On 28 September 2012, the Financial Reporting Council (“FRC”) announced changes to the UK Corporate Governance Code (the “Code”) intended to increase accountability and engagement through the investment chain.  Key changes to the Code include:

  • FTSE 350 companies are to put their external audit contract out to tender at least every ten years with the aim of ensuring a high quality and effective audit whether from the incumbent auditor or from a different firm;

  • audit committees are to provide to shareholders information on how they have carried out their responsibilities including how they have assessed the effectiveness of the external audit process, the approach taken to the appointment or reappointment of the external auditor and information on the length of tenure of the current audit firm and when a tender was last conducted;

  • boards are to confirm that the annual report and accounts taken as a whole are fair, balanced and understandable to ensure that the narrative sections of the report are consistent with the financial statements and accurately reflect the company’s performance;

  • companies are to report annually on their boardroom diversity policy, including gender, and on any measurable objectives that the board has set for implementing the policy and the progress it has made in achieving those objectives; and

  • companies are to provide fuller explanations to shareholders as to why they choose not to follow a provision of the Code.  The FRC has amended the introductory section of the Code entitled “comply or explain” in order to address the issue of poor quality explanations where a company is deviating from the Code.  The introductory section now contains additional wording requiring companies who are deviating from the Code to (i) set out the background, provide a clear rationale for the action it is taking, and describe any mitigating actions taken to address any additional risk and maintain conformity with the relevant principle; and (ii) where deviation from a particular provision is intended to be limited in time, indicate when the company expects to conform with the provision.  The introductory section is not subject to “comply or explain” and is intended only as background and guidance.  However, the FRC believes that the additional wording will be helpful for companies to understand what is expected of them and for shareholders to have a benchmark against which to assess explanations.

The changes to the Code apply from 1 October 2012 and the FRC has published an updated version of the Code and Guidance for Audit Committees.  The FRC has also published transitional arrangements with respect to the introduction of ten year retendering to ensure it can be introduced without significant disruption.

FINANCIAL REPORTING – INTERNATIONAL STANDARDS ON AUDITING

On 28 September 2012, the FRC issued revised International Standards on Auditing (ISAs) (UK and Ireland).  The changes in the standards are mainly directed at:

  • enhancing auditor communications by requiring the auditor to communicate information that the auditor has obtained in the course of the audit about matters that the auditor believes will be relevant to the board or audit committee in fulfilling their responsibilities; and
  • extending auditor reporting by requiring the auditor to report, by exception, if the board’s statement that the annual report is fair, balanced and understandable is inconsistent with the knowledge acquired by the auditor in the course of performing the audit, or if the matters disclosed in the report from the audit committee do not appropriately address matters communicated by the auditor to the committee.

The revised standards are effective for audits of financial statements for periods commencing on or after 1 October 2012.  The revisions support changes to the Code and Guidance for Audit Committees that have also been issued by the FRC on 28 September 2012.

FINANCIAL REPORTING – AUDIT EXEMPTIONS, ACCOUNTS AND CHANGE OF ACCOUNTING FRAMEWORK

On 11 September 2012, the Department for Business Innovation and Skills published the Companies and Limited Liability Partnerships (Accounts and Audit Exemptions and Change of Accounting Framework) Regulations 2012 (SI 2012/2301) (the “Regulations”).  The Regulations come into force on 1 October 2012 and apply to accounts for financial years ending on or after that date.  The key changes introduced by the Regulations are:

Widening of audit exemption for small companies

The Regulations widen the exemption from audit for small companies to provide that a company only has to meet the general small company criteria for accounts and reports under the Companies Act 2006 (the “Companies Act”) to qualify for the exemption.  To qualify as small in a financial year, a company must, during specified financial periods, meet any two of the following criteria: (i) average headcount less than 50; (ii) turnover not exceeding £6.5 million; and (iii) balance sheet total not exceeding £3.26 million.  The Regulations repeal the previous additional requirement that a company must meet both the criteria as to turnover and balance sheet total even if it also satisfies the average headcount condition.

Exemption from requirement to audit individual accounts for subsidiaries

The Regulations introduce an exemption from the requirement to audit individual accounts for subsidiary companies whose parent undertaking is established under the law of an EEA state.  Various conditions must be satisfied in order for the subsidiary company to qualify for the exemption, in particular the parent undertaking must give a statutory guarantee of the debts and liabilities to which the subsidiary company is subject as at the last day of the financial year in which the subsidiary company is seeking an audit exemption.  Various categories of company are excluded from the exemption including quoted companies, some financial services companies and trade unions and employers’ associations.

