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Comments from ACCA
March 2006

ACCA is pleased to comment on the DTI’s extended consultation on i) the future of the Business Review and ii) mandatory narrative reporting more generally.

ACCA was disappointed to hear of the Government’s decision to abolish the statutory Operating and Financial Review (OFR). Our view was that the proposal to introduce the statutory OFR had been subjected to thorough consideration and consultation over a number of years and that a workable set of provisions had been developed as a result of that process.

We found it unfortunate that the whole process was short-circuited by what appeared to be a sudden decision coming shortly after the new company law reform bill (containing provisions on the OFR) had been presented to Parliament. Given that substantial investment in the statement had already been made by the DTI, ASB and companies themselves, we were unconvinced by the argument that abolition would save money and cut red tape. The decision also ignored the contribution which the work carried out on the OFR might still make to the IASB’s project to produce an international statement on narrative reporting by listed companies.

We did not consider that the OFR requirements as set out in the 2005 regulations were so prescriptive and burdensome as to have caused substantial compliance difficulties to listed companies. Further, we felt that the Government’s decision to abolish the statement failed to pay adequate heed to the conceptual rationale for the OFR as first put forward by the company law review steering group when preparing its original proposals on this matter, viz the OFR should, in part, be a means by which the company’s directors report on how they have carried out their (expanded) legal duties.

ACCA remains supportive of the OFR as a vehicle for reporting by listed companies and, in the absence of any statutory requirements, will continue to encourage public interest entities to publish their own OFRs under the ASB’s revised guidance. We consider that the OFR will remain a more comprehensive and a more stakeholder-focused analysis of the company’s position than the Business Review, for the reasons we discuss below.

The content of the Business Review vis-a-vis the OFR

The statutory OFR would have required relevant companies to report on ‘the main trends and factors which are likely to affect the company’s future development, performance and position.’ This was in addition to describing the company’s strategy and objectives and the principal risks and uncertainties facing the company (the latter being a disclosure requirement which is admittedly reiterated in the Business Review rules).

We accept that the requirement to outline risks and uncertainties will, when taken together with the directors’ report requirement to indicate likely future developments, create an onus for companies to cover some material prospective information. But what will be lost, we suggest, is the encouragement to provide an explanation of the main drivers and influences in the external environment which are likely to have a bearing on the company’s future. The current directors’ report only calls for disclosure of future developments in the business of the company – this could be construed as only calling for some disclosure of the company’s own future plans, excluding the drivers and influences which might have a material bearing on the company’s prospects and which could be of significant interest to stakeholders.

Further, the Business Review as drafted does not give equivalent prominence to the disclosure by companies of non-financial issues relevant to the development and performance of the business. The current regulations only require companies to analyse their development, position and performance, using non-financial key performance indicators (including indicators which relate to environmental and employee matters), where appropriate and to the extent necessary for an understanding of the development, performance and understanding of the business.

Even if companies chose to report social or environmental information in their Business Review, this would not, as things stand, need to encompass details of any policies or commitments that the reporting company had agreed with respect to these matters. We consider that a proper understanding of events and performance on the part of the reader is always likely to be aided by an explanation of the context in which that information is presented.

More generally, the OFR regulations would have meant companies reporting a comprehensive picture of their objectives, achievements, prospects and risks, all in the context of a company’s operating environment and stakeholder relationships. Compliance with the Business Review rules, as they are currently presented, would result in less information being disclosed, in more piecemeal fashion, and a loss of the ‘big picture’ dimension which is characteristic of the OFR model. It must also be borne in mind that the requirements of the Business Review are aimed at a much wider class of company than was the case with the statutory OFR, and for this reason its provisions are necessarily less tailored to the circumstances of public interest entities.

Another area of concern with the Business Review, which in our view could amount to a serious practical difficulty and have long-term consequences for the quality of corporate reporting, is the absence, as yet, of any clear and authoritative guidance for companies on how the reporting requirements in the Review are expected to be met. In the absence of any such guidance – and as we understand the position ASB is not prepared to issue it – we do not see that the introduction of these new disclosure rules will in practice bring about any material improvements in company reporting.

