Ashurst Governance and Compliance Update Issue 19

1. Queen's Speech contains Audit Reform Bill

The Queen's Speech 2022 has been published. Despite numerous articles in the press to the contrary, an Audit Reform Bill is one of 38 different legislative measures that will make up the agenda for this session of Parliament. The Bill will bring forward legislation based on the government's 2021 'Restoring trust in Audit and Corporate Governance' consultation, feedback on which will be published 'shortly'.

The stated purpose of the draft Bill is to:

• Rebuild trust in the UK’s audit, corporate reporting and corporate governance system and the insolvency regulatory framework.
• Ensure accountability for those with key roles in that system.
• Increase resilience and choice in the statutory audit market – reinforcing the UK’s reputation as a world-leading destination for investment.

The main elements of the draft Bill will:

• Establish the new statutory regulator, by reconstituting the Financial Reporting Council as the Audit, Reporting and Governance Authority and giving ARGA effective powers to enforce directors’ financial reporting duties, supervise corporate reporting, and oversee and regulate the accountancy and actuarial professions.
• Provide new measures to open up the audit market, including a new approach of managed shared audits in which challenger firms undertake a share of the work on large-scale audits.
• Bring the largest private companies in scope of audit regulation by including them in the definition of ‘public interest entities’.
• Reform the regulation of Insolvency Practitioners to give greater confidence to creditors and strengthen corporate governance of firms in or approaching insolvency so that ‘asset stripping’ can be more effectively tackled.

Ashurst comment: 'That the Bill is being brought forward is to be welcomed. Various aspects of the current audit and corporate governance regime are in need of repair and enhancement, not least the audit regulator itself. However, it will be interesting to see the extent to which some of the more controversial proposals have survived, and with ARGA being given powers to enforce certain directors' duties and the introduction of managed shared audits, it is clear that some of them have. What also remains to be seen is the government's appetite for pushing through the reforms given their likely breadth and the amount of Parliamentary and civil service time they will take up as a result'.

Other Bills of note included in the Speech include:

• An Economic Crime and Corporate Transparency Bill which will be brought forward to tackle illicit finance and reduce economic crime and which will enact many of the proposals contained in the government's February 2022 White Paper focused on reforming Companies House. For more detail, see Ashurst Governance & Compliance update, Issue 14.
• A Modern Slavery Bill which will seek to increase the accountability of companies and other organisations to drive out modern slavery from their supply chains. This will include the long-awaited strengthening of the reporting requirements currently set out in section 54 of the Modern Slavery Act 2015 and of application to UK incorporated companies which supply goods or services with a turnover of more than £36m. The Bill will require in scope companies to set out the steps taken to prevent modern slavery in their supply chains, mandate the reporting areas to be covered in such statements, and require relevant companies to publish their statements via a government run registry. It will also introduce civil penalties for organisations which do not comply.

We will issue more detailed updates as policy statements, further consultations and draft legislation is published.

2. FRC research: Modern slavery reporting requires significant improvement

In conjunction with the Anti-Slavery Commissioner and Lancaster University, the Financial Reporting Council has published a review of reporting on modern slavery by UK incorporated main market listed companies, specifically a sample of 100 FTSE 100, FTSE 250, and Smallcap companies.

The review examines reporting practice in modern slavery statements mandated under section 54 of the Modern Slavery Act 2015 (MSA) for 'in scope' companies, being those which supply goods or services with a turnover of more than £36m. It also investigates the extent to which companies are reporting on modern slavery in annual reports as part of their requirement to describe how opportunities and risks to the success of the business have been considered and addressed, with a particular focus on section 172 statements.

By way of reminder:

• As part of its Annual Review of Corporate Governance Reporting 2021, the FRC published findings from research carried out by Lancaster University on the extent to which companies are including modern slavery in their disclosures as part of their responsibility to consider the interests of their stakeholders in their annual report.
• The government published updated guidance: 'Transparency in supply chains: a practical guide' in December 2021 to explain how companies should comply with the MSA reporting requirement.

