13 July 2012 Email: codereview@frc.org.uk Chris Hodge Financial Reporting Council Fifth Floor Aldwych House 71-91 Aldwych London WC2B 4HN Dear Chris REVISIONS TO THE UK CORPORATE GOVERNANCE CODE AND GUIDANCE ON ADUIT COMMITTEES IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes. They are responsible for the management of 4 trillion of assets, which are invested on behalf of clients globally. These include authorised investment funds, institutional funds (e.g. pensions and life funds), private client accounts and a wide range of pooled investment vehicles. In particular, the Annual IMA Asset Management Survey shows that IMA members managed holdings amounting to just over 40% of the domestic equity market. In managing assets for both retail and institutional investors, IMA members are major investors in companies whose securities are traded on regulated markets. Therefore, we have an interest in the Corporate Governance Code from the perspective of our members as institutional investors in companies. Boards stewardship of those companies, the reports issued on that stewardship and auditors assurance over that information is vital in helping investors understand companies and their strategies. Undoubtedly the financial crisis undermined confidence in this framework and we welcomed the FRC s initiative on Effective Company Stewardship and it now seeking to enhance transparency. We particularly welcome the FRC enhancing the reporting by audit committees and draw your attention to the enhanced disclosure guidelines for boards and others developed by the Global Auditor Investor Dialogue, of which we are part, at www.enhanceddisclosure.org. Meaningful disclosures facilitate engagement, and reduce the amount of time and resources required of both investors and companies. However, there are certain proposals where we have concerns. We set out our key reservations below and in the attached Annex our more detailed observations. 65 Kings wa y Lo nd on W C2B 6TD Tel:+44 0)20 7831 0898 Fax:+44(0)20 7831 9975 w w w. i n v e s t m e n t u k. o r g Investment Management Association is a company limited by guarantee registered in England and Wales. Registered number 4343737. Registered office as above.
Requiring directors to state the basis on which they believe the annual report is 1) fair, balanced and reasonable and 2) provides users with information to assess the company s performance, business model and strategy is likely to add clutter without necessarily enhancing transparency. It could also result in standardised reporting on the process followed as opposed to more informed disclosures on how reliable the information is. There are also many types of user. The primary audience of accounts should be the holders of ordinary shares, as the providers of the risk capital and bearers of the residual risk. The existing main and supporting principles under C.1 which state that the board should present a fair, balanced and understandable assessment of the company's position and prospects in relevant reports should be sufficient. Whilst we support improved reporting by audit committees, it is important that this does not undermine the role of the unitary board and its responsibility for the annual report overall. Proposals for the committee to advise the board on the entire annual report could be seen as a delegation of power. It also places a further burden on the audit committee and does not take into account that some companies have committees that deal with particular aspects of the annual report such as risk committees. We support companies being expected to put their audits out for tender every ten years. However, the long terms auditors can hold office means that certain of our members consider that if a company has not had a change of auditor in say, 15 or 20 years, then it should be required to do so. Please contact me if you would like clarification on any of the points in this letter or if you would like to discuss any issues further. Yours sincerely Liz Murrall Director, Corporate Governance and Reporting 2
Preface The FRC proposes adding to the Preface of the Code a reference to the interest of debt holders, and other providers of non-equity capital, in the governance of the company. IMA supports this amendment in that both debt and equity holders have a common interest in the long-term stability of a company, and often investors that hold equity will also hold debt in a company. However, such an addition would be better made to Section E of the Code rather than in the Chairman s statement. Requiring the contribution of debt holders to be recognised in the Chairman s statement is likely to result in standardised reporting. However, amending Section E would recognise that a company s board and management should enter into a dialogue with all types of investor not just equity shareholders. It also reflects better the proposed text for the introduction of the Stewardship Code. Comply or explain For the continuing credibility of comply or explain companies need to provide clear and meaningful explanations when they choose to deviate from the Code. In order to address the issue of poor quality explanations, the FRC published a paper What Constitutes an Explanation under Comply or Explain? in February. This identified a number of features, including, for example, a clear rationale for the action taken and any mitigating actions. The FRC is now proposing to refer to these features in the introduction to the Code which is not subject to comply or explain, but is intended as guidance. Views are invited on whether it would be helpful to identify the features of a meaningful explanation in the introduction to the Code and, if so, whether the proposed addition correctly identifies those features. IMA strongly supports the comply or explain approach to corporate governance but certain of our members have noted that: there can be a reticence for certain companies to explain non-compliance with the Code leading them to comply when this may not be in the best interests of the company; disclosures and explanations can sometimes be standardised and of limited use; and not all companies provide adequate explanations for non-compliance and some consider any explanation will suffice. Thus we