At the Lib Dems Autumn conference in 2009 I called for correction of a party policy paper (‘Are we being served?’) that incorrectly stated the Operating and Financial Review (OFR) was still in place. The statutory OFR had been repealed in December 2005. It is little surprise the party policy-makers had got confused as to where things stood in UK corporate governance legislation given the history is now so convoluted (but well explained in a paper by Radley Yeldar). BIS sets out the background in their new consultation document:
“The business review is an essential element in company narrative reporting. The EU Accounts Modernisation Directive required all companies other than small* to prepare a business review. These requirements were implemented by the Companies Act 1985 (Operating and Financial Review and Directors’ Report etc) Regulations 2005, which introduced a mandatory Operating & Financial Review (OFR) for quoted companies with effect from financial years beginning on or after 1 April 2005. The Regulations recognised a reporting standard for OFRs prepared by the Accounting Standards Board. They also provided an enhanced audit requirement whereby the auditor needed to state whether any matters coming to their attention in the course of the audit were inconsistent with the information in the OFR.
“The statutory OFR was repealed in December 2005 and, following further consultation, the Business Review provisions were enhanced for quoted companies and restated in the Companies Act 2006; these provisions came into effect for reporting years beginning on or after 1 October 2007. The Business Review requires companies to provide broadly the same information on non-financial matters as the earlier OFR. Briefly, all companies, other than small, are required to prepare a business review as part of the directors’ annual report. The purpose is to help shareholders assess how the directors have performed their duty to promote the success of the company. Quoted companies must also, to the extent necessary for an understanding of the company’s business, include information on environmental, employee, social and community matters, as well as on contractual and other arrangements essential to the business. The Business Review does not include the enhanced audit requirement for the OFR or statutory recognition of a reporting standard.”
[* Turnover not more than £6.5m/ balance sheet total not more than £3.26m]
How quickly times change! By the time the Liberal Democrats’ election manifesto was published there was an explicit commitment to: “reintroduce the Operating and Financial Review, dropped in November 2005, to ensure that directors’ social and environmental duties will have to be covered in company reporting.” (pg 26)
This then carried through into the Coalition Agreement with a commitment to: “reinstate an Operating and Financial Review to ensure that directors’ social and environmental duties have to be covered in company reporting, and investigate further ways of improving corporate accountability and transparency.” (pg 10)
Effectiveness of the ‘Business Review’
When the OFR was repealed Phil Hodkinson (then Group Finance Director, HBOS) said in BITC Members’ Viewpoint, November 2005: “It came as a huge surprise to hear that Gordon Brown had sacrificed the OFR on the altar of red tape reduction. It is thought by some to be a setback, as some worry that it sends the message that corporate governance and corporate responsibility don’t matter.
“But what has not been scrapped is the implementation of the EU Directive on Directors Reports which, while not requiring forward-looking statements, will require companies to report on most of the key performance indicators that would have been required by the OFR.
“There were huge and perhaps unreasonable expectations around the OFR. It was a long time coming, being the joining together of the Company Law Review recommendations and the European Accounts Modernisation legislation. There was, therefore, plenty of noise around it from the lobby for mandatory social and environmental reporting, all of which led to a lack of clarity about its role in requiring social and environmental disclosure.
“What resulted was an accounting standard. But the new ingredient was the requirement for directors to be forward looking in their views – an ingredient that has now been lost. It was not, however, primarily a tool for social and environmental disclosure.”
There has not been a vast amount of research undertaken on the effectiveness of the ‘Business Review’ requirement, but then its application remains fairly new. Studies that stand out are those by PWC, KPMG, the ASB, ICAS and CORE – and show Hodkinson’s observations in 2005 to have been rather prescient.
PWC concluded in ‘The Business Review and AIM‘ (2007) that:
“…while Main Market companies are increasingly recognising the benefits generated by greater transparency of reporting, AIM companies do not appear to be maximising this opportunity to the same extent. In what is a highly competitive and volatile market, the report shows that there is real scope for AIM companies to present investors with a clearer picture of the performance and future direction of the company. According to the research, only 54% of AIM companies gave investors a view of the business and market in which the company operates, compared with 100% of their Main Market counterparts.”
