Included in this issue of our Governance & Compliance Update: Investment Association statement on gender diversity and executive pensions; FRC consultation on stronger going concern standard for auditors; FRC publishes draft Plan and Budget 2019/20 and more...
Investment Association publishes statement on gender diversity and executive pensions
The Investment Association (IA) has announced that it will use its Institutional Voting Information Service (IVIS) in the 2019 AGM season to highlight companies 'who are lagging behind on diversity, or pay pension contributions to executives at rates above the majority of the workforce'. Under the new policy, IVIS will 'red-top' companies which:
- have no women or only one woman on their board; and / or
- pay newly-appointed directors pension contributions which are not in line with the majority of their employees.
By way of reminder, a 'red-top' represents the highest level of warning that IVIS issues and is reserved for companies where, in its opinion, shareholders should have the 'most significant and serious concerns'. IVIS will also issue an 'amber-top' (the second highest warning) to companies not on course to meet the requirements of the Hampton-Alexander review, for 33 per cent. of women on their board by 2020. IVIS will also highlight any board with women representing 25 per cent. or less.
More recently, the IA and the Hampton-Alexander Review has written to 69 FTSE 350 companies which have no or only one woman on their board outlining concerns about gender diversity and seeking clarification of the action those companies intend to take to address the issue.
FRC publishes consultation on stronger going concern standard for auditors
The Financial Reporting Council (FRC) has published a consultation on revisions to the International Standard on Auditing (ISA) (UK) 570 - Going Concern. This proposes to increase the work required of auditors when assessing whether an entity is a going concern and impose requirements on UK auditors which are 'significantly stronger' than those required by international standards.
The FRC proposes:
- auditors make greater effort to more robustly challenge management’s assessment of going concern, thoroughly test the adequacy of the supporting evidence, evaluate the risk of management bias, and make greater use of the viability statement (on which, see the next item below);
- improved transparency with a new reporting requirement for the auditor to provide a conclusion on whether management’s assessment is appropriate, and to set out the work it has done in this respect; and
- a stand back requirement to consider all of the evidence obtained, whether corroborative or contradictory, when the auditor draws its conclusions on going concern.
The consultation closes on Friday 14 June 2019.
FRC publishes draft Plan and Budget 2019/20
The FRC has published for consultation its draft plan and budget for 2019 / 2020 which sets out its priorities for the year and the resources it will need. Strategic priorities include:
- supporting the transition from the FRC to the new Audit, Reporting and Governance Authority;
- using the FRC's powers to set audit standards and monitor and supervise auditors to drive a step change in audit quality;
- monitor and take action to promote the quality and usefulness of corporate reporting through a programme of corporate reporting reviews which cover the whole annual report; and
- promoting corporate governance and investor stewardship, such as through the proposed new Stewardship Code and monitoring and reporting on early adoption of the revised UK Corporate Governance Code – particularly in areas of stakeholder engagement, culture, chair tenure, nomination committee reporting and remuneration. The FRC also intends to consult on enhancing viability statements and its guidance on Risk Management and Internal Controls.
The consultation closes on 8 May 2019.
BEIS Committee reports on the Future of Audit
The Select Committee for Business, Energy and Industrial Strategy (Committee) has published its report on the future of audit which sets out its proposals to address a 'lack of trust' in the UK audit market. Issues dealt with and recommendations from the report include:
- The audit product
- The detection of fraud must continue to be a priority within audits. Audits should state how potential fraud, including by directors, has been investigated.
- The Brydon Review of the quality and effectiveness of audit should explore how to make audits more forward looking. It should also consider broadening the scope of audit to cover the entire annual report, albeit with different levels of assurance and reporting – 'critical areas' such as corporate governance and payment practices reporting 'ought to be subject to a robust assurance process and meaningful reporting'.
- To assist engagement with shareholders, auditors should make a presentation at the AGM to show how they have challenged management and exercised professional scepticism.
- The FRC should consider requiring companies to publish the audit report at the same time as results are announced.
- Capital maintenance
- The government and FRC should urgently produce a clear, simple and prudent definition of what counts as realised profits for the purposes of distributions – the Committee supports defining realised profits as realised in cash or 'near cash'.
- Companies should be required to disclose the balance of distributable reserves in annual accounts and break down profits between realised and unrealised.
- A solvency-based system should be adopted – where dividends can only be paid when the board is satisfied (and makes a statement to that effect) that the company will, having paid the dividend, still be able to meet its debts as they fall due.
- Separating audit from non-audit
- The Committee believes there is a strong case for independent audit firms and that the economic separation of audit and non-audit is highly desirable. Thus the Committee encourages the Competition and Markets Authority (CMA) to aim for full separation of audit and non-audit services and 'not let one-off, short-term implementation costs weigh too much in its calculations'.
