News
Stephen Haddrill
Chief Executive
Financial Reporting Council
5th Floor, Aldwych House
71-91 Aldwych
London WC2B 4HN
31 March 2011
Dear Mr Haddrill
Effective Company Stewardship - Enhancing Corporate Reporting and Audit
Thank you for giving us the opportunity to respond to the above consultation.
The Investor Relations Society's mission is to promote best practice in investor relations; to support the professional development of its members; to represent their views to regulatory bodies, the investment community and government; and to act as a forum for issuers and the investment community.
The Investor Relations Society represents members working for public companies and consultancies to assist them in the development of effective two way communication with the markets and to create a level playing field for all investors. It has nearly 600 members drawn both from the UK and overseas, including the majority of the FTSE 100 and much of the FTSE 250.
Our response is based on feedback we have received from our members who are engaged in the preparation of Annual Reports both as companies and advisors.
In its recent consultation, the Department for Business, Innovation and Skills set out questions in regard to the future of narrative reporting. We offered our views (a copy of which is attached below). Briefly, our points were:
• Investor Relations people aim to set the context in which the company's ambitions and achievements should be seen.
• In writing a report, preparers have regard to their different audiences, needing different perspectives; introducing standard fixed obligations on all companies does not allow flexibility to tell their equity story.
• We believe however that companies should be encouraged to take advantage of all communication channels, including annual report.
• As a consequence of regulatory and guidance changes, the required content of the annual report has grown exponentially.
Investor relations teams are responsible, with company secretarial, corporate communications, finance and other colleagues, for producing the annual report on behalf of the Board. It is a significant task, which regulators can do much to help with. In responding to your consultation therefore, we aim to address a number of areas. Why are further changes necessary; what are the challenges that issuers face; what role does the annual report play; how can technology help, and how can costs be contained?
First, the impact of changes. We remain to be convinced that further rule changes and new guidance will result in better information for investors and other stakeholders. We see no evidence that lack of transparency was at the heart of the financial crisis. Indeed banks were among those sectors regularly recognised as top performers for their annual reports.
The extent and complexity of the regulations and guidance on annual reports is already demanding. One must look in different places for rules on reporting - why (Companies Act),what (Companies Act and Listing Rules), how (FRC ASB RS1, and the Governance Code), when (Listing Rules and DTR's). Simplifying - not adding to - this morass would be helpful, allowing companies to focus on quality, not quantity. It would also allow the Governance Code (and the company's part of the Stewardship Code bargain) time to bed in.
Indeed, the growth of previous initiatives on going concern, sustainability, risk, the business model and others identified by regulators as ‘key', has already expanded the annual report pagination.
The FRC faces a difficult dilemma. Expanding the rule base, or extending the guidance by redrafting the RS1 guidance, creates a natural template for preparers to follow, with resulting box ticking. We would prefer to see broad scale guidance given to companies, which allows companies to tell their own equity story.
Second, perspectives on annual reports generally. In our view, reports generally have improved radically in the last 5 years. It is true that there is a wide gap between top performers (regularly recognised by the array of awards), and the rest. We would observe that the attributes of the top performers 5 years ago, are now a regular feature of the average. Best practice has evolved. We suspect that the gap depends more on the view of the company on the importance of the report, and that ‘rules' will not change this. The median performers will inevitably aim to keep up with, albeit lag, best performers.
We support the view that the annual report is ‘underpinning', ‘holistic and confirmatory'. It should be part of the continuum of real time and periodic reporting. There should be no "surprises". And the timeframe in which annual reports are produced do not make them a document on which to base even medium term trading decisions.
But it plays an important role; without it, the market's understanding of the company story - pieced together from individual disclosures - would be fragmented and dissonant. It provides a very useful discipline for management to stand back and review progress against stated objectives on a regular basis. However it is only one part of the puzzle, and to focus on it as the key vehicle for investor communications is to misunderstand its role. IR teams rarely - if ever - face questioning from investors on something disclosed in the annual report.
There appears to be a direction of travel towards the narrative section of the annual report being subject to further assurance or audit. This would cause us concern. The time pressures and processes through which reports are produced is intense. Allowing time for verification of a statement around, for example, ‘market leadership' could disrupt the process and result in bland, general statements which would reduce the value of the report to shareholders. We should avoid a replication of the US MD&A reporting, which in our view adds very little to investors' understanding, precisely because it is heavily reviewed by lawyers and auditors.
Your consultation encourages companies to disclose that which is relevant; investors need to understand the company's view of the context in which it is operating. These statements need to be balanced and fair, but inevitably they will contain subjective statements which do not always lend themselves to objective external verification.