The review concluded that:

Modern Slavery Act statements

• Overall reporting on modern slavery in both MSA statements produced in accordance with section 54 and in annual reports lacked the information needed for shareholders and wider stakeholders to make informed decisions.
• One in ten companies failed to produce a statement despite it being a requirement of the MSA to do so.
• Where companies did comply, only one third of MSA statements were considered 'clear and easy to read'. The majority were fragmented, lacked a clear focus and narrative, or were unduly complicated. Longer disclosures did not necessarily mean they were more informative; excessively long disclosures often contained boilerplate reporting or were a sign of a poorly structured statement.
• Disclosure of key performance indicators to measure the effectiveness of the steps taken to minimise modern slavery risks was particularly poor. Only a quarter of companies disclosed results against their KPIs and just 12 per cent of companies confirmed that they made informed decisions based on those KPIs.
• Within MSA statements, less than half of companies provided a clear and comprehensive discussion of modern slavery concerns in the context of their organisational structure, operating and supply chains. A similar proportion of companies (46 per cent) described their policies on slavery and human trafficking in an informative manner. Disclosure therefore often lacked detail, failing to provide information on how policies operated in practice, or how their effectiveness was measured.
• Company size, sector and business complexity were found to be important factors influencing the level of transparency in MSA statements. While FTSE 100 companies provided significantly more information in comparison with other size groups, the difference between FTSE 250 companies and Small Caps was much less pronounced. The FRC believes that company-specific issues such as leadership style and corporate culture may be playing a significant role here.
• The vast majority of MSA statements were wholly backward-looking, with only a minority clearly identifying emerging issues or a long-term strategy. This finding is consistent with companies opting for a reactive, rather than proactive, approach to addressing modern slavery risks but, it should be noted, is likely also a legacy of the MSA requirement to report on a company's most recent financial year.
• Although the majority of companies report that they assessed modern slavery risk in their own business and supply chain, less than a third (28 per cent) disclosed an action plan based on the risks identified.

Modern slavery disclosures in annual reports

• In annual reports, reporting on modern slavery was minimal. This suggested that many companies do not view human rights issues in their workforce and supply chain as a principal source of risk. For some companies with positive relationships with suppliers and relatively short supply chains, the FRC feels this is understandable; for others, it might raise questions about whether sufficient attention is being paid to the issue.
• Only 14 per cent of annual reports provided a direct link to the corresponding MSA statement. The FRC believes that the lack of appropriate cross-referencing not only reduces visibility and transparency on modern slavery issues but undermines efforts to address the risks.
• The findings from annual reports were consistent with evidence of 'patchy' reporting on risk assessment and effectiveness in MSA statements, with very few companies referring to performance indicators in the context of modern slavery.
• Relatively few companies reported on internal controls linked to the oversight of human rights and slavery in their annual report. Fewer still provided any information about when and how frequently their modern slavery policies and governance arrangements were reviewed.

3. Supply chain disclosure – FR Lab guidance published

The FRC's Financial Reporting Lab has published its first 'insight' into current market issues in which it sets out guidance for companies in relation to supply chain risks and associated reporting.

The Lab considers that clear and concise disclosures are key for investors. As such investors are likely to look for information that helps them understand:

• the context of the supply chain – i.e. its size and scope, its nature and resilience, the extent to which sustainable procurement practices are embedded, and the impact on current and future operations, reputation, and brand; and
• the impact of supply chain uncertainties, risks and opportunities on long-term value creation and the actions management are taking to address them.

