CEO Stephen Haddrill gives speech at FRC event on “Enhancing trust in European companies, improving investor confidence and facilitating long-term shareholder engagement"
News types: Speeches
Published: 26 April 2013
Find below the plain text version of CEO Stephen Haddrill's speech at the FRC's “Enhancing trust in European companies, improving investor confidence and facilitating long-term shareholder engagement – the role of high quality corporate governance and financial reporting” event in Brussels on 22 April 2013. To download the formatted version, click here (PDF).
Good afternoon and welcome to the Financial Reporting Council.
We are the UK’s regulator for setting accounting, auditing and actuarial standards. We are here today to continue our programme of engagement with Europe. Our theme is “Enhancing trust in European companies, improving investor confidence and facilitating long-term shareholder engagement”.
We strongly believe that regulators like ourselves, responsible for how companies go about counting their success, how they report their success, how they govern themselves and how they are externally audited, have a great deal to say about rebuilding trust.
We are focussed today on effective engagement at European level to achieve our common goals.
We are proud of the strengths of the UK governance and reporting system and what we have done to secure investor confidence in capital markets in the UK and Europe. However, we recognise that trust is at a low point. So, looking forward we have a challenge to develop the next agenda, not looking back to the crisis, but creating a new vision for business of the future. In doing so we must restore trust while at the same time enabling enterprise and risk taking to flourish and so promote growth.
We are fully committed in this task to engage with the European Parliament, the European Commission as well as other key stakeholders in Brussels. We want to play a productive role in the European debate and will continue to extend, deepen and strengthen our constructive engagement in the EU. It is for this reason that we have opened an FRC office here in Brussels where Cecilia Thorn, our Head of European Affairs is based full time.
Good afternoon and welcome to the Financial Reporting Council.
We are the UK’s regulator for setting accounting, auditing and actuarial standards. We are here today to continue our programme of engagement with Europe. Our theme is “Enhancing trust in European companies, improving investor confidence and facilitating long-term shareholder engagement”.
We strongly believe that regulators like ourselves, responsible for how companies go about counting their success, how they report their success, how they govern themselves and how they are externally audited, have a great deal to say about rebuilding trust.
We are focussed today on effective engagement at European level to achieve our common goals.
We are proud of the strengths of the UK governance and reporting system and what we have done to secure investor confidence in capital markets in the UK and Europe. However, we recognise that trust is at a low point. So, looking forward we have a challenge to develop the next agenda, not looking back to the crisis, but creating a new vision for business of the future. In doing so we must restore trust while at the same time enabling enterprise and risk taking to flourish and so promote growth.
We are fully committed in this task to engage with the European Parliament, the European Commission as well as other key stakeholders in Brussels. We want to play a productive role in the European debate and will continue to extend, deepen and strengthen our constructive engagement in the EU. It is for this reason that we have opened an FRC office here in Brussels where Cecilia Thorn, our Head of European Affairs is based full time.
Corporate Governance and Stewardship
We strongly believe that good governance enhances corporate performance. A well governed Board will be clear about its vision for the business and its strategy for achieving it. At the same time, it will manage risk effectively and be a good steward of the assets entrusted to it, all of which should enhance sustained profitability.
In September 2012 we revised the UK Corporate Governance Code.
This Code operates on a “comply or explain” basis, an approach backed by many in Europe.
Comply or explain has allowed us to be more aspirational: companies have accepted change more readily knowing they have flexibility in adoption. So the UK has achieved annual election of directors, separation of the roles of Chairman and CEO and independent audit committees without the need for regulation.
We therefore welcome the European Commission’s support for the principle of “comply or explain” in the Company Law Action Plan, and its recognition that corporate governance codes can play an important role in raising standards and spreading best practice.
The Commission has rightly highlighted that the credibility of this approach requires any explanations to be clear and company-specific so that shareholders can judge whether they are appropriate.
In February 2012 we published a paper titled ‘What Constitutes an Explanation under Comply or Explain?’ which identified a number of features of a meaningful explanation. These included, for example, providing a clear rationale for the action taken and describing any mitigating actions. The FRC believes that companies must understand what is expected of them and that shareholders have guidance on how to assess estimations.
Nevertheless, this approach depends on investors and their fund managers paying attention to what companies tell them. This means investors engaging with companies and exerting their influence. Some do this very well but not all are willing to invest the time. Through the Stewardship Code for institutional investors we strongly encourage them to do so. We are very proud of the FRC Stewardship code for institutional investors and we would like to see such a code work in a European context.
In our updates to the UK Corporate Governance Code late last year, we included a requirement that companies should explain their policies on boardroom diversity and progress on achieving them. This is a similar approach to the proposed disclosure requirements in the 4th Directive which the Commission published last week.
The FRC believes strongly in the business case for diversity in the boardroom. However, we don’t believe that enforced quotas are the way to achieve it.
Our approach is already delivering results in the UK. The latest data published earlier this month suggests that – despite a temporary slowing in the rate of progress – the UK is on course to meet the Commission’s target of 40 per cent female non-executive directors by 2020.
It is also important that in focusing on targets for non-executives we are not distracted from the most important issue, which is developing the executive pipeline. Boards need to pay attention to this too.