Exemption from requirement to prepare individual accounts for dormant companies

The Regulations introduce an exemption for dormant subsidiaries from the requirement to prepare individual accounts and to deliver individual accounts to the registrar.  In order to qualify for both exemptions the company in question must meet the same criteria, and make the same filings, as those required for subsidiary companies who wish to use the audit exemption (see paragraph above entitled Exemption from requirement to audit individual accounts for subsidiaries) including the requirement for a parent undertaking guarantee.  Companies excluded from the exemption include quoted companies, some financial services companies and trade unions and employers’ associations.

Change of accounting framework from international accounting standards to UK Companies Act standards

The Regulations widen the circumstances in which a company (or group), producing accounts in accordance with international accounting standards (“IAS Accounts”) may switch to producing accounts in accordance with the Companies Act (“Companies Act Accounts”).  Provided the company (or group) has not prepared individual Companies Act Accounts (or consolidated Companies Act Accounts, in the case of a group) at any time during the five years preceding the first day of the financial year for which it now wishes to produce Companies Act Accounts, it will be able to switch.  The existing option to switch to Companies Act Accounts following a “relevant change of circumstance” remains.  Relevant changes of circumstances are where:

  • the company becomes a subsidiary undertaking of an undertaking that does not prepare its accounts in accordance with IAS Accounts;
  • in the case of individual accounts only, the company ceases to be a subsidiary undertaking;
  • the company ceases to be a company with securities admitted to trading on a regulated market in an EEA state; or
  • any parent undertaking of the company ceases to be an undertaking with securities admitted to trading on a regulated market in an EEA state.

Audit and accounts exemptions (above) apply to Limited Liability Partnerships

The Regulations amend the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008 to apply to limited liability partnerships the same exemptions from audit and requirements to prepare individual accounts and to deliver individual accounts to the registrar, and the same change in the provisions governing the applicable accounting framework for individual and group accounts, as those introduced by the Regulations in relation to companies (summarised in the paragraphs above entitled Widening of audit exemption for small companies, Exemption from requirement to audit individual accounts for subsidiaries, Exemption from requirement to prepare individual accounts for dormant companies and Change of accounting framework from international accounting standards to UK Companies Act standards).

UK STEWARDSHIP CODE

On 28 September 2012, the FRC announced changes to the UK Stewardship Code (the “Stewardship Code”) intended to increase accountability and engagement through the investment chain.  Changes to the Stewardship Code include:

  • clarification of the respective responsibilities of asset managers and asset owners for stewardship and for stewardship activities that they have chosen to outsource;

  • investors are to explain more clearly how they manage conflicts of interest, the circumstances in which they will take part in collective engagement and the use they make of proxy voting agencies;

  • investors are to disclose their policy on stock lending and recalling lent stock; and

  • asset managers that sign up to the Stewardship Code should obtain an independent opinion on their engagement and voting processes having regard to an international standard or a UK framework such as AAF 01/06 (Assurance reports on internal controls of service organisations made available to third parties).

The changes to the Stewardship Code apply from 1 October 2012 and the FRC has published an updated version of the Stewardship Code.  The FRC encourages all signatories to the Stewardship Code to review their policy statements from 1 October 2012 with a view to producing an updated statement as soon as is practical.

NEW PROPOSALS

Takeovers Directive

The European Commission proposes to clarify the concept of acting in concert, through guidelines from the Commission and/or European Securities and Markets Authority, to provide more certainty as to the extent to which investors may cooperate without acting in concert.  The Commission intends to announce proposed measures in October 2012.  We will continue to monitor and report on developments in relation to these proposed measures.

Possible new mandatory quota for women on corporate boards in the EU

It has been reported that new legislative proposals are to be introduced shortly at EU level which would require Europe’s listed companies to ensure that by 2020 at least 40 per cent of non-executive board positions are filled by women or else face fines and other sanctions.  The EU justice commissioner is expected to formally announce this in October 2012.  We will continue to monitor and report on developments in relation to the possible introduction of the new mandatory quota.

BIS proposal for new route to IPO market for high-growth companies

On 20 September 2012, the Department for Business, Innovation and Skills announced that it has developed proposals to attract entrepreneurs and high-growth companies to list their businesses on the London Stock Exchange.  Proposals will include a planned new procedure for high-growth companies wishing to list on the premium segment of the main market of the London Stock Exchange which is likely to include amendments to free float requirements, eligibility criteria and reporting requirements.  Currently, at least 25 per cent. of the shares of a company applying for a premium listing must be held by the public in one or more EEA states at the time of admission.  This may be reduced to as little as 10 per cent. under the new rules.  The LSE is now due to consult on the proposals and report before the end of the year.  The reforms are expected to be implemented early in 2013.  We will continue to monitor and report on developments in relation to these proposals.