Ashurst Governance and Compliance Update - Issue 22

1.  FRC Position Paper sets out its plan to support reform programme

The Financial Reporting Council has published a Position Paper setting out the actions it proposes to take in support of the government's reform of the UK audit and corporate governance framework. By way of reminder, in June 2022 the Department of Business, Energy & Industrial Strategy published its response to the consultation it launched in its March 2021 White Paper.

The Position Paper sets out five broad areas of focus as the FRC transitions to becoming ARGA: The Audit, Reporting and Governance Authority. These are:

• Revisions and additions to its existing suite of Codes, Standards and Guidance to implement reforms.
• The development of new standards 'in shadow form' to allow for voluntary adoption ahead of legislation – for example, minimum standards for Audit Committees.
• Setting expectations for the markets regulated by the FRC to drive behavioural changes ahead of statutory powers coming into effect. This follows the approach the FRC has taken regarding the operational separation of audit practices in the largest UK audit firms.
• The development of guidance to address issues set out in the government response, subject to that guidance meeting the bar set by Sir John Kingman – i.e. that the FRC should be sparing in its issuance of guidance and should focus on those areas where it has expertise.
• Setting high-level expectations around the future supervision and monitoring activities which will flow from the proposed revisions to existing Codes, Standards and Guidance and any additions to that suite of documents.

Of relevance here, the paper covers proposed reforms affecting corporate governance and stewardship, corporate reporting and audit. It also sets out how the FRC will incorporate developments in international standard setting into the reforms, such that it only has to amend each Code, Standard or piece of Guidance once. This, it acknowledges, will require complex sequencing.

Corporate governance and stewardship

The focus of revisions to the UK Corporate Governance Code will be as follows:

• Providing additional support in existing Code Provisions where reporting is currently weaker, taking account of issues raised in recent FRC research and reports, as outlined in the FRC's most recent annual report on the use of the Code and its most recent Culture report.
• Revising those parts of the Code which deal with the need for a framework of prudent and effective controls to provide a stronger basis for reporting on, and evidencing the effectiveness of, internal control around the financial reporting process.
• Making necessary revisions to reflect the wider responsibilities of the Board and Audit Committee for expanded sustainability and ESG reporting and, where commissioned by the company, appropriate assurance in accordance with a company’s 'Audit and Assurance Policy'.
• Including a Provision for boards to consider how audit tendering undertaken by the company takes account of the need to expand market diversity.
• Updating the Code to ensure that it covers proposed changes to legal and regulatory requirements, including strengthening reporting on malus and clawback arrangements.

The revised Code will be supported by updates to the three principal guidance documents which accompany it, namely the FRC's Guidance on Audit Committees and its Guidance on Board Effectiveness as well as its Guidance on Risk Management, Internal Control and Related Financial and Business Reporting which will be amended to take account of changes required to Code Principles and Provisions in relation to internal control and its effectiveness.

As stated above, the FRC will also develop for use, initially applicable on a voluntary basis, a set of minimum standards for audit committees, setting out expectations on how they should work to address the issues raised by the Competition and Markets Authority in its 2019 Statutory audit services market study. To that end, the FRC will hold round table discussions with stakeholders in the second half of 2022 to develop these standards, so they are available for 2023 financial year ends. Where possible these standards will consolidate various pieces of existing guidance and provide a single source of information. These standards will also address how audit committees can support greater market resilience and diversity when tendering for audit services ahead of legislation requiring them to do so. Supervision against the standards is expected to commence in 2024, again subject to legislation.

Ultimately the FRC's intention is that the revised UK Corporate Governance Code will apply to accounting periods commencing on or after 1 January 2024 to allow for sufficient implementation time. In turn this means the FRC intends to consult on a revised Code and supporting material from Q1 2023.

Note that the FRC are not proposing further revisions to the Stewardship Code in this period.

Corporate reporting

Various reforms in this area will require either primary or secondary legislation. The FRC intends to play its part by developing 'implementation guidance' ahead of that legislation in relation to:

• The Resilience Statement* (which will subsume going concern reporting and viability statements currently required by the Code).
• The reporting of measures taken by directors to combat fraud.
• The Audit and Assurance Policy* and related disclosure requirements.
• Capital maintenance and dividends reporting*, including in relation to distributable profits, which will succeed guidance issued by the ICAEW/ICAS.

Items asterisked will also be the subject of FRC projects to assist in the development of the new reporting requirements themselves.

The FRC's Guidance on the Strategic Report will be revised but only once the government has set out its policy on the use of international sustainability disclosure standards. Indeed, the FRC takes the opportunity to voice its strong support for the work of the International Sustainability Standards Board in seeking to develop a global baseline for sustainability reporting.

Subject to the extension of the FRC's Corporate Reporting Review powers to cover the entirety of the annual report, the FRC intends to include new reporting disclosures in its review processes from the date on which any new reporting requirements come into force. It also intends to expand its 'What Makes a Good…' series to include 'What Makes a Good Annual Report and Accounts' and to continue to publish case outcomes of reporting reviews on a quarterly basis, including references to any findings related to non-financial disclosures where appropriate.