For the FRC it is important that proposals take a long term view and aim to enhance trust in European business and the European economy. We are therefore studying closely the Commission’s Green paper on long-term financing of the European economy.
The Kay Review into Long-term financing in the UK noted that the equity market has for some time ceased to be a source of net new capital for companies, and therefore argues that its role is nowadays mainly to be the focus for corporate governance control. We do not agree with this narrow view of the role of the equity market.
The market for risk capital, when it is working well, enables savers to share in the growth of the most successful companies, and those companies to attract risk-sharing capital at the lowest possible cost. It is a powerful driver of growth. We need perhaps more than ever, in the wake of the banking crisis, a diverse, well-functioning capital market. The provision of risk capital to companies depends on the confidence providers can have that their interests are protected. Protected, that is, by a good board, and buttressed by clear and honest reports on the company’s performance. Hence our work on reporting as well as auditing governance.
The information companies provide should be directly relevant to the promotion of long term equity ownership, and stewardship reporting should be clear, relevant, timely and related closely to the needs of long term owners who need to play their part as stewards.
Much of our work is directed towards these aims. Take, for example, the inquiry we asked Lord Sharman to lead, into going concern assessments – a point of serious concern following the financial crisis. Lord Sharman’s panel believed that the primary purpose of the going concern assessment should be to reinforce responsible management of risk. He also argued that the going concern considerations made by directors - and reviewed by auditors - should cover both solvency and liquidity; and that these should cover a longer period than they currently do. Our new guidance to directors on going concern, on which we are currently consulting, reflects these recommendations.
Sharman also recommended that the going concern assessment should be integrated with business planning and risk management. Its report stipulated that investors should be given a fuller picture of the principal risks the entity faces, rather than highlighting going concern risks only when there are significant doubts about the entity’s immediate survival. We are consulting on this now.
If reporting requirements are designed intelligently, they can be used to create more focus in the business on its longer term sustainability. This applies to financial reporting just as much as to the front half of the report. Financial statements need to do more than help forecasts of earnings and cash flows: they need to portray the progress of the business. Only if investors have this information can they engage in real discussions as to how value can be created and sustained in the long-term.
IFRS/ Accounting standards
That brings me to the role that high quality corporate reporting plays in underpinning investor confidence in Europe. We support global accounting standards which underpin confidence and provide a common platform for growth.
We are pleased to be one of the inaugural members of the Accounting Standards Advisory Forum. We hope to be a critical friend to IASB, bringing practical and principled views of investors, preparers and auditors.
We also wish to be part of strong European representation to the IASB. That representative effort must reflect the variety of European interests in the early stages of standard setting. There is a time for a single European voice in standard setting and a time for reflecting the breadth of EU experience.
We are therefore pleased that Commission has asked Mr Maystadt to look at the structures and processes of influencing IFRS in Europe to ensure this is done as well as possible.
As part of our work on the ASAF we also believe it is important for the user voice to be heard and promoted by standard setters. We plan to hold discussion groups in London and Brussels with investors in order for us to better understand their priorities and concerns with continued global convergence. Evidently there is frustration around the US delay, but we believe that continued work with the IASB, especially to get early adoption of IFRS 9 and an effective endorsement programme, can put Europe at the forefront of implementing modern accounting practices.
We will give our support to initiatives that drive up the quality of corporate reporting, including narrative reporting, while reducing the regulatory burden on business and the complexity of information within reports. We support the drive towards deregulation for SMEs and proportionate requirements for smaller quoted companies, such as through reduced corporate reporting and accounting requirements. However, we stress that this must not be at the cost of investor support for smaller companies. Strong investor protection, transparency and investor information are paramount where SMEs are concerned.
Audit
Now let me turn to audit. Audit quality contributes to financial stability. We believe that all proposals should be tested in terms of their impact on audit quality. It is most important that the company has the best auditor they can find. They cannot be certain they have achieved that unless they retender the audit on a regular basis. We have introduced once every ten years in the UK.
We do not favour mandatory rotation because the incumbent auditor, who may be the best auditor, has to go, however good a job they are doing.
I know some have said that companies will not retender. Our recent experience shows this is not the case. HBSC and Barclays have both put their audit out to tender, many others are doing so and many are changing audit firm.
The debate has focused on audit rotation, but at the end of the day. What is most important is the quality of the audit opinion and the usefulness of the reports of the audit committee and the auditors. We made changes to our Corporate Governance Code in 2012 to improve transparency of audit committee reporting on key judgements on how audit quality is assessed. We are currently consulting on introducing a requirement for auditors to report on audit risks, scope and materiality. We proposed both these sets of changes in response to requests from investors to have more insight as a basis for engagement on audit quality.
So to conclude, we need to keep investors at the heart of our thinking.
Confidence in markets and companies remains critical for investors. Our work in the years ahead in driving behaviours, setting standards and monitoring conduct must be developed in the context of a vision for corporate governance and reporting where the needs of investors are paramount and where boards, auditors, fund managers and others all have the right incentives to put their stewardship role first so that good stewardship and their interests, are in short, aligned.
The theme of this event is to address how high quality corporate governance and financial reporting can foster investment and trust.
Investors have the power to make choices that directly affect capital markets. What is important is making sure that they can make those choices based on objective and useful information. Corporate governance and reporting are an essential element in helping them make that choice and this is an area in which Europe can lead the world.