We also have concerns about your vision of a more pro active role for the audit committee in taking responsibility for the annual report. We believe that it is very important that the whole board should take responsibility for the annual report and that this duty should not be delegated to part of the board.
Similarly, you propose an extension of the role of FRRP; commentary is always welcome, and we believe it is helpful for the FRRP to continue to assess the progress that companies are making to achieve the better disclosure. However, any further intervention by the FRRP should avoid an approach such as the SEC comment letters, requiring work to provide generalised justifications.
Technology; we are delighted that you support the potential of ‘technology' to enhance accessibility and useability of the data in annual reports. We particularly endorse your recommendation for ‘companies to decide how and where they provide particular information'. We hope that this initiative combined with the recently announced proposals in The Plan for Growth to ‘simplify the reporting framework to enable quoted companies to provide clear and relevant information to investors about strategy, performance and risk in a simpler and more concise report, with supporting information provided on the company's website', will result in simpler and more concise Annual Reports with useful back up information provided on websites.
However we would caution against assuming substantial cost savings. Very little of the overall cost of producing an annual report comes from the printing costs; getting to the stage of creating a PDF is where the expense lies.
We would also suggest that the FRC encourages use of other technologies such as moving image, webcasting (virtual annual general meetings?), social media (tweets announcing the availability of news postings?).
Finally, you observe that increased confidence in corporate reporting would outweigh the costs. Simply expanding the size of annual reports -which your proposals would inevitably do - would increase direct costs, as would the increased internal costs resulting from more complexity. We struggle therefore to understand how these direct costs can be translated into direct benefit for the company.
While we therefore applaud your efforts to enhance reporting, which we believe is a central objective of IR teams, we have concerns over whether this is the right time to be introducing new, more extensive guidance, which itself could encourage a reversion to boiler plating. We support your intent to create a forum to share experiences and market developments, providing it includes support from across the spectrum, including preparers.
Thank you again for the opportunity to comment. We look forward to seeing the next stages in the development of regulators' approach to oversight of best practice reporting, in particular, in regard to questions asked by BIS, and highlighted again in the ‘Plan for Growth' review. Our detailed comments on your consultation follow below.
Yours sincerely,
Richard Davies
Chairman of the Society
Detailed Response to FRC's proposals to enhance corporate reporting and audit.
The Investor Relations Society fully endorses the FRC's objective of increasing transparency through higher quality narrative reporting particularly focussing on business strategy and risk management. The Society fully supports the view that directors should take full responsibility for ensuring that the Annual Report, viewed as a whole, provides a fair and balances report on their stewardship of the business.
Our responses to the key recommendations in your discussion paper are as follows:
1. Directors should take full responsibility for ensuring that an Annual Report, viewed as a whole, provides a fair and balanced report on their stewardship of the business.
The Society fully supports this recommendation to help achieve a ‘fair and balanced' report. We believe that transparency in reporting is a fundamental part of investor relations and underpins all communications between issuers and owners. As discussed in your paper, some companies have produced exemplary narrative reporting, but best practice has not yet become the norm, and greater involvement by the board in the ‘processes' of the report would help greatly with widening best practice. We do not believe that further extension of guidance and the introduction of Narrative Reporting Standards is either necessary or correct at this stage. We would be concerned that the introduction of ‘standards' into an area, which of necessity relies on elements of subjective judgement, would add to the potential for more boilerplate reporting which everyone agrees should be avoided.
2. Directors should describe in more detail the steps that they take to ensure:
• the reliability of the information on which the management of a company, and therefore directors' stewardship of the company, is based; and
• transparency about the activities of the business and any associated risks.
The Society fully endorses these views and would go as far as to say that it is fundamental that Boards have put in place the correct internal communications and risk reporting systems to make themselves properly aware of the financial risks inherent in the company's business model and the physical risks arising from the company's trade. However we would caution against the introduction of reporting ‘guidelines' which can lead to boilerplate disclosure.
3. The growing strength of Audit Committees in holding management and auditors to account should be reinforced by greater transparency through:
• fuller reports by Audit Committees explaining, in particular, how they discharged their responsibilities for the integrity of the Annual Report and other aspects of their remit (such as their oversight of the external audit process and appointment of external auditors);
We do not believe that it is fundamentally the role of the Audit Committee to hold management to account. It is the responsibility of the Chairman and the non executive directors to hold the executive directors to account and it is for all directors to accept the tenants of Board collective responsibility.
We also do not believe that it would be sound for the audit committee to be perceived as having responsibility for the annual report which we regard as the responsibility of the whole Board. It is dangerous for the Board to delegate responsibility for the annual report to a sub committee when all members of the Board should understand and subscribe to the contents of the annual report.
