Britain Waters Down Narrative Reporting Reforms

Good news for public companies in Britain: Regulators there have scaled back their requirements for narrative reporting, opening the door to simpler compliance even if companies must add a few new disclosures here and there.

The moves are part of a larger effort to simplify the blizzard of words most public companies publish in their annual reports, which British regulators have faulted as heavy on jargon but light on insight for the average investor. Last year the government proposed sweeping plans to overhaul filers' narrative reporting, but the draft rules published earlier in November are considerably less visionary.

Under the government's revised plans, a listed company's accounts will include a stand-alone strategic report explaining its main business goals and how well it is achieving them. Individual shareholders could elect to receive that slimmed down briefing instead of the full annual report and accounts.

Government minister Jo Swinson said the reforms will increase corporate transparency and give shareholders an easier basis to hold companies accountable. The move is a response to “growing concerns” that the narrative information in annual reports lacked clarity and wasn't always useful to shareholders, Swinson said.

Under current corporate law, British-listed companies must include a “directors' report” in their annual filings, which includes a section called the “business review.” The former covers most compliance disclosures, while the latter gives a narrative account of strategy performance. But legally the business review is classified as a sub-section of the directors' report—meaning the narrative reporting can become buried under a mountain of compliance detail.

The latest reforms would replace the business review with a stand-alone strategic report. The new report would cover the same ground as the business review, but with two mandatory reporting requirements added: one about human rights concerns, and the other about the number of women employed throughout the company.

The draft regulations don't define what a human rights issue is, but companies would need to report them “to the extent necessary for an understanding of the development, performance, or position of [their] business.” The disclosure stems from existing requirements that U.K. filers report on environmental, employee, and social and community issues.

Companies will also need to disclose the number of women they employ on their boards in senior executive positions and in the whole organization. The regulations define a “senior executive” as someone who has “authority and responsibility for planning, directing, and controlling the activities of a company and is an employee of that company.”

The proposed regulations would also end several compliance disclosures that companies now make in their directors' report as well, under the logic that those disclosures either are no longer relevant or are now reported elsewhere. Examples are the requirements to disclose significant contracts and to provide a policy statement on how the company deals with suppliers.

What's Out

The government did decide to drop three big changes that it floated in a consultation paper on narrative reporting issued last year.

First to go was the idea that directors should individually sign-off on the new strategic report, to underline their responsibility for its accuracy. But regulators now say that idea had “almost no support” during the consultation process, and directors have collective responsibility for the whole annual report anyway.

“Given the previous rhetoric, I can't help thinking that the government has not made the most of the opportunity to help reporting catch up with the needs of today's capital markets and other key stakeholders.”

—Charles Bowman,

Audit Partner,

PwC

Also deleted was a proposal that the strategic report should be covered by an “enhanced” audit. The idea of an enhanced audit has hovered around British reporting rules since 2005, when regulators implemented rules for an “Operating and Financial Review” very much like the new strategic report. With the OFR came a new requirement for the company's auditor to report any information found during the audit that was inconsistent with what the directors were saying in the OFR. The OFR was scrapped after just a year because companies complained about the compliance burden, and the enhanced audit died along with it.

Last year the government suggested reviving the enhanced audit and applying it to the strategic report and estimated compliance costs at around $91 million. In the end, however, “there was little appetite to change the level of audit or assurance given to narrative reporting,” according to a government briefing note on the regulations.

Another proposed change would have seen the directors' report stripped down into a simplified template, making it easier for companies to tick off a wide range of compliance disclosures in one place. But that plan has been shelved too, as the government said it couldn't agree upon a template with investors and companies.

Will It Work?

Swinson maintains that the updated rules will still “reenergize” company reporting, despite their diminished scale. Others are skeptical. Law firm Linklaters described the changes as “relatively minor” in a briefing to clients. The strategic report is just the business review by another name, it said, and many companies already provide a narrative discussion of their business model and strategy because the U.K. Corporate Governance Code has required that since 2010.

REGULATION EXPLANATION

Below is an excerpt from a PwC bulletin on new narrative reporting regulations:

The ‘strategic report'

The draft regulations will require companies to produce a separate ‘strategic report', which would replace the business review and separate it from the rest of the directors' report.

The strategic report will incorporate the existing content of a business review. But for quoted companies, it will also include the following to the extent necessary for an understanding of the company's development, performance or position:

a description of the company's strategy and business model;

identification of any human rights issues; and

disclosure of the number of women on the board, in senior executive positions and in the whole organization.

Summary financial statements

Currently, some companies choose to produce a summary financial statement, which they can send to shareholders instead of the full annual report. The draft regulations replace the summary financial statement with the strategic report so that companies will be able to send only this to shareholders.

Removal of reporting requirements

The draft regulations remove several reporting requirements from all or some companies. From the strategic report, they remove the current business review requirement for information about essential contractual arrangements.

From the directors' report, they remove the following reporting requirements, which have either been superseded, are already required elsewhere or are not considered to provide meaningful information:

information about the company's principal activities;

information about asset values;

information about charitable donations;

the requirement for private companies to give information about the acquisition of their own shares; and

information about the policy and practice of payment to creditors.

What do I need to do?

BIS has asked for views on the draft regulations by Nov. 15, 2012. Management should consider whether the draft regulations represent an improvement on the existing framework and whether they will facilitate ongoing improvement in reporting.

This could be an opportunity for management to consider the structure and content of their current reporting, as well as the implications for board oversight, and the quality and availability of internal reporting.

More specifically management should consider the following:

How easy would you find it to present a concise view of your company's strategy, risks, business model and results?

What implications will this have on your year-end reporting strategy, and what are your views on the benefits of providing shareholders with a concise summary of the key information?

Should the strategic report be presented separately from the body of the annual report?

Source: PwC.

The proposals in their final form “don't actually permit anything that companies with a bit of imagination cannot already do,” says Charles Bowman, audit partner at PwC. “Given the previous rhetoric, I can't help thinking that the government has not made the most of the opportunity to help reporting catch up with the needs of today's capital markets and other key stakeholders.”

John Davies, business law expert at the Association of Chartered Certified Accountants, wishes the government stuck with its idea of abolishing the directors' report. “I think they could have retained that. It would have made it clear that the information in the directors' report is a succession of individual disclosures that don't have a great deal in common with each other,” he says.

Davies says the U.K. government had to curb its plans because the European Union is likely to agree on a new directive on narrative reporting next year, and “that will have an influence on what Britain can and cannot legislate for in this area.”

“I think they are trying to make sure they don't over-reach themselves and commit to something that they might have to withdraw,” Davies says. “The way forward is to create a pretty sparse skeleton for what the strategic report should look like, while retaining the freedom for companies to evolve their reporting practice.”

The government's original proposals “were significantly more far-reaching than the final outcome,” says John Gollifer, general manager at the Investor Relations Society—but, he says, he likes that. The latest regulations “are a much more balanced and sensible approach,” he said. “It would appear to us that reform has gone far enough.”

The draft regulations were subject to a brief consultation period, which has already closed. Baring last-minute hitches, they will take effect from October 2013. Before then, the Financial Reporting Council will publish reporting guidance explaining what it thinks a strategic report should look like.

The government says it wants to see ”succinct and meaningful” reports, and acknowledges that the FRC guidance would be “an important part of the package”. Whether the reforms achieve their aim will may well depend on what the FRC comes up with.