Audit

As noted in the government's response, the scope of an audit will remain unchanged. Nevertheless, the FRC intends to consult on changes to address some of the policy issues raised through revisions to standards, including revisions to the FRC's Ethical Standard.

In overview, in this area of the reform package, the FRC propose:

• Significant revisions to the Ethical Standard, not least to reflect the expanded definition of a Public Interest Entity. It aims to consult on a revised standard in Q1 2023.
• Revisions to several ISAs.
• New performance standards to support a consistent approach on assuring internal controls reporting and the Resilience Statement.
• A new policy paper on the proposed market resilience and competition objective for ARGA.
• A new PIE auditor registration process (from Autumn 2022).
• Improvements to audit qualification, training and skills.

We will, of course, issue further updates as consultations and other implementing measures are published.

Ashurst comment: The Position Paper lays bare the careful planning that various organisations will need to undertake to ensure that the reform package is delivered in a structured and coherent manner. It also highlights the volume of additional material directors and governance teams will need to assimilate should they be at the sharp end of the reforms.

2.  Economic Crime and Transparency: Verification requirements regulations published

We reported in AGC update, Issue 15 that the Economic Crime (Transparency and Enforcement) Act 2022 had been fast-tracked through Parliament in part as a response to the invasion of Ukraine. The Act will require entities incorporated overseas and which hold certain types of real estate in the UK to register with Companies House, providing details of beneficial owners with significant influence or control and certain managing officers and trusts. Information supplied by a relevant entity will need to be verified and updated annually. It will be a criminal offence for a relevant entity not to register. In AGC update, Issue 21, we reported that draft regulations implementing aspects of the new register of overseas entities had been issued.

By way of update, the Register of Overseas Entities (Verification and Provision of Information) Regulations 2022 have now been published. These regulations stipulate that an entity cannot register with Companies House unless details relating to its ownership and managing officers have first been verified by a 'relevant person'. A 'relevant person' is defined by reference to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 and includes credit and financial institutions, auditors, insolvency practitioners, external accountants, tax advisers, independent legal professionals, trust or company service providers, estate agents and letting agents.

We will publish further updates as and when further implementing legislation is published and the commencement date for the regime is determined.

3.  Integrating ESG in UK debt capital markets

The Financial Conduct Authority has published a Feedback Statement (FS 22/4) which summarises the responses it received to the 'discussion chapter' it included in CP 21/18 and which looked at the integration of ESG-related matters in UK debt capital markets. Specifically, this asked for feedback on the potential harms that may require policy intervention and on actions the FCA could take to enhance market effectiveness and promote a sound ESG data 'ecosystem'. It sought views on issues related to green, social, sustainability and sustainability-linked debt instruments (ESG-labelled debt instruments), including:

• prospectus and ‘use of proceeds’ ('UoP') bond frameworks;
• the role of verifiers and second party opinion or 'SPO' providers; and
• ESG data and rating providers.

The FCA has also published Primary Market Bulletin 41 which expands on the FCA's response to feedback in relation to listed ESG-labelled debt instruments.

In FS 22/4 the FCA states that it intends to take a measured approach to listed ESG-labelled debt with the aim of setting clear parameters in a growing market. In PMB 41, the FCA:

• encourages issuers of ESG-labelled UoP debt instruments to consider voluntarily applying relevant industry standards such as the Principles and Guidelines that the International Capital Market Association has developed for green, social and sustainability bonds;
• reminds debt issuers, their advisers and others of their existing obligation to ensure that any advertisement is not inaccurate or misleading, and consistent with the information contained in any prospectus; and
• encourages issuers and their advisers to consider verifiers' and assurance providers' expertise and professional standards in relation to ESG information.

FS 22/4 and PMB 41 also clarify the FCA’s views on current practice in debt markets and potential future regulatory action in relation to ESG data and rating providers.

4.  Revised UK Stewardship Code lauded by asset managers and owners

By way of reminder, the revised UK Stewardship Code took effect on 1 January 2020 following the FRC's recognition that improvements were needed so that better information on stewardship practices could reach the public domain. The FRC has recently published a report presenting findings from independent researchers who sought to understand current stewardship practices and evaluate the impact of the revised Code on those practices. In summary, asset managers and owners provided positive feedback on the Code and how it encourages qualitative reporting.

Survey respondents also described the steps they have taken, including in relation to governance arrangements, hiring and research budgets, and upgrading of their reporting and data collection. All organisations in the research sample reported organisational restructuring had been undertaken to better integrate stewardship within their investment decision-making, as required by the revised Code. More than three quarters of asset managers surveyed felt that engagement between investors and issuers has improved due to the Code. In terms of areas for future improvement, respondents noted the need for more guidance and feedback as well as the need for better alignment of various frameworks that signatories may opt to adhere to.

The research was carried out via an anonymous online survey as well as through semi-structured interviews with asset owners and asset managers who had applied to become signatories to the Code.

Ashurst comment: The positive sentiment among market participants is an encouraging early sign, though we note that the methodology may skew results towards participants who are proactive and more highly-engaged.