Included in this issue of our Governance & Compliance Update: FRC updates governance and reporting guidance to cover Interim Reports; Law Society publishes guidance on virtual execution and e-signatures and more

FRC updates governance and reporting guidance to cover Interim Reports

The Financial Reporting Council (FRC) has published updated guidance for companies on Corporate governance and reporting to include Interim Reports.

The FRC's view is that:

  • Directors will need to exercise judgement about the nature and extent of the procedures that they apply to assess the going concern assumption at half-year. This might include disclosures of:
    • any material uncertainties to going concern;
    • assumptions made about the future path of COVID-19 and public health responses;
    • the projected impact on business activities;
    • use of government support measures; and
    • access to bank and other financing.
  • Issues which might trigger a need to re-examine the going concern assumption and going concern and liquidity risk disclosures include:
    • a significant adverse variation in operating cash flows between prior budgets and forecasts and the outturn in the first half of the year;
    • a significant reduction in projected revenues for the second half of the year based on plausible scenarios for the COVID-19 pandemic and public health responses, and taking into account government support measures;
    • a failure to obtain renewal or extension of committed financing facilities; and
    • a failure to sell capital assets for their expected amounts or within previously forecast time-frames.
  • If going concern has become a significant issue since the previous annual financial statements, directors should undertake procedures similar to those that they would have carried out for annual financial statements to ensure that all relevant issues have been identified and considered.
  • Noting that it is not a legal or regulatory requirement, it is a matter for a company to decide whether to engage their auditors to perform an interim review engagement.

FRC publishes study of audit quality indicators

The FRC has published a review of the use of tools to flag signs of poor quality audits, encouraging more effective use of them in order that timely corrective action can be taken.

The FRC examined how audit firms are using audit quality indicators (AQIs) and assessed their benefits. Across the largest six firms, it found:

  • monitoring of AQIs is an important foundation for initiating actions and interventions to improve audit quality; and
  • firms must focus on forward-looking and granular AQIs to ensure they are identifying early interventions which could prevent deficiencies in audits.

The FRC also assessed the breadth of AQIs reported publicly by UK firms in their annual Transparency Reports as well as their use by Audit Committee Chairs and investors and, in doing so, identified areas in which the public reporting of AQIs requires improvement:

  • AQIs reported in the UK are concentrated on five areas whilst other countries require firms to report on eight or more;
  • publicly-reported AQIs are not easily accessible or comparable across firms; and
  • few Audit Committee Chairs and investors were aware of published AQIs.

The FRC believes there is merit in exploring whether, following the model used in other countries, audit teams should report AQIs specific to individual audits direct to Audit Committees, not least to assist Committees in assessing the effectiveness of the external auditor. The FRC plans to consult publicly on proposed standards for disclosure of AQIs by UK firms in due course.

Glass Lewis publishes guidance on its approach to COVID-19

Glass Lewis has published its views on how COVID-19 will impact on governance and broader ESG issues now and in future.

As an immediate response, Glass Lewis updated its virtual meetings policy to give the market certainty about its support for such meetings, and has continued to update its guidance, including as to the timing and format of shareholder meetings.

Highlights from the statement include Glass Lewis' contextual approach and intended use of "discretion" and "pragmatism" when evaluating company performance and:

  • its expectation that all governance issues and most proposal types will be impacted by the pandemic, including through to 2021;
  • its expectation that there will be: a significant number of amendments to existing remuneration plans; "crocodile tears" for maintaining or even increasing executive compensation levels; and substantial adjustments to equity compensation plan proposals;
  • its belief that there will be a "marked increase in shareholder concerns on re-pricing, dilution, burn rates, hurdle adjustments, changes to vesting periods, caps and cuts on incentives, and the quality of disclosure concerning the limits and exercise of board discretion. Companies with strong pay structures will be challenged to abide by them, and firms with less robust programs will be forced to choose between lying in the bed they’ve made or changing arrangements and all but guaranteeing shareholder ire";
  • its view, as regards balance sheet and capital management, that there will be widespread pausing of buyback programmes, the suspension of dividends and an increase in capital raisings. In that context, Glass Lewis believes that some companies will need more flexibility to carry out capital raisings than shareholders are used to;
  • its expectation of an increased amount of "shareholder activism, M&A, lawsuits and consolidation as macro conditions improved"; and
  • its view that a lack of gender and/or age diversity on boards potentially creates systemic risk given the profile of those most seriously affected by COVID-19. In the short term, Glass Lewis expects this to manifest itself in reduced attendance rates with directors, particularly those over-committed, reducing their board seats as the crisis increases demands on their capacity. This will be an important test of succession and board refreshment programmes, with "the ability of boards and management to successfully navigate the crisis and outperform their competitors" set to highlight the "stark differences in the effectiveness of boards, directors and their governance structures".

Guidance published to assist with TCFD reporting

The Climate Disclosure Standards Board (CDBS) and the CPD (formerly the Carbon Disclosure Project (CDP)) have published a document which purports to contain the "building blocks" for disclosures using CDP data and the CDSB Framework which are aligned with the Task Force on Climate-related Financial Disclosures (TCFD) methodology.

The guidance itself also notes that CDSB, in collaboration with TCFD, has developed the TCFD Knowledge Hub. This provides the latest tools, resources, case studies and insights to help organisations implement the TCFD Recommendations. It also hosts the CDSB's online courses, which are designed for those seeking to increase their understanding of climate-related financial disclosures.

ESMA undertakes consultation on SME Growth Markets and MAR technical standards

The European Securities and Markets Authority (ESMA) has published a consultation on the functioning of the small and medium enterprises (SME) growth market regime. By way of reminder, both AIM and The AQSE Growth Market (formerly the NEX Growth Market) have SME growth market "status" in the UK. ESMA has also published two draft technical standards precipitated by the amendments to the EU Market Abuse Regulation (MAR) intended to promote the use of SME growth markets. The consultation closes on 15 July 2020.

The consultation paper:

  • sets out an assessment of the state of play of the SME growth markets regime in the EU and asks for stakeholders’ views on the amendments proposed;
  • seeks stakeholders’ input and proposals on suggested initiatives to improve the attractiveness of the SME growth markets regime; and
  • presents ESMA’s proposals for MAR-compliant liquidity contracts and lighter touch requirements as regards the format and content of the insider lists.

ESMA plans to publish its final conclusions towards the end of the year. Clearly their implementation in the UK will be Brexit dependent.

Law Society publishes guidance on virtual execution and e-signatures

The Law Society has published guidance on the use of virtual execution and e-signatures during the COVID-19 pandemic. It sets out:

  • a statement of the law;
  • views as to best practice; and
  • suggestions as to how contracts may be entered into in an effective manner, where it is not possible to follow what is otherwise understood to be best practice.