welcome the FRC providing guidance on meaningful explanations in that they should include a clear rationale for the action taken and describe any mitigating actions. This guidance should help companies understand what is expected of them and give investors a benchmark against which to assess explanations. Meaningful disclosures facilitate engagement, reduce the amount of time and resources required of investors and companies, and lessen the perception of a comply or else approach. Provision B.2.4. The FRC is proposing to amend Provision B.2.4 to require companies that have made use of an external search consultancy to disclose whether they have any other connection with the company. IMA supports this in that in will ensure consistency in the way that relations with external advisers are reported. This disclosure is already required when external board reviewers or remuneration consultants are used, and there are more detailed disclosures when the external auditor provides non-audit services. Provision B.6.2. On the use of external advisers, some companies state in their annual reports that the board review had been independently facilitated but do not identify the reviewer. It is proposed that this should 3
be explicit in Provision B.6.2. For the sake of consistency, the FRC is also proposing to add similar wording to Provision B.2.4 (in respect of external search consultancies) and D.2.1 (in respect of remuneration consultants). IMA supports this in that it will ensure that investors are better able to judge the independence of such advisers. Provision C.1.3. To encourage boards to pay attention to disclosures in the business review and on the business model and strategy, they are to explain the basis on which they believe the annual report is fair, balanced and understandable and provides users with the information necessary to assess the company s performance, business model and strategy. Views are invited on whether the proposed wording achieves the desired effect and, if not, how it might be improved. It is important that an annual report is fair, balanced and reasonable. However, for boards to be required to state the basis on which they believe the annual report is so and provides users with information to assess the company s performance, business model and strategy is likely to add clutter without necessarily enhancing transparency. Such disclosures could also become standardised on the process followed, as opposed to being informed disclosures on how reliable the information is, and certain of our members consider they would blur accountabilities and responsilbities between directors and auditors. There are also many types of user. We maintain that the primary audience should be the holders of ordinary shares, as the providers of the risk capital and bearers of the residual risk. Whilst reporting is expected to meet a growing set of needs and some consider it should also be aimed at other stakeholders, such as creditors, employees, bankers, customers and suppliers, these other stakeholders are protected by contractual and other rights that are not shared by shareholders. In summary, we consider the existing main and supporting principles under C.1 that: the board should present a fair, balanced and understandable assessment of the company's position and prospects in relevant reports, should be sufficient. Rest of Section C Views are invited on the proposed revision to Section C of the Code and the Guidance on Audit Committees, including whether the right balance has been struck between changes to the Code (which is subject to comply or explain ) and the Guidance (which is not). Provision C.3.2. Under the proposals the audit committee is to consider the whole annual report with a view to advising the board whether it is fair, balanced and understandable and provides the information necessary for users to assess the company's performance, business model and strategy. It is to report to the board on how it has discharged its responsilbities. IMA considers it important that the audit committee does not undermine the role of the unitary board and its responsibility for the annual report overall. This proposal could be seen as a delegation of power. It also places a further burden on the audit committee and does not take account of the fact that some companies have committees that deal with particular aspects of the annual report such as risk committees. The audit committee should remain within its remit and focus on financial reporting, controls around that reporting, and the role and work of the internal and external auditors. It should report to 4
the board to enable the board to exercise its responsilbities but only on these matters. Similar concerns apply to the related proposals in the Guidance to Audit Committee. Provision C.3.6 This introduces a comply or explain requirement for FTSE 350 companies to put the external audit contract out to tender at least every ten years. The draft Guidance in a new paragraph after 4.20 recommends that companies indicate their intention to put the audit out to tender in the previous annual report so that here is time to undertake an effective open process. Auditor appointments should be within a robust and transparent system of governance. IMA supports companies being required to put their audits out to tender every 10 years or explain why they have not done so as proposed. This disclosure would give a locus for investors to discuss the position with the audit committee and ensure that auditors that have held office for a long time are subject to scrutiny. In particular, the long terms that auditors hold office can impact their independence and objectivity. Thus some of our members consider that within this framework there needs to be a further safeguard such that it if there has not been a change of auditor in say, 15 or 20 years, then a company should be required to do so. There also needs to be more accountability to investors. At present effectively the company at the instigation of its board - hires its own scrutineers in that investors ratify the reappointment at each AGM but are not involved in the process. Thus we welcome proposals to require companies to report a year in advance of their plans to tender. This would