The KPMG Audit Committee Institute undertook some of the earliest broad-based research I am aware of on the take up of the Business Review. In ‘Narrative reporting – season 2’ (Audit Committee Quarterly – Issue 22, 2008) Nicola Collins observes that “whilst there is little regulatory guidance on what should be in the detail of a Business Review the Accounting Standard Board’s best practice statement on producing OFRs (RS 1) provides useful guidance for companies compiling their Business Reviews. Many companies appear to have adopted elements of this best practice guidance although only two out of the 74 surveyed stated that they had prepared their statements in line with RS 1.
“There does appear to be a slight shift this year with more companies incorporating their CSR issues into the main body of their Business Review. There has been an increase of seven percent in companies disclosing KPIs on employees (35 percent compared to 28 percent last year) with employee motivation/satisfaction being the most common.
“There is a two percent decrease in companies disclosing measures relating to health and safety issues (23 percent of companies compared to 25 percent last year) with mining and gas, water and multi-utility companies focusing on this issue more than other sectors. Interestingly the number of companies disclosing KPIs relating to customers has nearly doubled rising from 17 percent to 30 percent. Banks, fixed line telecommunication, and travel and leisure companies are the most prolific in this area. Disclosure of environmental KPIs is also on the increase with 28 percent of companies disclosing in this area compared to 21 percent last year. Reporting on social and community issues has remained steady at nine percent.”
In ‘Rising to the challenge: A review of narrative reporting’ (2009) the ASB raise a number of issues:
“we think that describing the business should go beyond just products, services and geography to include business processes, distribution methods and structure of the business – in other words the disclosure of the business model.”
“We concluded that the CSR sections of annual reports contain significant immaterial clutter that is not necessarily essential for making resource allocation decisions. For example, it is a good thing that many companies are now using refillable glass bottles in meetings, but this is not a decision changing piece of information. One potential reason for this deluge of information is the regulations, which require discussion of all three of employees, environment and social and community or disclosure of the type of information that has been excluded. Social pressures make it difficult for a company to flag up non-disclosure in any of these areas, with the result that companies disclose all three, regardless of the importance of each to
the business.”
“…further work also needs to be undertaken to consider whether the focus should be on integrating all reporting into one place or having separate stand-alone sustainability reports.”
A report for ICAS focused on the media sector (‘The Influence of the Business Review on Reporting UK Media Sector KPIs,’ ICAS, Nov 2009) suggested the need for more research:
“Some companies are not complying with the disclosure requirements at all, suggesting that policy makers may have to take further action. To inform policy making in this area, further research is necessary:
• to ascertain why companies have not yet responded to the Companies’ Act requirements for reporting KPIs; and
• to determine whether users of accounts find KPIs useful for their decision-making processes.”
Writing for the CORE Coalition in ‘The reporting of non-financial information in FTSE100 Annual Reports‘ (
Middlesex University, 2010)
Professor Adrian Henriques concluded: “Before the introduction of the new Companies Act, some who held the ‘enlightened shareholder view’ believed that companies would automatically report information affecting stakeholders because it would overall be in their interests to do so. This would have meant that the Business Review would contain information pertinent to other stakeholders. This is only proving to be true to a very limited extent. The analysis of the Business Reviews of FTSE companies found insufficient reporting of risks from the shareholder point of view as well as from that of other stakeholders. The Business Review does not appear to be serving the purpose for which it was intended.”
The Minister’s views
Introducing the Government’s Consultation on The Future of Narrative Reporting, Ed Davey MP, Minister for Employment Relations, Consumer and Postal Affairs (the new Corporate Responsibility minister in all but name!) says: “…the recent economic crisis has put a spotlight on all aspects of our regulatory framework including our corporate governance model and forced us to consider where things have gone wrong and why. The broad consensus is that, while the UK model of corporate governance is not essentially flawed, there are areas where we all need to do better – as Government, as companies and as shareholders.”
