Draft Companies Act 1985 (Operating and Financial Review and Directors' Report Etc.) Regulations 2005
Second Standing Committee on Delegated Legislation
Thursday 3 February 2005
The Committee consisted of the following Members:
Chairman: Mr. Bill O'Brien
†Barker, Gregory (Bexhill and Battle) (Con)
†Bellingham, Mr. Henry (North-West Norfolk) (Con)
Bottomley, Peter (Worthing, West) (Con)
Bruce, Malcolm (Gordon) (LD)
†Burden, Richard (Birmingham, Northfield) (Lab)
Cotter, Brian (Weston-super-Mare) (LD)
Evans, Mr. Nigel (Ribble Valley) (Con)
†Jones, Mr. Kevan (North Durham) (Lab)
†Love, Mr. Andrew (Edmonton) (Lab/Co-op)
†McNamara, Mr. Kevin (Hull, North) (Lab)
Pollard, Mr. Kerry (St. Albans) (Lab)
†Sheridan, Jim (West Renfrewshire) (Lab)
†Simon, Mr. Sion (Birmingham, Erdington) (Lab)
†Smith, Jacqui (Minister for Industry and the Regions)
†Tami, Mark (Alyn and Deeside) (Lab)
†Watson, Mr. Tom (West Bromwich, East) (Lab)
Jenny McCullough, Ian Cameron, Committee Clerks
† attended the Committee
[Mr. Bill O'Brien in the Chair]
Draft Companies Act 1985 (Operating and Financial Review and Directors' Report etc.) Regulations 2005
9.55 am
The Minister for Industry and the Regions (Jacqui Smith): I beg to move,
That the Committee has considered the draft Companies Act 1985 (Operating and Financial Review and Directors' Report etc.) Regulations 2005.
It is a pleasure, Mr. O'Brien, to have this debate under your chairmanship. The statutory instrument amends the accounting and reporting provisions of the Companies Act 1985 in several ways. It will introduce a requirement for quoted companies to prepare an operating and financial review. It will extend the fair review of the company's business in a directors' report, as required under directive 2003/51/EC of the European Parliament and the Council of the European Union, generally referred to as the modernisation directive. It will provide for a review by the company's auditors of the operating and financial review and amend the requirements for auditors' review of directors' reports. It will also establish a parallel criminal and administrative enforcement regime for the OFR and the directors' reports.
At the heart of this development is the objective of ensuring an effective framework for corporate activity that will give confidence to shareholders, business and other stakeholders, and ensure that capital markets work effectively, thus ensuring prosperity for all. Transparency of company reporting is a key part of making capital markets work effectively and building trust in corporate Britain.
As the company law review recognised, it is important to have qualitative and quantitative reporting, which is why it recommended the adoption of the OFR. The OFR represents a step change in the way in which directors report to their shareholders on the performance and prospects for the business. The information that will be disclosed in the OFR has often not been well captured in traditional financial statements—information about a company's strategy, prospects, opportunities and risks, the more intangible and so-called soft assets and key relationships with stakeholders, for example.
More individuals and families own shares than ever before, either directly or indirectly through holdings in pensions funds and so forth. Employees often receive share options as part of their remuneration package or in lieu of cash bonuses. It is increasingly important that shareholders should be able to understand how well the business that they own is prepared for the future. The OFR will improve the usefulness and
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relevance of information, which will enable shareholders to achieve a better understanding of the company's business and the potential for it to succeed. It will encourage an open dialogue between shareholders and business to stimulate long-term wealth creation. Although aimed at shareholders, it will also be important to other stakeholders, including employees, suppliers, customers, regulators and other users of reports and accounts, such as those particularly interested in the environment and the broader community.
The OFR will also benefit companies. In preparing the OFR, directors will need to consider carefully the significance of issues impacting on the company's future performance. Many companies already recognise that, and some have been preparing OFRs voluntarily for a number of years. However, the quality of those voluntary OFRs has been uneven, and we are therefore introducing a mandatory requirement to ensure that the benefits that I have outlined are realised and that best practice is extended.
