Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016
Lord Henley
That the Grand Committee do consider the Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016.
Lord Henley (Con)
My Lords, the main purpose of these regulations is to fulfil our obligations to transpose the non-financial reporting directive. While we remain a full member of the EU, we will continue to implement EU legislation in a positive and cost-effective fashion. That is why we are here today.
The non-financial reporting directive builds on provisions in the earlier EU accounting directive which require certain business entities to disclose a range of non-financial information alongside their accounts. The accounting directive applies only to certain types of business undertaking, which have limited liability. For simplicity’s sake, I will generally refer in my remarks to companies, but the Committee should bear in mind that these remarks apply also to qualifying partnerships and groups.
I stress that the scope and requirements of the non-financial reporting directive are intended to capture companies that are likely to have the most impact on society and the environment. The requirements therefore apply to large companies that are defined as public interest entities and which have more than 500 employees. The requirements also apply to a company if it is a public interest entity and is the parent of a large group that has more than 500 employees within the group. Public interest entities are entities whose activities are of major interest to the public; they include banks, insurers and quoted companies. We estimate that the total number of UK companies that will be impacted by the regulations beyond familiarisation costs will be around 260 public interest entities. A further 15,000 subsidiaries of public interest entities will also be impacted by the need for reporting across the corporate group. The directive was strongly influenced by the United Kingdom’s existing regime for non-financial reporting. Consequently, the new framework broadly mirrors the requirements that currently apply to all the UK’s quoted companies, regardless of their size. However, the regulations cover all large public interest companies, not just those quoted on the Stock Exchange. Companies do not have to be quoted for their activities to have far-reaching consequences.
At present all companies, except those that are eligible for the small companies regime, must publish strategic reports. Within the strategic report, companies should provide an analysis of the company’s position and performance, and for large companies this includes using non-financial information. Quoted companies must also publish information about environmental, social, community and human rights issues, including information about any policies of the company in relation to those matters. The report must also include specific disclosure on gender diversity for directors, senior managers and employees. The strategic report is the narrative element of a company’s annual report. It provides colour and context for the accounts and should be forward looking to provide reassurance on the company’s direction of travel for investors and suppliers. Issues, such as cybersecurity and employee matters, can be as significant as the financial issues covered in company balance sheets.
The regulations we are discussing today require eligible companies to disclose, to the extent necessary for an understanding of the company’s position, information on environmental, employee, social and human rights. This is already required by the United Kingdom’s existing regime for some of these companies. However, the regulations also require disclosures on anti-corruption and anti-bribery matters. Companies must also describe any policies pursued by the company in relation to any of these matters and identify any principal risks. These disclosures will provide companies with an opportunity to bring discussions on these issues to the boardroom and demonstrate to shareholders and other parties that they are considering issues in their proper context and addressing potential risks.
The regulations will strengthen the current regime by requiring companies that do not have policies in these areas to provide an explanation for not doing so. I want to stress that companies are not required to make policies to have something on which to report, but they will need to consider whether they should have policies about these matters. Furthermore if they decide they should not, they will have to explain the reason for this omission. The requirements are sufficiently flexible to enable disclosures to be specific to the company. This balance, between specifying categories and allowing companies flexibility to provide relevant information, should ensure reporting is meaningful and cost effective.
A Green Paper, as noble Lords will know, has recently been published on corporate governance in the UK. I believe that the regulations will complement and support work to reform corporate governance by providing greater accountability and transparency on the position and wider impact of companies. Disclosure is important to ensure that shareholders have the information they need to hold directors to account. It is also a way of increasing investor and consumer trust in the business, providing broader confidence that it is being run well. By way of reassurance, I add that the regulations do not require the disclosure of information about impending developments if the disclosure would be seriously prejudicial to the commercial interests of the company.
The Government have worked closely with the accounting sector throughout this process, from the earliest negotiations to the implementation stage. In the consultation earlier this year, stakeholders recognised the need to transpose the directive. During the consultation, stakeholders raised concerns about how the requirements would interact with the United Kingdom’s existing regime. The requirements provide that a company which reports under the EU’s framework qualifies as having complied with overlapping elements of the United Kingdom’s domestic regime. The regulations also permit voluntary compliance with the non-financial reporting directive disclosure requirements. This means that companies can avoid the complexities of moving between reporting obligations during their lifecycle as their size, in financial terms or number of staff, increases or decreases year to year.