Further we do not think that the Audit Committee should come between the executive directors and the shareholders. Shareholders are primarily interested in talking to CEOs and CFOs supplemented by Chairman and SIDs as required. These are the primary points of contact between companies and their investors.
and:
• an expanded audit report that:
• includes a separate new section on the completeness and reasonableness of the Audit Committee report; and
• identifies any matters in the Annual Report that the auditors believe are incorrect or inconsistent with the information contained in the financial statements or obtained in the course of their audit.
We do not consider that an expanded audit report will add substantively to the level of understanding of readers of the annual report. It is our understanding of existing practice that an auditor is required under ISAs to ‘report whether, in the auditor's opinion, the information given in the directors' report is consistent with the financial statements.' As many companies include the business review in the Directors' report by cross reference, this effectively includes this information in the auditors' review of consistency.
We also have concerns that an expansion of the annual report as proposed would simply create a boilerplate statement, without adding to the information needed by investors. We believe that more focused reporting would achieve this. We do not think it is realistic to expect auditors to report on the reasonableness of the audit committee report.
4. Companies should take advantage of technological developments to increase the accessibility of the Annual Report and its components.
We fully support the concept that companies should make full use of technology to improve access to their annual reports and, in fact, the advent of the internet and the wealth of additional information which is now provided by companies on their websites has done much to provide a more even playing field for all investors. Private investors now have access to presentations and meetings which previously were only available to selected analysts and investors. This can only be good for transparency and governance. But the advent of the website and the ability (and requirement) for companies to update information effectively in real time also opens up the wider question of the utility of the traditional annual report, which of necessity reflects only a snapshot of the company at a moment in time and is out of date almost as soon as it is published.
In addition to this issue, as also mentioned in your discussion paper, we are very concerned at the increasing length of annual reports. So we are supportive of the notion that companies should facilitate access to the on-line version of their annual report and the Society has for some years provided guidance on Best Practice for on-line annual reports which inter alia recommends that companies should provide both HTML and searchable pdf versions.
However, we have 2 concerns on the proposals in your consultation.
First, the majority of the cost of producing a report lies in producing the final proof, from which the PDF or printing is created. Since the changed default under the Companies Act, allowing companies to seek shareholders' approval to require shareholders to opt in to hard copy, many companies have been actively marketing electronic access. This has involved putting PDF's and interactive PDF reports on their websites or creating full HTML annual report micro sites. The cost of doing this is significant and for some companies it may well outweigh the saving from printing fewer hard copies. Although many companies have had success, reducing their print runs significantly, many users still prefer hard copy, including institutional fund managers. We do not believe that further rule changes would substantially reduce the numbers wanting a hard copy and we do not think substantial cost savings will accrue .
Second, we also do not think that XBRL will provide any worthwhile improvement in the searchability of individual reports, in the short or medium term. The HMRC iXBRL requirement introduced this month covers so few data points, and only at the subsidiary level, as to make it of no use to analysts. Even in 2013, with more data points added, the data is still inadequate for the purposes of investment analysis. The absence of historical data, and the absence of searchable narrative also contribute to the limited use to which XBRL can be put.
Whilst we support the view that investors should be encouraged to view annual reports on-line, not everyone will. It is therefore likely that some form of printed document will be required for some time to come.
5. There should be greater investor involvement in the process by which auditors are appointed.
As noted in your consultation paper, shareholders already have the right to vote on the reappointment of auditors, and although it is the case that auditor appointments are normally recommended by management, the power to overturn such recommendations is real and could be used by shareholders if required. We are not convinced that it would be practical or good governance to discuss the appointment or reappointment of auditors with ‘a number of principle investors'. Most institutional shareholders are already still assimilating the increased governance requirements placed on them by the stewardship code and the experience of our members in arranging meetings with major UK institutional shareholders is that they are already heavily burdened with meetings.
If it is felt that more transparency is required in respect of this process we would support the alternative proposal that increased disclosure should be provided in respect of the process by which auditor appointment/re-appointment was decided.
6. The FRC's responsibilities should be developed to enable it to support and oversee the effective implementation of its proposals.
We are not persuaded of the need for a significant enhancement of the FRC's powers. We think that the current system works reasonably effectively. In particular we do not understand how your proposal for ‘real-time intervention in the interests of investors and the capital markets' would operate.
We support the proposal that the FRRPs remit should be extended to cover the whole of the narrative content in annual reports and in particular we endorse the FRRPs previous statements that it is important that narrative reports should properly reflect the financial results.
As we do not support the view that auditors' reports require to be significantly enhanced, we do not believe that the AIUs role needs to be extended.
7. The FRC should establish a market participants group to advise it on market developments and international initiatives in the area of corporate reporting and the role of assurance and on promoting best practice.
