This review of the Companies Act 2006 (Strategic Report and Directors Report) Regulations 2013, requires narrative information to be presented in a way that allows companies to “tell their story” to investors concisely and provide a holistic and meaningful picture of an entity’s business model, strategy, development, performance, position and future prospects.
This narrative content should also link related information as well as providing this material in a fair, balanced and understandable way.
Two years on, this article explores where and how companies have progressed in their journeys with these requirements, as well as discussing what’s left to do in order to make this reporting truly user-friendly and effective for investors.
The strategic reports published by the larger listed companies (FTSE 350), in the first year following the review were, by and large, disappointing.
Few companies had given the purpose of the strategic report serious thought with most simply rehashing the front end of their previous annual reports and labelling it a “strategic report”.
A few, 14%, met all the requirements but the less ambitious companies prefaced their existing business and financial and operational reviews with short strategic reports and then signposted readers to relevant information disclosed elsewhere so as to fill any gaps in understanding.
The least impressive provided a “dog’s breakfast” approach to the strategic report where the former financial, operational and CSR reports were all bundled together, leaving the reader to discern what was of importance and how all these aspects related to one another.
A year further along the journey and companies have progressed their reporting of the strategic review.
The consequence is that the front end of the annual reports is getting longer, and the strategic report as a contributor is now averaging just below 43 pages versus 40 pages for the previous year.
The narrative business model descriptions are becoming more comprehensive with 73% of FTSE 350 companies providing good and detailed explanations versus 61% for the previous year.
While the business model part of the report has shown signs of considerable effort being made by those responsible for preparing the annual reports, other parts of the strategic report are lagging behind.
Anecdotally, we hear that making any meaningful improvement in reporting is not an easy process, and it is as closely linked to the time availability and willingness of management to make these changes as the quality of the internal information itself.
Most companies are comfortable providing comprehensive and informative descriptions of their performance throughout the year and at the year end. This is a long-standing requirement of financial reporting.
But when it comes to looking forward rather than backward, here the challenges start to rear their heads.
In 2014 only 43% of companies gave a helpful description of their planned future development, with less than 40% illustrating how their strategy, key performance indicators and risks interrelate.
The introduction of the viability statement (2014 UK Corporate Governance Code) at the end of this year will be a step towards addressing this issue, as it will require companies to demonstrate the link between strategy, operations and risk.
A handful of early adopters among the FTSE 350 have chosen to report viability statements already, giving an indication of what is to come. The majority of the FTSE 350 are keenly awaiting the September year-end reporting, as they will be the first to report formally under the new guidance.
Already there are differences in approach, with the more successful reporters making clear the links between the viability statement and the principal risk disclosures, without duplicating information.
A strong topic of debate has been the period over which these reports should look. The FRC has steadfastly declined to provide guidance.
The initial indications are that the favoured period will be three to five years, but this may be challenged once the utility companies with their longer investment horizons start to report in the new year.
Risk and disclosures
The integration of the impact of risks and their disclosures are worthy of closer inspection, as they bring into stark relief the potential reporting difficulties for company viability statements.
In analysing 2014’s FTSE 350 reporting, there were some rather alarming results, with 30% of companies not making any updates to the principal risks compared with the previous year’s annual report. Furthermore, the risk disclosures were rated as “general” or “weak” for one-third of the companies.
There was a slight improvement in 2015, with 27% of companies not making any updates to their principal risk registers and 25% of companies reporting “detailed” risk and uncertainties (versus 18% in 2014).
The 2014 Code also placed greater emphasis on the need to give more detailed information as to mitigating actions, challenging the boards to provide more insightful explanations of how the company addresses significant risks to the business through the year.
It is worrying, therefore, to find that 6% of FTSE 350 companies did not provide any mitigating actions for the principal risks facing their businesses in their 2015 annual reports.
Long way to go
For many companies there is a long way to go before they are seen to truly embrace the principles behind the strategic reports, namely increased transparency.
Demonstrating a coherent and contextualised approach to “live” risk-management processes, business planning as well as longer term views on strategy and business viability, remain laudable objectives.
If management doesn’t buy into the principle, then reports will continue to grow in length but investors will be none the wiser.
Ahead of the next reporting season, companies should therefore dedicate the time and thought necessary to ensure that their reporting will address the growing expectations of investors and shareholders, and in doing so, help them to stand out from the crowd.
Claire Fargeot is a consultant in investor relations, Grant Thornton Governance Institute.