briefing here.
The Financial Reporting Lab of the Financial Reporting Council (FRC) has published a thematic review of companies’ viability and going concern disclosures, highlighting areas for improvement and offering examples of best practice.
The review follows the FRC’s previous reports on going concern, risk and viability issues published in June 2020 (see our blog post here) and October 2020 (see our blog post here).
The report recognises that Covid-19 and its economic effects continue to impact companies and explains that investors appreciate more tailored, detailed explanations of how management intends to deal with challenges to solvency and liquidity over the short, medium and long term.
Key recommendations in the review include:
- Inputs and assumptions – Companies should provide more granular qualitative and quantitative detail of the inputs used and assumptions made in each scenario and how they have been determined.
- Principal risks and uncertainties – Disclosures should be explicitly linked to particular principal risks and uncertainties, and indicate how those risks have been modelled in viability scenarios. Investors also want to understand how resilient the company is to risks that could threaten its going concern status or long-term viability and what mitigating actions could be taken.
- Period of assessment – For both the viability and going concern disclosures, the period of assessment should be specifically identified and justified by reference to as many company-specific factors as possible, including the company’s business model, strategy and development, any investment or capital allocation plans and its debt profile and expected repayments.
- Significant judgements – Any significant judgements that have been applied in determining whether the company is a going concern, or whether there was a material uncertainty in respect of going concern, should be disclosed clearly, with an explanation as to why such judgement has been deemed appropriate.
The Financial Reporting Lab of the Financial Reporting Council (FRC) has published a report on risks, uncertainties, opportunities and scenarios and the FRC has published a thematic review on streamlined energy and carbon reporting.
Risks, uncertainties, opportunities and scenarios
The Lab report on risks, uncertainties, opportunities and scenarios sets out investors’ expectations in relation to reporting in these areas and gives best practice examples.
The report says that investors are looking for information relating to risks, uncertainties and opportunities that contributes to their understanding of a company’s business model, longer term strategy, resilience and viability. It emphasises the inter-relationship between risks, uncertainties and opportunities.
Key recommendations in the report include:
- Governance and processes – Investors want to understand a company’s risk management processes, who is responsible for the various aspects of monitoring and managing risks, and how the outputs are presented to the board or risk committee. Investors are also keen to understand how these processes adapt or change over time and how effectively they have functioned.
- Approach to disclosures – Disclosures should be appropriately linked to other aspects of the annual report including the business model, strategy and viability statement.
- Scenarios and stress testing – Investors finds scenarios and stress tests particularly helpful given they provide insights into areas that are uncertain and cannot necessarily be predicted or calculated with certainty. The report emphasises that scenarios should be company-specific and that it is useful for companies to explain how they influence its strategic decisions and the company’s business model.
Streamlined energy and carbon reporting
The FRC’s thematic review on streamlined energy and carbon reporting follows its thematic review on climate reporting which it published in November 2020 (see our corporate update 2020/21).
The Energy and Carbon Reporting Regulations (2018/1155) require quoted companies to disclose their energy consumption, and large companies and limited liability partnerships to report on their greenhouse gas emissions and energy consumption (see our corporate update 2018/23).
The thematic review contains a helpful summary of the requirements, highlights examples of emerging good practice and sets out the FRC’s expectations for reporting.
Key observations in the thematic review include:
- Compliance with requirements – Overall compliance was good, with only a few errors or omissions in reporting identified. Many companies also went beyond the mandatory requirements, for example by disclosing scope 3 emissions or seeking independent assurance on the data disclosed.
- Methodologies – Companies are required to describe the methodologies used for calculating their greenhouse gas emissions and energy consumption. The FRC notes that reports did not always provide sufficient information about the methodologies used, including which entities were included in group-wide disclosures. It also notes that cross-referencing to information on a company’s website does not meet the requirements.
- Ratios – Companies are required to disclose a ratio which expresses the company’s annual greenhouse gas emissions in relation to a quantified factor associated with the company’s activities. The FRC notes that it was sometimes unclear whether the ratio selected was the most appropriate for the company’s operations as encouraged by the Government’s Environmental Reporting guidelines which accompany the streamlined energy and carbon reporting regime (see our corporate update 2019/3).
- Energy efficiency – The “principal measures” taken by the company to increase its energy efficiency are not always clearly described by companies.
The Financial Conduct Authority (FCA) has published a consultation paper (CP21/24) on proposals to require premium and standard listed companies to make disclosures in relation to gender and ethnic diversity at board and executive management level.
