In late March, Stephen Haddrill, chief executive of the U.K.’s Financial Reporting Council (FRC), wrote to investors to highlight some recent changes to the content of companies’ annual reports and what investors might expect to see in the coming crop. He encouraged shareholders to engage with companies to let them know what information they would like to see included. More importantly, and this is stressed under every topic, he calls on shareholders to challenge companies if they fall short of expectations.
The topics covered in the letter are:
Risk, internal control, and viability
Brexit (the potential U.K. exit from the European Union)
Alternative performance measures
Accounting policies and impact of new standards
This is the first year of enhanced reporting on risk and internal control and the first that calls for the inclusion of a viability statement under the requirements of the U.K. Corporate Governance Code. In order to strengthen disclosures on long-term viability, said Haddrill, “Companies may choose the appropriate time period for their viability statements, although the period assessed should be significantly longer than 12 months.” Investors should also expect to see an explanation of the period chosen.
The new strategic report is “intended to be an important source of forward-looking information about strategy and risk.” Haddrill also points to his recent letter to audit committee chairs in which he provides guidance on reporting during market volatility. In addition to the subjects covered in his advice to investors, this letter also tells audit committee chairs to make sure that material post-balance-sheet events are disclosed, along with their estimated financial impact and any material uncertainties that such events might cause or have caused. Companies are encouraged to “disclose how…risks specifically affect them, the range of potential outcomes, and any mitigating actions.” Investors are told to challenge companies on the inclusion of risks, especially those relating to cyber-risk and climate-change related risks, which, he has been told, are rarely addressed.
He also raises the question of Brexit risk and indicates that companies should be reporting on the risks and uncertainties associated with a potential exit from the European Union, or even a renegotiation of its relationship with the union.
Next on the list, in what has also become a Securities and Exchange Commission focus in the United States, the use of non-GAAP (Generally Accepted Accounting Practices) performance measures should be carefully examined, Haddrill wrote. Investors should expect clear definitions and “reconciliations to, and explanations of, how they relate to GAAP measures.” Expanded auditor reporting requirements, introduced in 2013, were the subject of a recent guide on the impact of extended auditor reports (see #5 in the accompanying box outlining sources of further information). The Financial Reporting Lab’s recent report Disclosure of dividends – policy and practice (See #6 in the accompanying box) gives opinion on the improvement of the disclosure of dividends.
The letter also contains a reminder to look closely at companies’ “comply or explain” statements, where they explain why they have not complied with parts of the governance code. These should include: “the background to the matter…a clear rationale for the action being taken and…any mitigating activities.” Again, investors are encouraged to challenge companies where they believe these explanations are not “persuasive.” Speaking at a Management, Governance, and Regulation in the Changing Investor Landscape conference a few years back, Haddrill defended the United Kingdom’s “comply or explain” system, saying: "Investors have more rights and more potential influence in the U.K. system than in almost all other countries. If those rights and if that influence is not used, our defence of the system [in Brussels] would be damaged. We will see rules come in those circumstances, and regulators will take over the job of stewardship as they already do to some extent in the financial services sector. If investors want to preserve the current U.K. system, they must use it, or there is some serious risk of losing it."
Companies should also explain “critical judgements and accounting policy choices,” and they should “identify the precise nature of the judgments they made, rather than merely repeat what the standards require.” He refers to three major standards issued by the International Accounting Standards Board in the last two years: IFRS 15, Revenue, IFRS 9, Financial Instruments, and IFRS 16 Leases, and cautions investors to look for implementation of these standards.
Finally, the letter calls for comments on reporting quality to be sent in, though for serious concerns investors should use the formal complaints mechanism via the FRC’s Corporate Reporting Review team. There has been little reaction from investors to the letter thus far.