Reassessing the risks lead

Reassessing the risks

16 January 2015

The FRC's David Styles puts the latest update to the Corporate Governance Code in context

While the media coverage often focuses on remuneration, the key issue in the latest update to the UK Corporate Governance Code was going concern and risk reporting. This arose from the financial crisis as it became apparent banks and others in the financial sector weren’t reporting adequately on the risks they were facing. 

Lord Sharman was asked by the FRC to investigate this further. He found that there was misunderstanding by investors about companies adopting the ‘going concern’ basis of accounting. Investors were inferring longer-term viability on the basis of going concern statements than was strictly the case.

It took time to get the recent Code changes right, with three consultations taking place. Any solution had to address the discrepancy between the expectations of investors and the intentions of the companies when they made the statements. Inevitably there were divisions amongst our stakeholders, but a number of corporates and investors supported the fact that companies needed to say more about judgements on risk and the factors they were taking into account, while on the investor side they needed to make considered judgements about the information they were being given.

The Code now asks companies to make two statements: a going concern statement on the basis of accounting principles and a longer-term viability statement taking into account the company’s current position and risks, and its future prospects, and significant risks arising.  The directors can decide the time period for this statement, which should be at least a year but we hope it will be longer. There is also flexibility about how directors structure the statement.

We are not asking directors to hire a clairvoyant: boards should already be assessing risk effectively. But we are asking them to be more transparent to investors about their thinking. If the statement is made in the Strategic Report, it is covered by the safe harbour provisions in the Companies Act. As long as the directors make the statement in good faith and can demonstrate this, they should not be liable to action by shareholders. This should give directors more confidence in how they disclose the information.

The role of investors is crucial too. When companies make these statements it will be very important to assess them carefully and make considered judgements. 

We want the UK to be somewhere which has a good reputation for governance so that investments here will be looked after, but this should not be on the basis of a rule book, which means you can’t take reasonable and proportionate risk.

This fits with the FRC’s vision, which is looking to the long term and making the UK an attractive place for investment. In line with this, the Code now asks companies to explain remuneration policy in terms of how it benefits long-term company performance; it also asks companies to describe how they will engage with shareholders following significant votes against a resolution at a General Meeting (full details are available on www.frc.org.uk).

Inevitably it will take a certain amount of time to get used to the new disclosures. Inevitably there can be a herding instinct, but companies should be thinking about their own individual situations and how best to be transparent. We want companies to be thoughtful about governance, and make good explanations where they do not comply, rather than ticking boxes.

The first of the new governance statements won’t be required until well into 2015, so there is plenty of time to prepare, but it is never a bad thing to start early.

We have also changed the preface of the Code to talk about boards ‘setting the tone from the top’. It has to be said, there’s still a good deal of mistrust of the financial sector and about business more generally. Without being too prescriptive we wanted to give companies a steer that there will be shareholders and stakeholders who don’t feel that their concerns have been taken seriously or been dealt with, so they’d like to know more from companies about how they go about their business. And we need to address an unwillingness to talk about risk, which became apparent following the crisis.

The FRC believes that better engagement by shareholders helps to create better-performing companies, which in turn helps to give better returns to investors. It should be a virtuous circle. We want the UK to be somewhere which has a good reputation for governance so that investments here will be looked after, but this should not be on the basis of a rule book, which means you can’t take reasonable and proportionate risk.

We’ve been meeting with many company secretaries recently, and we enjoy a good relationship with the ICSA. The Code changes affect a number of players, but I’m very conscious that company secretaries are at the coalface when it comes to delivery and reporting.