The Society supports your proposals to encourage cross fertilization of best practice ideas between market participants and would be pleased to join in any forum which is established. We are not necessarily convinced of the need to have separate groups for financial and non-financial services as the principles of transparency and disclosure should be common across all companies. Also the desirable ‘expert' participants may be the same for both groups, putting an extra administrative burden on such people.
Appendix
Extracts from our response to the BIS review on the future of Narrative Reporting
We include below an overview of the issues which we consider are important as well as specific answers to your detailed questions where we are in a position to have an opinion.
Central to the investor relations task is ‘two way communication': communication of the equity story, the business model, its financials and the current state of the business and its prospects, together with listening to feedback from the financial audience. IR aims to set the context in which the company's ambitions and achievements should be seen. An important aim is to achieve the right balance between long term ownership and liquidity. An excess of either is problematic.
"Shareholder engagement" is at heart of what IR teams do.
So, in preparing an annual report today, companies have to start by considering who the report is for. Companies with long retail investor tails will write for an audience entirely different from one that is largely institutionally owned. Unionised companies, environmentally sensitive companies, multi-national companies will have their own specific audiences in mind. Layering obligations for ALL of these audiences on to ALL companies creates a regulatory repository, rather than a communications opportunity. Nonetheless, we believe that there is a place for an audited record of required information.
We believe however that companies should be encouraged to take advantage of all communication channels. These include meeting investors, analysts and other stakeholders, during which an investor presentation is often used. The investor presentation has a number of merits; timeliness, an ‘informality' and absence of mandated structure. This allows the company's management team the flexibility to share the specific information that the investors need about their company. One size of information set does not fit all.
Regular, timely updates are also key. Through regulatory disclosures such as half yearly results, Interim Management Statements and compliance with the DTR regime, regular updates to the company's non financial position are also provided. In addition, companies choose to update the market with non-mandated information throughout the year. This may be sales statistics, market share, production volumes etc. These are heavily used by analysts and investors.
The annual report is therefore another opportunity to communicate. However the narrative section faces many limitations. From the experience of IR professionals, it is rarely relied on as a key document. Some of the information contained is already in the public domain through one of the above alternative channels. Our concern therefore is to avoid the annual report becoming a historical repository for regulators' mandated information - rather than a useful additional information source for the market.
We are concerned that the annual report is rooted in the earliest versions of the Companies Act, in a completely different information era. Changes in the ‘audience' for the report, changes in investor decision making, rising focus on governance, and of course the way we consume information have made the concept of the annual report very different from its original intent. For example, as more and more companies have gradually taken up the opportunity presented by changes in Company Law to allow ecomms, fewer printed copies of the Annual Report are now necessary as investors generally look to the internet to provide far more up to date/relevant information.
As a consequence of these and other changes, the required content of the annual report has grown exponentially. We are also concerned that this regulatory approach may be inconsistent. The FSA Handbook regularly makes the point in its Disclosure and Transparency Rules that no two companies are the same, and consequently a principles based regulation is appropriate, rather than fixing a set of required disclosures. By contrast, the Companies Act, and the Financial Reporting Council's Reporting Standard 1, creates a ‘standard' - regardless of whether the content of that standard is relevant or not.
The gap between those whose reports embrace best practice, and those who simply seek to comply, is growing larger. This is partly due to the variable audiences for the reports, and partly to variable resources at small and large companies.
So what do we suggest?
First, we believe that any changes should be in the form of principles based guidance and encouragement, rather than new standards or regulations. As noted, creating a mandatory standard to be followed does not allow companies the flexibility to tell their own story, and risks a templated box ticking approach.
We think that any changes to the narrative reporting regime should bear in mind the total flow of information to the investor. The annual report should not be regarded as a standalone communication.
Also, we are not persuaded that the differences between the Operating and Financial Review and Enhanced Business Review are sufficiently stark to warrant changes in regulatory standards.
Second, we believe that regulations should embrace the use of technology. We agree with the sentiment behind the question "Would report users welcome a way of limiting the narrative report to a summary of the strategic issues with the more detailed supporting information presented separately for those who wanted that extra level of information?" Companies already use their corporate websites to deliver more detailed information about their businesses; recognising that information as part of the narrative report would allow annual reports to become focussed, uncluttered communication opportunities.
Third, inclusion of the auditing process is very important. We believe that audited data should be identified as such.
Fourth, we do not believe that adding to an already crowded AGM agenda by including an advisory vote on the Business Review would make a difference to the quality of narrative reporting.
Finally, costs of preparation are an obvious concern for all companies. By simplifying the guidance on what companies should include, regulators would encourage companies to invest more on those areas that matter to them and to their stakeholders.
Published: 31 March, 2011