20 October 2014
Extractive industries must report payments made to governments of host countries.
The UK’s implementation of the EU Accounting Directive Chapter 10: Extractive industries reporting will change the way business is carried out for small and large extractive companies.
From January 2015, the directive requires UK-registered gas, oil and mining companies to report on payments made to governments in all countries they operate. It has been adopted to increase transparency and help reduce corruption in those countries with reserves of valuable natural resources but with many extremely poor citizens.
This significant step to align processes with those outlined in the directive demonstrates the UK's continued support for the extractive industry transparency agenda – Prime Minister David Cameron also hopes to commit to the Extractive Industries Transparency Initiative (EITI).
Industry-wide regulation always prompts discussion among stakeholders, particularly when there are other reporting measures already in place, for example, International Financial Reporting Standards, International Trade Agreements and a number of other relevant EU laws and regulations.
Much of the sector must be questioning why the UK government feels that yet another precaution is necessary. Despite current measures, many corruption issues remain to which the extractive industries are exposed. The new requirement means that from the beginning of next year, companies will have to report what they pay to the governments of 'extractive host countries' – those countries in which they operate.
This poses the question of why this is not currently being done, given that current financial reporting standards require transactions to be documented.
Many companies already comply with these reporting standards but it is not often as straightforward to do so for the extractive industries. One reason is the complexity of dealings and transactions between companies and their extractive host countries.
In the oil and gas industry, for example, UK-registered companies operate in countries including Libya, Russia, Nigeria and Saudi Arabia. The business environment in such countries can differ significantly from that in the West. These countries are characterised by different governmental structures, which impacts the way that business relationships are handled.
A pertinent example is the chain of influence in Nigeria, where an overseas company would hope to develop a favourable relationship at three distinct governmental levels; national, state and local. The company also has to ensure that local citizens of the host country are in favour of the extractive activity – a task that is not always straightforward.
Wider current affairs can also have a detrimental impact on extractive activity. For example, the Syrian civil war and Russian trade embargoes. It is in situations such as these where the propensity for corruption is likely to increase, turning a simple business transaction into a minefield.
'Simply complying with the requirement will not solve prevailing issues'
High profile cases of corruption, most notably bribery, extortion and blackmail are occasionally exposed in the media. In 2012, the US Securities and Exchange Commission charged three oil executives with bribing customs officials in Nigeria to obtain oil rig permits required for drilling operations.
Panalpina World Transport Holding Limited, a Swiss freight-forwarding company, along with five other oil and gas service companies and subsidiaries, were fined over $156 million for making illegal payments to foreign officials in countries including Angola, Kazakhstan, Brazil, Turkmenistan, Azerbaijan, Russia and Nigeria. In the case of Panalpina, the company admitted to making the payments on behalf of customers such as Shell Nigeria, Transocean and Tidewater Marine, amounting to at least $27 million between 2002
As well as these high profile cases, there are lower levels of corruption beneath the radar. This is something that companies and their boards need to rectify. Greater transparency in transactions has the potential to help them to do so, if only by reminding corporates that there is a price to pay if their actions are discovered.
Boards and management of UK-registered companies affected by the change must ensure that appropriate systems and processes are in place. They can begin by reviewing how payments to their host governments are currently being made and documented.
Most, if not all, affected by this directive will have already carried out an audit by now. The next stage is to identify where there are reporting limitations, and how processes that will address these limitations can be put in place within the required timeframe.
Recording transactions made to foreign governments seems like a relatively straightforward task but the process involved can be very challenging in economies where corruption is prevalent.
Local officials may insist on undocumented payments before engaging with the extractive company. The boards of UK-registered companies must set the tone for how transactions should be made in areas where current processes are unclear.
Boards must ensure that they send out a strong message that integrity in dealings is now the norm.
The management team will have to ensure that appropriate systems are in place and are duly implemented. The UK government wants to reduce corruption in international trade but the impact is likely to be more far-reaching. Transparency also makes good business sense in terms of investment. The new requirement should also lead to improved corporate governance practices, foster better corporate social responsibility and improve ethical behaviour among UK companies. These potential outcomes are why boards should embrace this directive.
The threshold for reporting a payment is €100,000 so there is the potential for smaller payments to change hands without being reported. Boards should be looking at how they can go beyond compliance and ensure that all payments, irrespective of how small or large, are recorded. Some feedback suggests that the government could have done more to engage with smaller companies during the consultation period. There are also concerns that smaller UK companies may not be able to put appropriate systems and processes in place before January 2015.
Simply complying with the requirement will not solve prevailing issues. Company boards and management, along with governments, must do more to address and ultimately eradicate issues of corruption in trade.
Time will tell whether this directive will lead to reduced corruption in international trade.
Babawande Sheba is Head of Logistics and Operations at Greenwich School of Management