I must briefly mention another aspect to these regulations. Regulation 3 contains a minor correction to the transposition of the accounting directive. This ensures that the parent company of a small group cannot benefit from an exemption from the requirement to produce group accounts just because a member which is a public interest entity is established under the law of an EEA state and not in the UK. If a member of the group is a public interest entity in any EEA state, the exemption should not be available.
I am aware that some businesses can struggle with regulatory change to financial reporting. Many companies in scope of the regulations will have to adapt their reporting only slightly. Although the changes are not substantial, they will add value to company reporting in the United Kingdom. I could not discuss an EU directive without mentioning the implications of the result of the EU referendum. The Government have considered this carefully in our work and implemented the minimum requirements of the directive. There is no gold-plating.
The United Kingdom’s company reporting regime is well regarded. It is very important to maintain the United Kingdom’s reputation as a hub of global transparency. However, as our future relationship with the EU becomes clearer, this may lead the Government to examine whether certain aspects of company law are cost effective. In the meantime, building on the reputation of UK governance and the reliability of annual reports can contribute to making the UK an attractive place to invest. I commend these regulations to the Committee.
Lord Stevenson of Balmacara (Lab)
My Lords, I thank the Minister for introducing the order, which as he said catches public interest entities; that is, companies whose activities likely to have a significant impact on the economy and society, including companies such as banks and insurers and extending to partnerships and other groups. The issue at hand is how companies assess non-financial risks and opportunities and how they incorporate them into their business strategies and models. The areas of main concern are environmental policies, policies about employees, respect for human rights, anti-bribery and corruption policies and diversity policies.
The Explanatory Memorandum explains, and the Minister also mentioned, that the underlying problem is really one of information asymmetry between the users of non-financial information and the directors of the company—a matter that in some senses transcends any temporary concern one might have about EU legitimacy in this area. It highlights that while UK companies are pretty good at reporting on environmental, employer and diversity policies, they are pretty poor at dealing with human rights and bribery and corruption issues. If there are asymmetries, they can lead to sub-optimal investment and trading decisions as well as misalignment of managers’ incentives away from delivering best performance in the company.
While the primary policy is to increase the transparency of PIEs including increasing relevance, quantity, consistency and comparability of the non-financial information currently disclosed by strengthening and clarifying the existing requirements, there are two quite important secondary objectives. The first is to encourage companies to better assess the risks relating to such matters as bribery and corruption and the other matters listed, and to incorporate these into their business strategies and models. The second is to increase diversity in corporate boards and the staff of companies and to enhance transparency concerning their diversity policies in order to help facilitate more effective oversight of management and governance in the company. We support those aims.
I have a few questions for the Minister, but I hope he will understand that we are not objecting to the regulations as they stand. If it would be more convenient for him to write to me, I am happy for him to do so. However, first I will make one observation, which I tend to have to do when I am dealing with orders from the department from which the Minister has emerged. Regulations are supposed to come into force on the seventh day after the regulations are made. In other words, these do not comply with the long-standing convention, which I had thought informed much of the work done by the department, that regulations which affect business, and these clearly do, should be introduced on one of the common commencement dates, which are 1 October and 5 April. Why is that? Has the department sought special exemption which can exceptionally permit other commencement dates, and if so, will the Minister explain what arguments of necessity and urgency were used?
Secondly, the regulations implement aspects of directive 2014/95/EU on disclosure of non-financial and diversity information and also directive 2013/34/EU relating to an exceptional group account about which we have no comments. The main problem facing the Government is that the UK does not currently recognise the group of organisations known as public interest entities and a large proportion of the Explanatory Memorandum is taken up with trying to show how all public interest entities based and operating in the UK are in fact caught by the regulations. In particular, the directive sets out four limbs within which it characterises the PIEs it wants to be in scope. I enjoyed the tour d’horizon of our legislative framework in paragraphs 4.7 to 4.10 of the Explanatory Memorandum, which almost convinces the reader that all the right companies are due to be in scope of this SI—or are they? In practice, as paragraph 4.10 makes clear, without recourse to the European Communities Act 1972, there are no statutory mechanisms for designating a small but presumably important group of bodies. Can the Minister say whether any companies or organisations have slipped through the net, and if so, why no recourse to the ECA 1972 has been proposed?