In summary, our view is that, while we welcome the Government’s declaration of its commitment to the causes of forward-looking reporting and the disclosure of social and environmental information, reliance on the Business Review in its current form will not help it to achieve those ends.

Our recommendation for resolving this unsatisfactory situation is set out below.

A statutory option to prepare an OFR

As requirements of EU law, the Business Review provisions must remain, in their current minimal form or in some extended form. As indicated above, however, they are not sufficient to achieve the progress in company reporting which the Government apparently wishes to achieve.

Our preferred solution would be to retain the Business Review rules as minimum level disclosures but to give listed companies (or, conceivably, large companies or even companies more generally) the formal option of preparing an OFR in accordance with ASB’s Reporting Statement. Companies which took advantage of this option would be made exempt from the separate requirement to reproduce, in their directors’ report, information that they had included in their OFR (on the same lines as was the case under the former section 234(4)).

This solution would, in our view, be compliant with the requirements of the Modernisation Directive in that UK law would be laying down the minimum provisions demanded by that Directive while allowing individual companies to exceed them if they wished. Companies would therefore have the choice of complying with the bare rules set down in the legislation or preparing an OFR. Where companies chose to prepare an OFR, this would need to be published and filed with Companies House along with the company’s financial statements.

The principal virtue of this solution, from the point of view of the quality of corporate reporting, would be that companies, should they opt to produce an OFR, would be able to do so by reference to settled professional guidance as to the required standard and content of the statement, viz the ASB Reporting Statement. Those companies which prepare Business Reviews do not, nor will they have, any such guidance to refer to.

The proposal would also have the merit, from the Government’s perspective, of dispensing with the need for legislation to set out the detailed form and content of OFR statements, these matters having been already addressed by ASB.

If our approach were adopted, legislation would need to require the directors of any company which sought to take advantage of the option to make a declaration on its balance sheet (or its directors’ report) to the effect that it was doing so. This declaration would also need to confirm that the company was eligible to take advantage of the option by reference to any agreed statutory eligibility criteria.

To ensure that at least the minimum standards laid down by the Modernisation Directive were adhered to by companies taking advantage of the option, legislation would also need to require directors to include a statement in their company’s OFR to the effect that the statement had been prepared in accordance with the requirements of the ASB’s Reporting Statement. Legislation would not need to provide for any additional responsibility for the auditor since auditors already have a responsibility under auditing standards to review for consistency any additional statements prepared by the company and published along with their financial statements.

In considering its options on this matter, we recognise the Government’s concern to avoid i) gold-plating EU legislation and ii) imposing an overly-prescriptive approach. We believe that our recommended approach meets these concerns. With respect to i), the Government would not need to elaborate further on the minimum Business Review rules derived from the Modernisation Directive. With regard to ii), duplication of disclosure requirements would be avoided and companies would be given the choice of which set of rules to follow. Our approach would, we consider, help bring certainty and stability to the current unsatisfactory situation and would safeguard for the corporate reporting environment the advances in narrative reporting achieved by the development of the statutory OFR, while respecting the Government’s decision not to make the statement mandatory.

Disclosure of payment practices

Separately from the foregoing matters, we consider that, in the context of the Government’s wider review of narrative reporting, new onus needs to be given to the reporting by listed companies of their policies and practices regarding the payment of their creditors. The introduction of statutory interest under the Late Payment of Commercial Debts (Interest) Act 1998 has not led to any material improvement in the time taken by companies (and public authorities) to pay their creditors. As a result, the improvements in the payment culture that were envisaged back in 1998 have not materialised.

We consider it is time for the Government to re-consider the effectiveness of the current provisions of the directors’ report for public companies to report on their policies and practices regarding creditor payment. In our view, the current disclosure requirements are not conducive to the properly transparent reporting by companies on this matter since the disclosure formula contained in the law allows scope to companies to engineer figures which are favourable to them. Another issue is that, according to research carried out by the Federation of Small Business, very many public companies are simply failing to disclose the information that is required of them. There is, accordingly, a need to re-consider the nature of the disclosure requirements on this matter and the means by which compliance with them is assured.

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