Companies and Partnerships (Accounts and Audit) Regulations 2013

Lord Hodgson of Astley Abbotts Excerpts

Wednesday 17th July 2013 Grand Committee

[Viscount Younger of Leckie]

My Lords, as I was saying, in removing the requirement for reporting on policy and payment of creditors, we are taking this issue seriously. In November, my honourable friend in the other place, the Minister of State at BIS, Michael Fallon, wrote to companies to encourage them to become signatories to the prompt payment code. By 1 April 2013, more than 1,371 organisations had signed up to the prompt payment code. These regulations are not intended to stand alone and will be supported by guidance from the Financial Reporting Council. This guidance will be published for consultation in the coming weeks and will provide help for those companies whose thinking on their reporting is still in development.

I turn now to the third statutory instrument on today’s agenda, the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, covering reporting of directors’ pay. It is worth taking a few moments to elaborate on the reasons why it is important to make company reporting on directors’ remuneration more transparent. As the Committee will know, the Government’s comprehensive reforms to executive pay addressed concerns that the link between directors’ pay and performance has grown weak. This is damaging for the long-term interests of business and it is right that the Government are acting to address this failure.

These draft regulations are the final part of those reforms. Changes to primary legislation contained in the Enterprise and Regulatory Reform Act have given shareholders new voting powers to hold companies to account. These regulations give detailed effect to those changes for shareholders by setting out the information that quoted companies must include in a directors’ remuneration report. As a package, these reforms contribute to the Government’s wider aim of establishing a corporate governance system that supports long-term, sustainable growth. The regulations focus on the content of the company’s report on directors’ pay. They cover both the required disclosure of pay policy and the improved transparency of reporting on pay and I shall deal with those in turn.

First, on the remuneration policy, the Enterprise and Regulatory Reform Act amended the Companies Act 2006 to give shareholders new voting powers to hold quoted companies to account on directors’ pay. Quoted companies must put their remuneration policy to shareholders at a minimum interval of every three years. These regulations give effect to those changes by setting out the details of the information that quoted companies must give to shareholders in their directors’ remuneration policy. The policy must include: first, a description of the elements that make up each director’s remuneration package, such as salary, pensions and bonus; secondly, the maximum that may be paid for each of those elements; thirdly, an explanation of how payments are linked to different levels of performance and how that performance is measured; and, finally, the company’s policy on recruitment and exit payments.

In addition to the directors’ remuneration policy, companies will be required, as they are now, to produce an annual remuneration report setting out what directors have been paid in the past financial year. Remuneration reports can currently be long and opaquely written, which is why we are proposing significant changes to those reports to make it much clearer to investors how much directors have been paid and how this links to performance. In the new annual remuneration report, companies will have to: first, report the amounts paid to each director in terms of their salary, pension, benefits, annual bonus and long-term incentive plans, and provide a single figure for total pay; secondly, explain clearly how the payments relate to performance by giving details of actual performance against the targets set and how that relates to the amount received; and, thirdly, provide contextual information, including details of the fees paid to remuneration consultants for advice to the company relating to directors’ pay, and a comparison of the change in pay for the chief executive and the wider company workforce.

Under the changes to the primary legislation, shareholders will continue to have an annual advisory vote on a remuneration report. However, where a company’s shareholders reject the annual remuneration report, the company will be required to resubmit its pay policy to a binding vote at the AGM the following year.

I would make it clear that these reports are not intended to be long legalistic documents but to provide clear and meaningful information to company shareholders which allow them to hold the company to account. These regulations replace the current 2008 regulations on reporting and will apply to the same group of companies as at present—in other words, the approximately 900 quoted companies registered in the UK whose shares are listed on the main market.

These regulations have been developed in close consultation with a wide range of interested parties, including companies, investors and unions, to ensure the reforms achieve the policy intentions in a workable and lasting manner. This has been a challenging task and we are satisfied that we have successfully found the right balance. Indeed, several major companies have already started to adopt some of the new disclosures in this year’s annual reports.

I recognise that these are big changes, but we expect these regulations to be accompanied by industry-led guidance to aid companies and investors in their implementation of the regulations. We welcome this guidance, which is being developed by companies and investors together and is scheduled to be available in September. The guidance will be of real benefit in ensuring that companies provide a meaningful level of detail to their shareholders. However, and arguably more importantly, it also demonstrates the impact of improved engagement between companies and investors, engagement which we are starting to see and which will be the final part of making sure that these reforms lead to real and lasting change. I commend these orders to the Committee.

[Lord Hodgson of Astley Abbotts]

My Lords, I am grateful to my noble friend for his clear explanation of the three instruments. I want to focus my remarks on the last two—the strategic report regulation and the one that is concerned with directors’ remuneration. Before I go any further, I need to declare an interest, which is on the register. I am the senior independent director, or SID, of a FTSE 250 company, and the chairman of its remuneration committee. So these orders are far from being of academic interest to me. On Friday, the day after tomorrow, I will meet our remuneration consultants in Wolverhampton to discuss the implications of the instruments that we are talking about this afternoon. It is important that we should move sometimes from the rarefied atmosphere of this Committee Room and see what the things we discuss are going to mean on the ground and their real implications for British industry. With great respect to my noble friend and his officials, sometimes the reality of what is being proposed is some way distant from the undoubted good intentions with which the regulations are drafted. If this makes me sound a bit parochial, I am afraid that I am not going to apologise for that, because what we are considering and will no doubt pass today is going to affect 900 of Britain’s largest companies. I am concerned with the practical implications.