As well as highlighting the need for narrative reporting to be future-focussed and material in disclosure Davey rightly highlights the need for “a clear link between the company’s strategic objectives and the criteria for payments to directors.” He goes on to explain that the reinstatement of “an Operating and Financial Review to ensure that social and environmental duties have to be covered in company reporting and to investigate further ways of improving corporate accountability and transparency is central to achieving these aims.”
Davey has three objectives. To:
- see what we can do collectively to drive up the quality of narrative reporting to the level of the best, including on social and environmental issues;
- empower shareholders so they can step up and act as effective owners in the long term interests of the companies in which they invest; and
- achieve coherence without increasing the regulatory burden on business.
Consultation
The Consultation invites you to contribute your views in four areas: Value of narrative reporting; the Business Review; Directors’ Remuneration Report; and Potential costs. Most significant will be the debate on whether a statutory reporting standard or guidelines based approach should be introduced — and whether shareholders’ advisory notes should be produced.
Value of narrative reporting
1. Are company directors providing useful and relevant information on the company’s:
i) forward-looking strategy and
ii) principal risks and uncertainties?
2. What are the constraints on companies providing information on these issues?
3. Does the information provided reflect the issues discussed by the directors in board meetings?
4. Does the information help shareholders to press directors on key issues relating to strategy and risk, or inform their business decisions?
5. If a company does not provide sufficient or material information to you, do you challenge it? Is there anything which could help you to do so?
6. What other sources of company information do you use and how valuable are they (e.g. information provided on the website, analysts’ briefings, dialogue with the company, corporate social responsibility report)?
7. Is there scope to reduce or simplify the requirements on which companies report?
8. Is there scope to arrange the information in a more useful way?
Business Review
9. Looking at an Operating & Financial Review and the existing business review (see Annex D), do you see value in reinstating elements of an OFR and if so what would they be? In particular, would a statutory reporting standard help to improve the quality of reporting?
10. The business review provisions require quoted companies to report, to the extent necessary, on:
- main trends and factors likely to affect the future development, performance and position of the company’s business
- information on environmental matters
- information on employees
- information on social and community matters
- persons with whom the company has essential contractual and other relationships
i) Is this information useful to you? How do you use it?
ii) Could disclosure be improved? If so, how?
iii) Are there key issues which are missing? If so, please explain?
11. Would more guidance be helpful? If so, what form should this take? For example: best practice example, sample Key Performance Indicators, etc?
12. Should there be a shareholder’s advisory vote on the Business Review?
13. Are there non-regulatory solutions to increasing quality through better guidance or publicising excellence in business reports? If so, what?
Directors’ Remuneration Report
14. Do the current disclosure requirements provide clear and usable information about:
- the total remuneration paid to directors, and how this is made up;
- the performance criteria for payments to directors, and how these relate to the company’s strategic objectives;
- company performance against these criteria, so that there is a demonstrable link between pay and performance;
- the process by which directors’ remuneration is decided?
If not, please explain including any views on how this might be improved
Potential Costs
15. If you can provide any information on costs associated either with the existing narrative reporting requirements eg preparing your business review or your views on potential costs and benefits in relation to any of the ideas in this consultation, please give details.
Your chance to respond to the consultation ends on 19 October 2010.
Implications of the formation of the International Integrated Reporting Committee
Perhaps the most significant issue – not touched upon in the BIS consultation document – is how the conclusions of the Department for BIS consultation will mesh with the work of the newly formed International Integrated Reporting Committee announced on 2 August 2010. Given this new global initiative, it will be interesting to see how Accounting for Sustainability (A4S), the ASB and BITC respond to this latest push on reporting standards that could result in the emergence of a UK statutory reporting standard.
Further reading
BITC response to the draft OFR regulations (August 2004)
Guidance for Smaller Quoted Companies on preparing a Business Review (Quoted Companies Alliance, 2006)
Printed annual reports and accounts guidelines (Investor Relations Society, 2006)
The Companies Act 2006: Directors’ Duties Guidance, David Chivers QC (CORE – The Corporate Responsibility Coalition, 2008)
Extracts from ‘The Future of Narrative Reporting – A consultation’ (August 2010) are Crown Copyright.