Since the work of the company law review, we have also been assisted by the OFR materiality group chaired by Rosemary Radcliffe, and I would like to put on record my gratitude to her and other members of the group. Between May and October last year, we conducted an in-depth consultation on detailed regulations, not only through the publication of a consultation document, but through meetings and events with stakeholders to discuss the proposals. The number and range of stakeholders who gave their time to respond shows clearly the importance that companies and those involved with companies attach to the issue. I thank all those who participated in the consultation and helped us to produce the regulations before the Committee. We carefully considered what stakeholders told us during that consultation, and announced several changes to the draft regulations last November. Those changes have strengthened our proposals, reduced the burdens for companies and enhanced the usefulness of the OFR for shareholders and other stakeholders.
Let me turn to the detail of the regulations. Regulation 8 requires the directors of a quoted company to prepare an OFR for each financial year. An OFR will be a balanced and comprehensive analysis of the development and performance of a company's business, including the main trends and factors underlying its performance and financial position during the year, together with the trends and factors that are likely to affect its performance in future years. That is important because we want companies to focus on more qualitative and forward-looking information than has traditionally been included in annual reports.
To comply with the objective and general requirements set down in the regulations, an OFR may need to include information on a range of factors relevant to the understanding of the business—for example, information about environmental matters, the company's employees and social and community issues. If, however, the directors decide that the nature of the company's business means that it is not
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necessary to disclose information about one or more of those issues, they must make a positive statement to that effect in the OFR. Those issues cannot simply be ignored.
The regulations implement the parts of the accounts modernisation directive that require an extension of the fair review in the directors' report. Directors are currently required to provide a fair review of the business in their report. The directive extends that requirement to a ''balanced and comprehensive analysis'' of the performance and development of the business during the year and of the company's position at the end of the year. The objective is similar to that of the OFR: greater transparency and precision in company reporting on performance in financial and non-financial matters. That said, we have been careful about burdens and duplication with regard to those two provisions.
Gregory Barker (Bexhill and Battle) (Con): Will the Minister clarify one point? She talked about encouraging companies to be more forward-looking and about greater transparency in financial reporting. Where is the line between what she is discussing and the territory of a profits forecast, which is a difficult area?
Jacqui Smith: Clearly, financial information will be included in the OFR, but we are not suggesting that information that would somehow prejudice the company's prospects needs to be produced at that time. We expect a considered analysis by the directors of the prospects, risks, opportunities, types of policy and other things that will affect the business, and we expect that to be provided in a much more open way than previously. There will continue to be provisions, through the listing rules and others, that relate to the disclosure of other financial information. Nothing in these regulations impacts or disturbs those provisions.
We have been careful about the burden and duplication. Under the regulations, all quoted companies, of whatever size, will have to prepare an OFR. However, if information is already in the OFR, it need not be duplicated in the directors' report. Although all companies will have to prepare a directors' report, small companies will not have to prepare the extended fair review, and we have taken advantage of the exemptions in the directive to exempt medium-sized companies from the requirement to include certain non-financial information.
It is clearly important that there is guidance and the ability to ensure that the information provided by the OFR and the directors' report is meaningful and relevant. We have ensured that in a range of ways. The legislative requirements for the OFR will be supported by an OFR standard, to be issued by the Accounting Standards Board, which is conducting a public consultation on a draft standard.
Regulation 10 provides for a review of the OFR by the company's auditors. The auditors must state in their report whether, in their opinion, the information given in the OFR is consistent with the company's annual accounts, and whether, in performing their
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functions as auditors, any matters have come to their attention that they consider to be inconsistent with the information given in the OFR.
The directors' report is subject to an audit review, which is more limited than that for the OFR. Regulation 3 requires the auditors to state whether the information contained in the directors' report is consistent with the company's accounts. The regulations also provide for a parallel criminal and administrative enforcement regime for both the OFR and the directors' report. Part 5 of the regulations extends the existing administrative enforcement regime in relation to defective accounts to cover defective OFRs and directors' reports.
The Financial Reporting Review Panel will review the OFR for possible omissions or mis-statements. However, we recognise that it is important to give companies the opportunity to become familiar with the new requirements and standards, and so we have provided that the Financial Reporting Review Panel's administrative enforcement role will begin one year after the regulations come into effect. It will therefore apply to OFRs for financial years beginning on or after 1 April 2006.
As I stated during the debate on the Companies (Audit, Investigation and Community Enterprise) Bill, good company law needs to provide the framework for successful enterprise. The regulations will build on that framework by requiring companies to report on the main qualitative factors underlying their past and future performance, thus improving the quality of investment decisions, the allocation of capital, and trust and confidence in corporate Britain.
