The plain text version of Stephen Haddrill's speech can be found below.
To download the formatted version, click here
Chief Executive, Financial Reporting Council
EY’s Financial Reporting Outlook 2016 Conference
Monday 7 November 2016
Good morning Ladies and Gentlemen.
In the couple of years since I last spoke at this conference, the challenges you face in reporting to your shareholders have grown significantly. Fortunately you have risen to face them.
Corporate reporting should tell the story of your business, its position, performance and prospects. It should do so in a way that is fair, balanced and understandable. Those are the requirements of the regulations and the Corporate Governance Code. The challenge for you today is to tell that story, particularly your view of prospects, in the midst of extraordinary economic uncertainty.
That is difficult, but far from impossible, as many companies have already shown in their reports and particularly in their analysis of the risks they face. It is not easy for a chief executive to recognise publicly the threats to their business, the downside risk as well as the opportunity. However, increasingly that balance is being achieved and I encourage all of you to test whether you are amongst the best.
Of course, since I last spoke, the reporting of future prospects and the risks to the company has been given focus by the introduction of the requirement in the Code for companies to report on their longer term viability. We are currently reviewing the effectiveness of these statements and I have been much encouraged to hear from many chairmen of major companies that the drafting of the statement has provided a positive focus for a better discussion of risk in the Boardroom.
Most companies have assessed their viability over a three year period, reflecting their normal planning style. Some have gone longer. Some have suggested they might look at a longer period in future when they have some confidence in the new risk assessment process. All are aware of the risks of having to tell shareholders that the period has been reduced.
The best statements have been clear why the period selected is right for the company. They have also explained how their assessment of their viability and of their risks has been stress tested and have given the range of assumptions considered. We encourage more companies to follow such examples.
In times of uncertainty the company’s view of its prospects is particularly significant but that does not take away from the importance of the bread and butter of reporting the story of the last year through the strategic report and the financial statements.
In our recent state of the nation study of corporate reporting, we were pleased to report that of the nearly 200 sets of reports and accounts we scrutinised in 2015/16, two thirds were closed without any need for follow up actions. So, well done! Of the others in all cases bar one, our concerns were satisfactorily resolved with companies agreeing improvements for the future.
Our goal in monitoring reporting is not to catch companies out but to promote continuous improvement through constructive dialogue. We are taking steps to enhance the transparency of our monitoring work so that individual companies and the market will have a better opportunity to understand our thinking.
We will, for example, inform companies if we have reviewed their reports and found no issues. At present companies are not aware that a review has taken place if it gives rise to no significant issues. We are also embarking on an experiment. We will notify some companies before they prepare their accounts that they will be reviewed. If this leads to better reporting by those companies we may extend this approach, although there will always be some mystery shopping.
Our monitoring work, combined with discussions with investors, gives us a good basis for advising preparers on what to pay attention to in their next report.
Some of their messages for the coming year will come as no surprise.
In terms of the strategic report, investors want to know as much as possible about how Brexit will affect the business. Inevitably that is clouded in uncertainty and so some different scenarios may need to be considered.
Investors are also asking more about cyber-risk and how it is being mitigated.
And they have been keen in many cases to get a better understanding of how company’s business model work. It is surprising how frequently it is not made entirely clear how a profit is made, how the company is different from its peers; to assist in this our Financial Reporting Lab has just produced its latest report on best practice in describing the business model.
Investors are also keen to get a better understanding of the confidence they can place in alternative performance measures. Investors often value the insight into the business provided by such measures but they also want to understand better how they relate to IFRS or UK GAAP numbers.
Last but not least, investors want to understand how dividend policies operate in practice and how these polices might be affected by the risks and capital management decisions facing the company. The Financial Reporting Lab has produced a report on this recently. In that report and in other statements we have encouraged companies to go beyond the basic requirements. In particular, we encourage more disclosure on distributable profits than the Companies Act requires.
Recent changes such as the introduction of the Strategic Report and viability statements have shifted the balance of reporting from a rear-view to a forward-looking perspective. As a result the company’s narrative on its prospects is becoming clearer. Reports are also more integrated with the key elements being properly linked to strategy, much called for in the great work done by the IIRC. The task now is to make all this common place. The best practice of some companies should become the norm not the exception. I would encourage you all to look out for the best and to use pointers to it, such as our Lab reports.