enable any investors that wish to engage more with companies on the matter and in the selection of auditors. Transitional arrangements The FRC recognises that the introduction of regular tendering for the external audit contract, even on a comply or explain basis, will need to be carefully managed. If all those companies that have not gone out to tender in the last ten years were to do so in the first year following the change to the Code the market would struggle to cope. It would also favour the Big 4 audit firms with their greater resources. Thus it intends only to apply the new provision to FTSE 350 companies in the first instance. The timing of any tender should be linked to: When the current audit engagement partner is due to rotate; and The length of time since the audit contract was previously put out to tender. The FRC proposes that where a company has put the audit contract out to tender in or after 2000, the tender process could be deferred until the latter stages of the incoming audit engagement partner s term (in other words, for a further five years). The combined effect of these proposals would be to defer the date for tendering the audit contract of a significant number of FTSE 100 companies until 2018 or later. Views are invited as to whether the transitional arrangements outlined above are workable, and whether there are alternative arrangements that should be considered. Any data on the frequency and pattern of tendering in FTSE 350 companies would also be very welcome. IMA considers that this is a pragmatic approach to the issue. We do not have any data on the frequency and pattern of tendering in FTSE 100 companies. Provision C3.7. It is proposed that there is a separate section in the annual report that describes the work of the audit committee, including the significant issues it considered in relation to the financial statements and how these were addressed, an assessment of the effectiveness of the external audit, the 5
approach taken to the appointment on reappointment of the external auditor, the length of tenure of the current audit firm and when the external audit contract was last out to tender. IMA welcomes steps to enhance audit committee reporting. A particular concern of investors is that the judgements made and processes followed during the preparation of the accounts and their audit is opaque. Indeed the audit committee plays an important role in this and whilst there are many communications between it and the auditor, these are rarely communicated to investors. In this context, we draw your attention to the enhanced disclosure guidelines for boards and others developed by the Global Auditor Investor Dialogue, of which we are part, at www.enhanceddisclosure.org. These have recently been updated. They recommend more transparency and that a company s audit should provide a non-boilerplate report on its activities, key audit issues and how they are managed, including: what steps it took to satisfy itself that the risk and control processes are effective; the significant assumptions for determining fair values, particularly mark to model; the factors considered when endorsing material write downs and impairments; and the work to ensure material securitisations and off balance sheet liabilities are disclosed. We would welcome these being given more consideration in any amendments to audit committee reporting. We also support the enhanced communication over audit tenure, the period since the last tender, and the tender and selection processes. This information will be helpful for investors in assessing the frequency with which companies change their auditor. Audit committees should also make themselves available, if necessary, to explain to major investors any changes of auditor and if shareholders request they should consult them on the selection of an alternative from a wider range of firms. At present, investors ratify the appointment at the Annual General Meeting and are not involved in the selection process. On the matter of non-audit services, as well as reporting on how auditor independence and objectivity is safeguarded when non-audit services are provided, investor confidence would be enhanced by better disclosure of the nature of non-audit services and associated fees, and if audit committees reported on the reasons for commissioning such services. Other matters Provision E2.2, Poll voting IMA considers the reference to voting on a show of hands seems to indicate that this is the preferred method of voting. There are benefits if all resolutions are voted on a poll in that: voting is more exact and equitable in that one vote per share is counted in a show of hands each shareholder has one vote and it is possible for a group of shareholders owning in aggregate a very small proportion of a company s outstanding capital to influence the outcome; voting is more transparent; overseas shareholders would be more inclined to vote UK shares as currently some are discouraged by the belief that the result is in most cases determined by a show of hands; and although a show of hands is believed to involve or enfranchise the private shareholder, the majority cannot and do not attend the meeting, for reasons of geography or timing, but they do complete proxy cards. 6
As the Code requires all proxies to be counted the additional costs involved in going to a full poll would be incremental. On the basis that attendance at meetings can be unrepresentative and in the interests of transparency and equity, we suggest the Code is amended such that best practice is to call a poll on all resolutions at company meetings. Principle E2, Use of the AGM The Stewardship Code encourages institutional investors to attend the General Meetings of companies in which they have a major holding, where appropriate and practicable. However, certain companies with a Premium listing hold their Annual General Meetings outside the United Kingdom. It would be helpful if such companies were encouraged in E.2 to arrange a satellite meeting within the UK with full voting entitlements for attendees. Risk committees There is much in the Code and guidance on the role and responsilbities of audit committees but no focus on risk committees. We consider this should be addressed. 7