Given those overarching considerations, the Lab then sets out questions and issues which may be useful for companies to consider in preparing their reporting. In summary, the information which investors will find useful will include:

• Access to raw materials and goods: The raw materials and goods that are critical to the business model in the short and medium term, and how the supply chains for these elements have been impacted by global disruptions; the international or local restrictions that might impact a supplier's ability to deliver; to what extent the supply chain is reliant on critical components; the impact of inflationary pressures on the supply chain; and the actions management are taking to actively monitor and manage those risks and consider and plan for longer-term impacts.
• Digital security, outsourcing and weaknesses in infrastructure: The nature and scope of the company’s digital infrastructure and supply chain including where physical components are located and data hosted; how suppliers and the company monitor for and mitigate against potential vulnerabilities; the plans which exist to ensure continuity of hosted services; and the extent to which the digital supply chain is reliant on critical components including the risks they pose.
• Legal, ethical and reputational considerations: How the company assesses its suppliers and owners; how it takes into account potential legal and reputational risks and the mitigations in place; how it monitors ongoing relationships with suppliers, including relying on external parties for verification; and, when changing suppliers, whether the change is consistent with wider business cultural values.

The insight also links to other resources which the FR Lab believe will useful in this context.

4. Consultation launched on EU Sustainability Reporting Standards

The European Financial Reporting Advisory Group (EFRAG) has published a consultation on the draft EU Sustainability Reporting Standards (ESRS).

ESRS will be used by firms required to report under the EU Corporate Sustainability Reporting Directive (CSRD) and which itself will significantly increase the extent of disclosure required under the existing Non-Financial Reporting Directive (NFRD). By way of reminder, it is currently intended that the amended NFRD will apply to a significantly larger constituency of EU incorporated companies including 'large' unquoted companies, potentially catching EU subsidiaries of UK incorporated companies doing business on the continent. It will continue to apply to EU and non-EU issuers of equity or debt securities admitted to EU regulated markets, albeit that it is also proposed that the threshold requirement of 500 employees for such entities will be removed.

The consultation seeks feedback on a first set of exposure drafts which correspond to the first set of standards required under CSRD. These cover environment, social, governance and 'cross-cutting' standards.

Feedback must be submitted by 8 August 2022. EFRAG intends to present the standards to the EU Commission for approval in November. It is envisaged that the CSRD will be finalised and come into force later in 2022, with the new requirements expected to apply in 2023.

For details of other EU sustainability-focused directives which may impact on UK incorporated companies, please see: EU proposed Directive on Corporate Sustainability Due Diligence Reporting.

5. ICAEW updates guidance on disclosure of auditor remuneration

The Institute of Chartered Accountants in England and Wales (ICAEW) has published a revised version (TECH 01/22 FRF) of its guidance on the disclosure of auditor remuneration for the audit of accounts and other non-audit services, in accordance with the requirements of the Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008 as amended.

By way of reminder, the Regulations require companies which are considered 'large' or 'medium-sized' for accounting purposes to disclose any remuneration receivable by their auditor for auditing their accounts. Such disclosures should be made in the notes to the accounts. 'Large' companies must also disclose remuneration receivable by their auditor or an associate of their auditor for non-audit services provided to the company or associates of the company. The guidance itself contains a series of Q&A on these disclosure requirements.

The guidance is substantively unchanged from the previous version, while changes have been made to reflect legal, regulatory and corporate governance developments since December 2013, in particular the fact that, since 2016, small companies are not required to disclose auditor remuneration.

6. FCA publishes final instrument implementing changes to its Handbook

The Financial Conduct Authority has published Handbook Notice 98 in which it deals with various amendments to its Handbook and, in particular:

• Changes to the Disclosure Guidance and Transparency Rules to allow listed companies to use version 2 of the UKSEF taxonomy issued by the Financial Reporting Council when publishing their annual financial reports in a machine-readable and tagged electronic format. The changes apply to reports filed with the FCA's National Storage Mechanism on or after 3 May 2022. For more detail, see Ashurst Governance & Compliance update, Issue 16.
• Changes to the Listing Rules which require companies to publish, on a 'comply or explain' basis, a statement in their annual financial reports on whether they have achieved certain board diversity targets, as well as numerical data in standardised reporting formats on various diversity metrics in relation to their board and senior management. The new rules apply to accounting periods beginning on or after 1 April 2022. For more detail, see Ashurst Governance & Compliance update, Issue 18.

The changes to the FCA Handbook are now in force.