01 October 2018 by Deepa Raval
Consideration of wider stakeholders and non-financial matters form the context for the FRC’s revised Guidance on the Strategic Report
It has been four years since the FRC published its first edition of the Guidance on the Strategic Report. Since then, public expectation of business has changed and there is an increasing focus on the need for businesses to consider their impacts on society.
Concurrently, there has been an evolution in reporting, enabling transparency on these broader matters and being a catalyst for behavioural change in organisations.
It is against this backdrop that we published our revised Guidance on the Strategic Report on 31 July 2018.
The purpose of the strategic report is set out in legislation as being ‘to inform members [shareholders] of the company and help them assess how the directors have performed their duty under section 172 [the duty to promote the success of the company].’
This purpose remains an important principle that companies should keep in mind when drafting their strategic reports.
The 2018 revisions to the Guidance on the Strategic Report are underpinned by two sets of legislative changes: non-financial reporting and section 172 reporting.
It is easy to get caught up in the detail of these requirements but the common theme running through both is a focus on considering the interests of wider stakeholders, particularly, employees, suppliers and customers. They also recognise that companies should consider the wider impacts of their activities. In our view, it will be necessary to consider both these aspects to ensure that a business is successful over the longer-term.
“Although companies are encouraged to consider the interests of wider stakeholders, the primary audience of the strategic report remains the shareholders”
It is important to highlight that although companies are encouraged to consider the interests of wider stakeholders, the primary audience of the strategic report remains the shareholders. Companies should continue to provide information in the annual report that is relevant to shareholders and make an assessment of materiality on this basis.
The new legislation adds additional layers to the strategic report framework, which creates complexity and companies should identify which parts of the new legislation apply to them. It is important that the new requirements for non-financial reporting and section 172 reporting are read and applied in the broader context of the overall framework of the strategic report.
Companies should consider the broader non-financial matters while thinking about the relationships to the business model and strategy and whether these give rise to principal risks.
The Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016 introduced additional requirements for reporting on environmental, employee, social, human-rights, anti-corruption and anti-bribery matters for public interest entities with more than 500 employees.
The requirements became effective for financial years beginning on or after 1 January 2017.
Over the last few years, there has been an increasing focus on reporting of non-financial information. In the context of the Guidance on the Strategic Report, we use ‘non-financial reporting’ to refer to the broader matters that impact company performance over the longer term.
In 2014, the EU published the Directive of disclosure of non-financial and diversity information (the Non-Financial Reporting Directive). Its aim was to harmonise reporting of non-financial reporting across Europe and has been implemented in the UK through the Non-Financial Reporting Regulations.
Although for many UK quoted companies the new non-financial reporting requirements represent a modest change to the pre-existing strategic report requirements, the FRC believes that this should be an opportunity for companies to ensure that consideration of non-financial matters is part of management and board discussions and that reporting on these matters is linked to the company’s business model, strategy, principal risks and key performance measures.
Companies within the scope of the new requirements are also required to report on the impact of their activities on stakeholders and provide details of any due diligence processes that a company has in place relating to non-financial matters.
Introduced by the Companies (Miscellaneous Reporting) Regulations 2018, section 172 reporting requires directors of all large companies to explain how they have had regard to the broader matters set out in section 172 of the Companies Act 2006. These requirements are effective for financial years beginning on or after 1 January 2019.
The concept of enlightened shareholder value lies at the heart of section 172. Although the duties themselves are not new, the reporting requirement is resulting in a renewed focus on them.
“The concept of enlightened shareholder value lies at the heart of section 172”
The list of broader matters that the directors must ‘have regard to’ when performing their duty include considering the consequences of any decision in the long-term, the interests of wider stakeholders and the impact of the company’s operations on the community and the environment – similar to the matters being considered for non-financial reporting.
The FRC expects that the new reporting requirement, together with complementary changes in the revised UK Corporate Governance Code, will stimulate board discussions on these broader matters.
The FRC’s Guidance on the Strategic Report encourages companies to identify their key stakeholders, explain how they engage with those stakeholders and how the interests of those stakeholders have been considered when making strategic decisions. It also encourages companies to consider capital allocation decisions including information on dividend policy.
The disclosure of a company’s business model and strategy remain the cornerstone of the strategic report. The business model should explain how a company generates and preserves value over the longer-term.
The increased emphasis on long-term value provides a common thread for our 2018 revisions to the Guidance on the Strategic Report.
Companies should also consider the key resources and relationships that support the generation and preservation of value. This will include tangible and intangible assets but may also include items that have not been recognised on the balance sheet.
These are some of the key messages to take away from the 2018 Guidance on the Strategic Report:
On a final note, good communication in corporate reporting is vital. Reporting is as much about communication as it is about compliance with the law. The annual report, including the strategic report and corporate governance statement, should tell a compelling story.