MYTHOLOGY is full of inventive punishments. Sisyphus was made to eternally roll a boulder up a hill only to watch it roll back down again because he taunted the gods. Like the one-time king of Ephyra, the FRC might wonder what it did to deserve its nightmare task of overhauling going concern.
Following three formal consultations and extended public debate, the FRC’s plans to implement the recommendations of the Sharman review are still far from consensus. But as the clock runs down and this year’s UK Corporate Governance Code update comes into force, the time for discussion is over.
The most recent proposals have brought investors, business and auditors closer to agreement on the basic principles behind the plans, but, as the FRC is expected to publish its final guidance in September, some divisive issues remain.
Third time lucky
In the aftermath of the 2009 financial crash, the FRC brought in Liberal Democrat peer and former KPMG and Aviva chairman Lord Sharman to get to grips with going concern – a principle in accounting that assumes a company will continue to operate in the foreseeable future.
The fallout of the financial crisis highlighted the imperfect nature of existing policy. While banks and their auditors met reporting requirements, assessing the businesses as healthy across a 12-month outlook, their stability was threatened in the following months.
In his 2012 report, Going Concern and Liquidity Risks: Lessons for companies and auditors, Sharman concluded the application of going concern and risk assessment should not be binary if they are to allow proper consideration and disclosure of risks without labelling the business as unviable. There is an “expectation gap” between the reporting sense of going concern and the common-sense understanding from which investors view the statements, he said.
However, moving from this binary model has proved one of the greatest sticking points. Following an initial consultation in January 2013, the FRC faced a barrage of criticism about its interpretation of Sharman’s recommendations, particularly as it attempted to clarify the definition of going concern as extending beyond that specified in accounting standards.
In January, Sharman panel member David Pitt-Watson issued a call to arms for investors, citing concerns over the watchdog’s direction of travel in its second set of proposals, after it amended its guidance to address corporate perspectives.
Reacting to “investor concerns”, the FRC confirmed it would consult for a third time – this time saying it would include the changes in its bi-annual review of the UK’s regulation for listed entities, the UK Corporate Governance Code.
The latest proposals are an attempt to bridge the gulf between shareholder and corporate positions. While accounting firms were also largely in opposition to the original draft guidance, their responses in this consultation, which closed in July, were more neutral.
In addition to enshrining the accounting standards definition of going concern in the code, the plans add the requirement of an ongoing viability statement from directors. This requires the board to consider the key risks to the business and consider whether the company is viable for the “foreseeable future”. The timeframe to which this refers would be set by the board, in line with the environment of the company’s specific industry, but the choice of timeframe should extend beyond 12 months and be explained by the directors.
While consultation respondents largely backed the FRC’s intentions, opposition to elements of the plans persists and concerns over the impact they could have on businesses and their directors remain.
GC100, which represents the FTSE 100’s top legal staff, has no objection to companies being asked to make two statements on going concern and ongoing viability. However, it was one of several groups to note that accounting going concern is mandated by listing rules and IFRS requirements, so it questioned “whether it needs in addition to be enshrined in the code”.
The clear distinction between the going concern and ongoing viability statements is supported, with GC100 saying the draft code’s wording “meets the objectives of the Sharman Panel’s recommendations”, particularly in considering a broader range of controls. It also feels it is “vital” companies decide the period of assessment.
However, the group has “residual concerns” over the legal implications for directors in making the ongoing viability statement, which could result in assessments with a high number of caveats “from which investors will derive limited value”.
“The further a company looks ahead, the increasingly uncertain the future becomes as economic, regulatory and political uncertainty means it is not feasible for directors to anticipate events and impacts on companies’ future in the long term. Directors may therefore be increasingly reluctant to make categorical statements past the foreseeable future,” it said.
The corporate vanguard
While the legal minds of the FTSE 100 cautiously backed the proposals, the index’s FDss were less accepting. The 100 Group, whose views are backed by the Investor Relations Society, continues to oppose the viability statement, although it “absolutely recognise[s] the importance of transparent and meaningful disclosure of risks”.
“In our view, this can be best achieved through promotion of best-practice examples and not a regulatory change and will not result in a material improvement in the reader’s understanding of the viability of a business,” the body that represents FTSE 100 FDs says in its response.
“All preparers we have spoken to will cross-reference the risk section so readers understand any viability statement must be caveated [sic] by these risks as a minimum.”