Paragraph 8 of the Explanatory Memorandum discusses the outcome of the consultation. I noticed one rather interesting area of controversy, to the effect that some stakeholders were,
“in favour of applying the Directive to all listed companies as well as the small amount of private companies that are in scope”.
The argument is that this would remove the small differences between the EU and domestic regimes, which I think the Minister referred to. The Explanatory Memorandum says that the principal reason for not gold-plating on this occasion was that it,
“would go beyond the minimum requirements of the Directive”.
Given that there was support among the consultees for going further than the minimum and that only a very small number of extra companies would have been captured, can the Minister tell us why this opportunity was not taken? It would have made more sense for external users of the information. It is a matter of regret that the information is not there. I understand that there is a voluntary procedure, but that is not what the consultees were asking for.
Finally, in paragraph 12.2 the Explanatory Memorandum explains that it is not necessary to make arrangements for a formal review of these regulations on what I think are rather specious grounds—that the regulations are amending,
“provision that is contained in primary legislation”.
However, paragraph 12.3 goes on to say that,
“the Department will keep the effect of the non-financial reporting requirements under review”.
The reason we are making PIEs disclose anti-corruption and bribery measures, as well as the others, is partly because of the EU directive but also because the Government accept—and they are right to do so—that it is necessary to encourage transparency and that a requirement to make this information available is in the best interests of the country because it will encourage “responsible corporate behaviour” as well as assist,
“the interests of other stakeholders such as creditors, investors and regulators”.
The Minister made that point. Can he explain this apparent reluctance to build a formal review mechanism into these new regulations and confirm that, as the department will in fact be reviewing them as if the requirement was in place, the review will be published?
Lord Henley
My Lords, I am grateful to the noble Lord for his very kind offer to someone such as myself, who is new to these matters, to write to him. I will certainly take him up on that. He might want me to take him up on that even after I try to answer some of his questions.
The noble Lord’s first question was about whether it would be possible to have a common commencement date. He said that it might be easier for companies if we stuck to 1 October or 5 April. The directive means that we can implement as close to the date as possible so as to avoid gold-plating. I understand that that means that the common commencement date does not apply. However, I certainly take his question on board and will come back to him if there is a better answer.
The noble Lord also asked whether there was a mechanism for a formal review. I can assure him that we always keep all these matters under review. The review process will certainly look in due course at whether all EU and domestic non-financial reporting regimes have led to unnecessary complexity for business. Obviously, that is something which will have to be kept in mind by the department.
PIEs were not recognised in the United Kingdom designation, as I understand it from the noble Lord’s question. There is no designation under the European Communities Act. He asked whether any companies have slipped through the net through this implementation. I can say that there is a legal definition of a public interest entity. The accounting directive defines what it is and we have used PIEs in the Companies Act when transposing the audit directive and the audit regulation because there are certain duties which only PIEs have—mandatory rotation and retendering of auditors, for example. The regulations further provide a list of entities to which the requirements apply, which is drawn from the accounting directive’s definition of a PIE. We believe that no companies have slipped through the net because we do not have our own definition; we are requiring what the accounting directive sets out.
I thank the noble Lord for his valuable comments. I can probably give him an assurance that there will be a letter in due course. I hope that, with luck, it might even arrive before Christmas. If it does not, it will be something for him to look forward to in the new year. I believe that his comments have been valuable, and that it is important to remember that the annual report can be used to present a very fair and balanced impression of a company, which goes beyond items on the balance sheet. These regulations strike the right balance between offering flexibility for companies to report on these issues of risk as they relate to their activities and providing a structure that makes the disclosures meaningful. The regulations should help to increase the transparency of how our companies behave and better equip shareholders to be active stewards of the companies they own. I beg to move.