DIRECTORS must give shareholders a more detailed account of the potential risks facing their companies under new controversial going concern requirements issued by the FRC, which are unlikely to appease investors critical of the reporting watchdog’s original plans.
The FRC today confirmed proposals for boards to include a ‘viability statement’ in the strategic report to investors as part of wider changes to the UK corporate governance code intended to improve the quality of information investors receive about the long-term health and strategy of listed companies.
The viability statement – a key feature of the FRC’s guidance on going concern – will provide an improved and broader assessment of long-term solvency and liquidity, and is expected to look forward “significantly longer” than the 12 months traditionally associated with going concern statements.
Under the changes, companies are required to state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks, and specify the period covered by this statement and why they consider it appropriate.
“Recognising the different circumstances business, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business. Crucially the directors should explain their reasoning to investors,” said Stephen Haddrill, CEO of the FRC.
However, investors are unlikely to be satisfied with the FRC’s final guidance – which is unchanged following the regulator’s most recent consultation on its controversial attempts to implement Lord Sharman’s guidance on going concern. Lord Sharman’s original recommendations, published in 2012, called for a more broad-based going concern assessment that takes into account solvency as well as liquidity risks, received widespread support from the profession.
In July, a group of top investors including Royal London Asset Management (RLAM), Legal & General Investment Management (LGIM) and the Local Authority Pension Fund Forum (LAPFF), warned that the FRC’s changes to going concern would be “damaging to the public interest” if implemented.
In a letter to the Financial Times, the investors accused the regulator of “perversely” proposing changes to the longer-term viability statement that “run contrary” to the aims of the Sharman Review.
They said: “Ensuring that directors of a company make a positive assertion to those providing capital about the business’s solvency is surely the least one might expect. However, the FRC’s proposal to amend the going concern statement has stirred up heated debate, with directors and audit firms arguing that it is not reasonable to expect them to offer a commitment on the future solvency of the business.
“We disagree with the FRC proposal. The directors’ obligations – and ultimately their accountability – to shareholders, revolve around just this commitment.”
Some of the strongest criticism of the FRC’s final consultation proposals came from Threadneedle. Head of governance and responsible investment Iain Richards claimed the substance of investors’ concerns and feedback had effectively not been 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 said at the time. “The continued limitations and hedging in the wording materially weaken its quality and perceived value and effectiveness.”
The FRC’s final position, which also forces companies to monitor their risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report, is still a compromise between investor demands and corporate wants. Investors have pushed for a longer timescale of solvency and assurance, while businesses hav been reticent to go beyond the longstanding 12-month view.
Nevertheless, implementing the new code will present “really big challenges for boards” according to ICAEW. Robert Hodgkinson, executive director at the accounting institute said: “There are two main challenges they face. Firstly, to work out what they need to change in their risk management and reporting to satisfy the new guidance.
“Secondly, they will need to decide over what period they consider their company to be viable so they can be ready to issue their new viability statement. In looking at this, they will want to think about what their other companies in their sector are doing and what their shareholders will expect.”
The updated code also incorporates changes to remuneration. Greater emphasis must be placed on ensuring that remuneration policies are designed with the long-term success of the company in mind, and that the lead responsibility for doing so rests with the remuneration committee; and companies should put in place arrangements that will enable them to recover or withhold variable pay when appropriate to do so, and should consider appropriate vesting and holding periods for deferred remuneration.
Hodgkinson added: “The level of interest in executive pay remains high among shareholders and the public. Government recently introduced new regulations to enhance shareholder engagement and disclosure by companies. The changes to the code announced today are broadly in line with those, linking pay to long-term performance rather than to its role in attracting and retaining talent.
The revised code will apply to accounting periods beginning on or after 1 October 2014.