Once something becomes successful, there is a tendency to tidy it up. On Sunday mornings, many people go to their local farmers’ market – a fine place for food, albeit of recent origin. It is chaotic, held in half of what, during the week, is a scruffy car park on what is obviously a cleared bomb site dating back to the middle of the last century. The owners of the car park have never attended to it much, and its many potholes give it an air of general neglect.
But now that the farmers’ market is a success, the tidying up process has begun. For a start, the market is being temporarily relocated to a pub car park nearby. Why? Because the car park is going to be refurbished for the first time in what is obviously decades. I fear the worst. No one will leave it at that. Once the tidying up process has gone into full swing, we will have uniform stalls in clearly marked locations. Gradually, the scruffy chaos which gave the event its charm will vanish.
It is human nature. Nothing is allowed to flourish and grow naturally. It must be regulated, and that regulation normally squeezes the life out of the original intentions. And so it is with the Operating and Financial Review which companies have been producing for more than a decade. In some cases, it has been short and terse. But many companies have used the OFR as a useful place to put explanations and background to intangible items which they feel add value to the company, and which shareholders and stakeholders would find useful.
It has, where people have taken to it and used it well, become a valuable additional way of reporting. And, in particular, it has been useful over the past few years as people have realised how important intangible assets and their measurement can be in an informed overview of a company and its prospects. Banks have realised that their only realistic competitive advantage lies in having better staff/customer relationships. None of this can be measured specifically, but indicators can be provided.
Then along comes the EU Modernisation Directive and an overzealous Department of Trade and Industry. The cry goes up that the OFR must be mandatory and, therefore, regulated. Suddenly, the enthusiasm for the OFR drains away almost overnight. Initiatives to give investors a better idea of what the company was up to, and to enable people to better make up their own minds, are cut back.
Instead, companies start listening to their lawyers, and what the lawyers advise is ‘limit what you say’ and ‘mind your back first, communicate with investors second’. We are back with the law of unintended consequences. It is not obvious that the reason the DTI suggested the OFR should become mandatory was to enrich lawyers and minimise the information given to stakeholders. But that is going to be the effect.
So it is refreshing, among the many submissions to the DTI during the consultation process on the OFR, to find someone coming up with an answer. Independent Audit, a company which does exactly what it says on the tin, devotes half its formal submission to what it calls ‘an alternative approach’. It makes the point that the DTI’s proposed regulation “is more extensive than that required by the EU”. It warns of “the unintended consequence of reducing the amount of information made available” and simply suggests: “Do not make the OFR statutory.”
It suggests that best practice in performance reporting could be encouraged through the use of codes which would be voluntary but carry the weight of approval of, say, the Financial Reporting Council. Over time, like the Combined Code, these could become formalised. This would encourage the creation of the OFR as a shareholders’ report whose objective would be “to provide commentary to shareholders on the factors influencing the financial statements and to explain how the financial statements provide a meaningful portrayal of past performance, the health of the company and its economic model”. It would also provide details of influences on future performance and risks, and other reports, such as those on corporate social responsibility and intangibles.
Added to this is a non-statutory audit process and a forum to identify where real gaps in information existed and to modify the best practice guidance required. It would, says the submission, “Be led by changing market standards driven by value to stakeholders.”
The choice is simple. Tidy the OFR into a useless legal requirement, or allow it to flourish and benefit companies, markets and stakeholders.