But are more changes coming? Yes. Some we know about. The recent and soon to be adopted major new accounting standards such as IFRS 9 have been well signposted. I would encourage you all to consider how much time it will take to adapt to these new requirements. The answer is almost certainly going to be longer than you think and the systems investments are not minor.
Looking further ahead the UK Government will need to decide how to adopt international accounting standards after we have left the EU. It is too early to say how that will be done. We will continue to support the development of a single set of high quality global standards for listed companies. But let me stress those words “high quality”. We will work hard before and after Brexit to influence the development of IFRS so that they can indeed be readily adopted in the UK.
Now, if I may, I will turn from reporting to the broader question of corporate governance. The Prime Minister and the Business Select Committee have raised major questions about the effectiveness of UK corporate governance, and suggested some major reforms, including having an employee representative on Boards.
The FRC has submitted evidence to the Select Committee and will play a major role in the debate that is gathering great momentum.
We must make sure that the strength of international investor confidence in UK Corporate Governance is recognised. This must not be jeopardised, particularly in times of economic uncertainty. At the same time we must also recognise that wealth creation is disproportionately favouring a few and this damages public trust in business, especially if those who are well rewarded do not uphold high corporate standards and are not held to account.
In addressing these concerns the right balance needs to be struck between the needs of enterprise, of investment and of accountability. In terms of accountability greater awareness of stakeholder concerns and better reporting to them as well as to shareholders needs to be achieved.
Some of the key recommendations the FRC makes are:
- That Boards should pay more attention to their responsibilities under Section 172 of the Companies Act 2006 to both shareholders and wider stakeholders and should report on how they have discharged these. For example, by showing how they have allocated funds between pensions, dividends, directors’ remuneration, and capital investment.
- That the remuneration committee should have a wider responsibility for scrutinising the pay and conditions of the company’s workforce as a whole and should report on the link between the remuneration structure and strategy.
- That the Government should review the enforcement framework in order to establish an effective mechanism for holding directors and others in senior positions to account if they fail in their responsibilities.
In pursuing such changes, the current strengths of UK governance: the unitary board, strong shareholder rights and the “comply or explain” approach, need to be preserved.
If changes to regulatory frameworks and to the Code are required, the FRC will play its part in ensuring that change to the Code is done carefully and through full consultation. We will seek to make sure this consultation fully engages a wide range of stakeholders, indeed a wider range than normal. We are already extending our outreach to those who can together speak for a broad cross section of our society.
The effectiveness of regulatory change will depend on the spirit with which companies address the challenge set out by the Prime minister as much as on compliance with regulation.
And that brings me, finally, to our work on corporate culture. We are indebted to a coalition of partners who helped us produce our report “Corporate Culture and the Role of Boards” in July; in particularly I should like to thank the CIPD, CIMA, the IBE, the CIIA and the City Values Forum, for their work.
Our report sets out a number of key observations and examples of best practice. In particular, it encourages Boards to:
- Recognise the value of culture: A healthy corporate culture is a valuable asset, a source of competitive advantage and vital to the creation and protection of long-term value. It is the board’s role to determine the purpose of the company and ensure that the company’s values, strategy and business model are aligned to it. Directors should not wait for a crisis before they focus on company culture.
- Demonstrate Leadership: Leaders, in particular the chief executive, must embody the desired culture, embedding this at all levels and in every aspect of the business. Boards have a responsibility to act where leaders do not deliver. Remuneration decisions. Decisions must be consistent with the desired culture. This includes decisions on appointments and remuneration incentives.
- Be Open and Accountable: Openness and accountability matter at every level. Good governance means a focus on how this takes place throughout the company and those who act on its behalf. It should be demonstrated in the way the company conducts business and engages with and reports to stakeholders. This involves respecting a wide range of stakeholder interests.
- Seek to measure what behaviours are actually occurring: Such metrics should be tailored to the behaviours and include external as well as internal stakeholder views.
I should also note that increasingly investors have recognised the importance of culture and are asking questions about it in their stewardship meetings with company chairmen. Reporting of culture is currently limited but is clearly an area on which more should be done.
So, ladies and gentlemen, thank you for your time. I hope that has given you an insight into the FRC’s vision and concerns across a broad front. We see excellent progress being made in corporate reporting. We look forward to more companies following in the footsteps of the pathfinders who are putting across the story of their company with balance and clarity. And I look forward to your questions.