New narrative reporting requirements
04 / 07 / 2018
In June 2018 the UK government laid The Companies (Miscellaneous Reporting) Regulations 2018 (the new reporting regulations) before parliament and also published Q&A guidance. Upon being approved under the affirmative procedure, the new reporting regulations will apply to company reporting on financial years starting on or after 1 January 2019. Not all companies are within the scope, which is, unhelpfully, based on a new set of criteria which are different to the SME test. The new reporting regulations amend the reporting requirements in Part 15 of the Companies Act 2006 (2006 Act) and the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008.
The new reporting regulations address two limbs of the government’s corporate governance reform plans, namely:
- the promotion of good corporate governance by requiring companies to explain how their directors have had regard to the matters in section 172 of the 2006 Act, and
- requiring companies to report certain pay ratios, thereby keeping the issue of executive pay in the spotlight.
The third corporate governance limb relates to requiring a corporate governance standard for large private companies which is specifically considered in the following article ‘New Corporate Governance Standards for Private Companies’. The proposal for workers on boards which was, somewhat surprisingly, suggested by Theresa May, has been quietly shelved.
Section 172(1) statement
Section 172 of the 2006 Act stipulates the general duty of directors is to promote the success of the company for the benefit of its members as a whole. However, the relevant section does not stop there, but continues to state that, in so doing, the directors must have regard to the interests of other relevant stakeholders, such as the company’s employees, suppliers, customers and others. The creators of Companies Act 2006 were very astute in how this statement both reflected the old common law position and moved the law forward. The “stakeholder factors” are not a secondary limb, but part of the lens through which the efforts of directors should be focused. However, this is poorly understood, indeed, including by government.
The government had a stated aim to “strengthen the voice of employees and other stakeholders” and, to that end, the new reporting regulations have created new narrative reporting requirements on the fulfillment of this duty, depending on whether a company falls within scope based on size and number of employees. New specific statements are required (1) in the strategic report describing how the directors have had regard to the matters in sec 172(1)(a)-(f) of the 2006 Act (the section 172(1) statement) and (2) in the directors‘ report describing how they have engaged with suppliers, customers and others in a business relationship with the company for all companies, (whether private or public, quoted or unquoted) ) which satisfy two of three criteria:
- turnover of more than £36m;
- balance sheet total of more than £18m;
- more than 250 employees.
The analysis is required in an individual company basis.
In addition, there is a specific requirement for a statement within the directors‘ report of quoted companies as to how directors have engaged with employees and taken account of their interests applies to any company with more than 250 UK employees, regardless of turnover and balance sheet total.
There may be some overlap in the case of companies with more than 250 employees which will be required to make statements in both the strategic report and the directors‘ report regarding employee engagement, and unquoted companies will now also be required to publish the section 172(1) statement on a website.
Companies in scope will need guidance in addition to what is contained in the Q&A as to what information they should include in their section 172(1) statement. The Financial Reporting Council is due to include such guidance when it revises its Guidance on the Strategic Report, and ICSA: The Governance Institute will, with the Investment Association set out practical ways in which companies can engage with their employees and other stakeholders in an update to prior guidance on stakeholder engagement.
We at Wedlake Bell are powerful advocates of good governance. However, these measures are the latest example of undeveloped and reactive policy making by government. The government remains too eager to create new measures and bind business with further ministerial red tape rather than work with the systems already in place. As previously noted, there seems to have been a wide misunderstanding of what section 172(1) of the 2006 Act actually states, but rather than engaging in a process to turn hearts and minds to support deeper understanding the government feels the need to create a fresh measure.
The real problem with this is that there is total duplication with section 414C of the 2006 Act (in effect since 1 October 2013) which already requires a strategic report to inform members of the company and help them assess how the directors have performed their duty under all of section 172 of the 2006 Act!
Do you even remember the promise from 2010 of “one in two out” for regulatory measures? That commitment has been long forgotten by government and was quietly buried with the end of the 2010-2015 coalition government. Business now has a Brexit deluge to look forward to over the coming six months where it will need to process 1,800 or so fresh statutory instruments.
As regards executive pay, quoted companies with more than 250 UK employees will be required to publish the ratio of their CEO’s total remuneration to the 25th, 50th and 75th percentile full-time equivalent remuneration of their UK employees in the directors‘ remuneration report, and all quoted companies will have to illustrate the effect of future share price increases on executive pay outcomes. Please note that these requirements do not apply to AIM companies.