Similar sentiments were expressed by BAE Systems, Capita and the Confederation of British Industry (CBI), particularly on the issue of whether the viability statement would be meaningful for investors. The business lobby group says it considers strategic reporting, non-financial reporting and additional disclosure of principal risks requirements as laying the groundwork for “meaningful engagement between companies and shareholders on the factors that will support long-term success”.
While the CBI agrees with the FRC’s concession to allow boards to set the timeframe to which the viability statement applies, Capita opposes this and the requirement for a viability statement. It argues the unpredictability of business and economic risks make it “natural for any company to adopt a very conservative outlook”, adding: “We are not convinced that this new requirement is necessary, advisable or that it will produce any benefit.”
Despite repeated assurance that directors would still receive protection from the safe-harbour provisions of the Companies Act, a number of respondents, including Barclays, cite concerns over the legal position of directors if their assessment of viability should be proved wrong. As a result, the bank shares GC100’s view that statements could have so many caveats that there is no value in their assertions.
Investor reaction to the FRC’s latest iteration of going concern is more positive than that given earlier in the year. But many respondents remain far from satisifed. In a letter to the Financial Times, nine of the UK’s most prominent shareholder representatives criticised the reporting watchdog’s plans to water down the ongoing viability statement.
And the tension between corporate wants and investor needs is evident, with some shareholder representatives saying the proposals do not go far enough.
Hermes Equity Ownership Services (EOS) agrees with clarifying the meaning of going concern and says the code “provides the elements for this framework”. However, it adds that companies’ intent and approach will be a crucial influence on the statements they produce.
“Those companies that decide to engage with the process will produce meaningful and useful disclosures, and those that don’t will more likely resort to bland, legalistic boilerplate,” it says. “Ultimately, poor viability disclosures will reflect poorly on the board, which then becomes an issue of competency rather than disclosure. It is for owners of companies to take a view on the quality of the disclosures and assess whether they reflect well on the process or not.”
The Association of British Insurers (ABI) finds the argument for retiring the use of going concern in the wider context of viability “disappointing”. It says: “Companies had not applied the appropriate meaning and assessment of going concern for a long time, instead deferring to the IFRS going concern basis of accounting. The accommodation of this by proposing two distinct versions of going concern has caused confusion: we have had to bifurcate a term of art.”
Some of the strongest criticism of the FRC’s proposals comes from Threadneedle Investments, with head of governance and responsible investment Iain Richards saying the asset manager does not “consider that the substance of investors’ concerns and feedback have been effectively taken on board or recognised”.
“Not least this includes the fact that making the viability opinion and assurance a subset of risk management is not appropriate,” he says. “The continued limitations and hedging in the wording materially weaken its quality and perceived value and effectiveness.”
Put it to bed
In addition to improving going concern and risk control at home, the Sharman review tasked the FRC with pushing its agenda abroad. This has proved “something of a struggle”, according to the watchdog’s chief executive Stephen Haddrill.
Appearing at a House of Lords Economic Affairs Committee hearing with FRC chairman Sir Win Bischoff in July, Haddrill said discussions with the International Accounting Standards Board (IASB) to raise the bar for going concern statements “haven’t really made any process”.
Responding to the comments, an IASB spokesperson said the organisation appreciates the input it receives from the FRC, through comment letters, the ASAF and other forums. But it added: “Developing a global standard means that we also need to listen to the views of the more than 100 countries that now mandate the use of IFRS, and those views are not always consistent.”
It could be said that attempting to influence the international accounting standards at a time when there is still uncertainty over the UK’s approach to going concern is ambitious, particularly as it is clear the 2011 inquiry has cast a long shadow over the watchdog, both in time and resources.
Its work on the proposals contributed to an 8.5% hike in levy rates for the 2013/2014 year, in order to fund additional resource. An additional 12 full-time staff members were taken on – going concern was one of four projects to benefit from extra workers.
Haddrill acknowledged at the hearing that respondents to the consultation are also keen to draw the matter to a close. He said: “I think companies are saying, ‘Can you please get on with it? After three consultations, it would be nice if you put this to bed.’”
The FRC hopes to make a statement regarding its final proposals mid-September, leaving little to no time to amend them before the UK Corporate Governance Code comes into effect on 1 October, but it seems the current position is untenable for major players on both sides of the business fence. Time will tell whether the FRC’s work on going concern is truly a Sisyphean task or it can bury the boulder.