- If an operational split is chosen instead, a review should be undertaken to determine whether the split has ended cross-subsidies and improved culture, independence and transparency.
- Audit fees
- The FRC should require greater reporting on audit fees. Auditors should report instances where they have performed additional procedures but have been unsuccessful in increasing their fee.
- The FRC should also be given more powers over audit fees.
- Ensuring independence, challenge, and professional scepticism
- The Committee is concerned that many audit committees do not appear to be factoring professional scepticism and challenge into their criteria for selecting auditors and instead are using 'cultural fit' as a desirable quality. The Committee is also concerned that committees do not appear to be spending enough time on audit matters.
- If audit quality, choice, resilience and the professional scepticism and independence of auditors remain a problem in future and despite other reforms, the independent appointment of auditors should be considered.
- The CMA should revisit increasing the frequency of audit rotations, which should be reduced to seven year non-renewable terms that can only be terminated in exceptional circumstances.
- "Cooling-off" periods of three years, during which non-audit services could not be sold after an audit engagement had ended, should be considered if a full structural split of audit and non-audit services does not take place, as this would remove a 'major' potential conflict of interest for auditors.
- The regulator should tighten the current rules on hospitality and apply them to prospective audit clients. Audit companies should publish details of all hospitality in full.
- Competition, choice and resilience
- The Committee has reservations about the utility and impact of joint audits. Nevertheless, it recommends that they are piloted in the upper reaches of the FTSE 100 and include a "'Big Four' and a challenger firm. The CMA should draw up proposals for the introduction of a segmented market cap offering challenger firms the chance to take up a proportion of audits across the FTSE 350.
- Due to their strategic importance, the government should examine the auditing of banks to explore whether additional safeguards are required.
- The Committee welcomes the government's acceptance that all company directors, regardless of their professional qualifications, should be accountable for their performance and liable to the regulator's sanctions, including if company reporting falls short of the required standards.
Home Office publishes report on the Modern Slavery Act 2015
The Home Office has published the Second Interim Report from the independent review of the Modern Slavery Act 2015 (2015 Act). The review considers the legal application of the 2015 Act and transparency in supply chains. In particular, it looks at the question of how to ensure compliance with the 2015 Act and improve the quality of statements made in accordance with it.
The report's recommendations include:
- removing the ability for companies to report that they have taken no steps to address modern slavery in their supply chains;
- requiring companies to report on each of the six areas specified in section 54(4) of the 2015 Act – currently there is only an expectation that they will do so;
- including a requirement in the Companies Act 2006 for companies to refer to their modern slavery statement in their annual reports;
- establishing a government-run repository to which companies are required to upload their statements and which should be easily accessible to the public, free of charge. Statements should state clearly the period in relation to which they are being made;
- requiring businesses to have a named, designated board member who is personally accountable for the production of the company's statement. Failure to fulfil reporting requirements or to act when instances of slavery are found should be an offence under the Company Directors Disqualification Act 1986; and
- the government strengthening its approach to tackling non-compliance, adopting a gradual approach to the necessary legislative changes: initial warnings, fines (as a percentage of turnover), court summons and directors disqualification should all be considered.
Government publishes guidance on making a modern slavery statement
The Government has also published guidance for organisations on publishing an annual modern slavery statement.
It includes information on:
- who needs to publish a statement;
- demonstrating compliance with the minimum legal requirements;
- what to include in a modern slavery statement;
- best practice; and
- where to find more resources and guidance, including the Home Office's statutory guidance.
Government publishes revised Environmental Reporting Guidelines updated for SECR regime
The government has published updated Environmental Reporting Guidelines (Guidelines) which are designed to help companies and LLPs comply with their obligations under the new Streamlined Energy and Carbon Reporting (SECR) regime.
The new SECR regime came into force on 1 April 2019 under the Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018 , and will apply in respect of financial years beginning on or after that date.
The updates relate to:
- group reporting legislation;
- public sector reporting requirements; and
- the mandatory greenhouse gas reporting requirement.
For more information, please see our Governance & Compliance update issued at the time of the publication of the first iteration of the Guidelines.
Gender Pay Reporting: Reflecting on Year 1 reports and producing a compelling report next time around
In this first article of a two-part series, Amanda Steadman, Principal Knowledge Lawyer in the Employment, Incentives and Immigration Group, considers the lessons to be learned from the first year of reporting, and in particular from the latest research and guidance, and our experience of guiding clients through the process.
In the second article, Amanda considers how to produce a compelling report and what measures will be most effective in helping close any gender pay gap over the longer term.