The consultation follows the publication earlier this year of the five year summary report of the Hampton-Alexander Review on improving gender balance in FTSE companies (see our blog post here) and the 2021 update from the Parker Review on ethnic diversity on FTSE 100 boards (see our blog post here).
The FCA is seeking views on changes to the Listing Rules which would require premium and standard listed companies to include in their annual report and accounts a statement confirming whether they have met specified board diversity targets as at a date during the financial year of their choosing. The proposed targets are that:
- the board comprises at least 40% women;
- at least one of the positions of Chair, CEO, CFO or Senior Independent Director is occupied by a woman; and
- at least one member of the board is from a non-white ethnic minority background (as categorised by the UK Office for National Statistics).
Companies not meeting the specified targets would be required to explain the reasons why they have not been met.
In addition, premium and standard listed companies would be required to include data on the gender and ethnic diversity of members of their board and executive management.
There would be prescribed tabular forms for all of the proposed new disclosures.
In addition, the FCA is seeking views on expanding the current diversity policy-related disclosures required by Transparency Rules which were originally introduced as part of UK implementation of the EU Non-Financial Reporting Directive in 2017 (see our corporate e-bulletin here).
The proposed changes include adding ethnicity, sexual orientation, disability and socio-economic backgrounds to the aspects of diversity currently in DTR 7.2.8A R.
The consultation closes on 20 October 2021 and the FCA aims to publish final rules by the end of 2021. Any new disclosure requirements would apply to financial years starting on or after 1 January 2022.
The Financial Reporting Council’s Financial Reporting Lab has published a Report on stakeholders, decisions and Section 172 statements. The report sets out investors’ expectations in relation to disclosures on stakeholders and the impact of decisions on them and gives best practice examples.
The requirement for companies to report on how directors have had regard to the matters in section 172 of the Companies Act 2006 (see our briefing for further detail) has driven companies to increase reporting on their stakeholders. However, the Report says that there are still calls for better information on how companies are having regard to their stakeholders and taking their perspectives into account.
Recommendations in the Report include:
- Stakeholders – When providing information on stakeholders, companies should:
- identify key stakeholders and their respective interests by reference to the company’s business model and strategy, noting where particular stakeholders’ importance may vary over time;
- describe stakeholder engagement processes, including feedback received, outcomes identified and the impact on decision-making;
- assess opportunities and risks which could impact stakeholder relationships and describe what measures are being taken to manage these relationships; and
- determine appropriate and reliable metrics to monitor stakeholder engagement and report against these metrics consistently.
- Decisions – When setting out the significant decisions taken during the year, companies should:
- link each decision back to the company’s purpose and strategy;
- explain how the decision was reached, including how stakeholders were considered and the potential impact of the decision on each group of them;
- be open about any difficulties or challenges in making the decision, including any prioritisation of particular stakeholder groups or offsetting of short-term negative consequences for long-term benefits; and
- cover the expected and/or actual outcomes of the decision and the long-term implications for the company.
The report also considers the section 172 statement more broadly, cautioning that the statement should cover all aspects of the section 172 duty, not just stakeholders.
Alongside the report, the Lab has also published a summary of key questions, which companies can use to enhance the quality of information provided to investors on stakeholders and decisions, and further guidance on Section 172 statements.
We have launched our second Corporate Governance Snapshot which is available here; this snapshot covers the UK government’s long awaited consultation paper on audit and governance reform.
Glass Lewis has published a paper setting out its views on Say on Climate votes.
The paper notes that “Say On Climate” votes, where listed company shareholders are given the opportunity to vote on climate-related proposals, are becoming an increasingly important part of the 2021 annual general meeting season. Both boards and shareholders are putting forward proposals for votes on climate-related matters.
Glass Lewis acknowledges that there are many positive aspects to Say On Climate resolutions but that they also present a number of challenges for investors and companies, particularly if the resolution relates to a company’s strategy or plans. It notes that, whilst many investors are supportive of such resolutions, views in the investor community are mixed.
Glass Lewis distinguishes between proposals that involve additional disclosure by companies, which it strongly supports, and those that offer a shareholder vote on a climate plan or strategy. It says it will generally recommend against management and shareholder proposals requesting that companies adopt a policy that provides shareholders with an annual vote on a climate-related plan or strategy.
On other proposals, Glass Lewis states that given their broad variety, and the lack of standardisation on how shareholders should evaluate these resolutions before voting, it will review each resolution on a case-by-case basis. The paper gives examples of various climate-related resolutions proposed to date and also provides examples of best practice disclosures in support of such resolutions.
Glass Lewis intends to codify its approach in advance of the 2022 AGM season, following investor, corporate and stakeholder engagement.