The business of which I am director is not a complex one. We brew beer in five breweries up and down the country and run just over 2,000 pubs across England, Wales and Scotland. We have no overseas operations and a pretty simple business model. I say that to my noble friend so that we can set in context the remarks that I am going to make about these two sets of regulations.

The Committee should be aware that, in 1995, our annual report was 25 pages long; by 2000, it was 41 pages long; and by 2005, it was 76 pages long. In spite of the observations in the Deloitte study included in the documents that have been circulated, which suggests that the size of annual reports is sloping off—I have yet to see a company whose annual report is shortening—last year it had gone up by a further 20 to 96 pages. So in 15 years, we have gone from 25 to 96 pages. I have to say that I do not think that that has helped the shareholders.

I looked through the objectives in the Explanatory Memorandum for the strategic report regulations, which says at paragraph 7.5:

“The suggested restructure and simplification of the reports aims at giving all stakeholders … the information they need in a clear and effective way so they can be active stewards of the companies they own”.

I thought, “Amen to that! Terrific!”. When my noble friend says, in his clear explanation, that we are going to simplify the framework, I say amen again. However, he went on to say that there is going to be a new section of the annual report. That does not sound like simplifying, it sounds like extending. It may have a simplified bit in it, but it does not sound to me as though we are going to shorten it, because he then went on to say that we are going to require the disclosure of other information.

I am particularly concerned about the growth in the annual report and, as I will explain as we go along, the effect that the growth in the size of annual reports has on individual shareholders. The fact is, as the Explanatory Memorandum makes clear, institutional shareholders are fine. They will turn up at our door, knock and say that they want to know about this, that or the other, and we will say, “God bless you guv’nor” and tell them. I am much more concerned about the average small shareholder.

We have a big shareholders’ list, probably not unconnected with the fact that we offer free pints of beer to every shareholder who comes to our annual general meeting. For small shareholders, less can often be more: something shorter and better focused can be attractive and advantageous. We are talking about a strategic report, concerned with the essence of what drives a company, but when I look at new Section 414C that is to be added to the Companies Act 2006, headed “Contents of strategic report”, I see that it has 14 subsections and begin to think, “Hello, what is going on here?”.

New Section 414C(7)(b) states that a quoted company’s strategic report must include information about,

“environmental matters … the company’s employees, and … social, community and human rights issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies”.

We have 2,000 pubs and five breweries. What are we going to write? It will be either a telephone book or the most anodyne and superficial stuff, because you cannot move between the two easily. What will happen is that the consultants will come along and say, “These are the words you need to use in your annual report. They will meet the requirements of the strategic report which we will approve this afternoon”.

New Section 414C(2)(b) says that the strategic report must contain,

“a description of the principal risks and uncertainties facing the company”.

That makes no distinction between risks that we can control and those we cannot. The major risk that we face is what happens to the UK economy. If it goes badly wrong, people do not go to the pub, they do not eat at the pub and they buy their beer more cheaply at the supermarket. However, saying that would give such a broad statement that it will be of little value to the company or the shareholders. Surely it would be much better if the regulations placed more emphasis on describing the key risks that were within the company’s control, rather than such broad generic statements, as I am sure we will get to.

At the other end of the spectrum, at the micro level, when we get to new Section 414C(8)(c)—and remember that we are discussing a strategic report—it states that it must include,

“a breakdown showing at the end of the financial year … the number of persons of each sex who were directors of the company … the number of persons of each sex who were senior managers of the company … and … the number of persons of each sex who were employees of the company”.

The employment of women is critical. Believe me, when my noble friend goes to the pub on the way home tonight he will find that a lot of the bar staff, the people who work there and a lot of the managers are women. However, do we have to have this in a strategic report? Is this going to add to the sum of human knowledge and put a shareholder in a better position to make a proper assessment of the company’s position going forward? Less is more.

My concern about these regulations, worthy though their purpose is, is that they do not provide enough specific focus for an individual company. We are going to get a series of bland statements. We are going to have a meat cleaver rather than a surgeon’s knife. The regulations continue to put far too great an emphasis on reporting the past, judge the ship by the shape of the wake and do not provide directors with sufficient safe-harbour provisions in respect of forward-looking statements. For noble Lords who are not familiar with the term “safe harbour”, it describes a means whereby you can say something about the future without being sued for doing so, provided that you do not say something that is utterly reckless.

We want directors to be encouraged to make more forward-looking statements, because that is what it is all about. To do that, they need proper safe-harbour provisions built into these regulations. I do not see them there and I hope that my noble friend can say something about this when he winds up. To be really helpful to shareholders, actual and potential company reports need to look forward and peer into the fog of the future, but directors will be reluctant to do so unless they have adequate protection.

--- Later in debate ---

[Lord Young of Norwood Green]

My Lords, I do not profess to be very expert in this area, but I declare an interest as vice chair of the Ethical Trading Initiative and somewhere in the comprehensive report from the noble Viscount there was a reference to environmental, social and human rights issues and supply chains.

I do not have a lot to say on the first set of regulations, which seem to be about tidying up and closing a loophole, although the question of whether there would be any tax consequences as a result of the changes occurred to me. I thought the point about narrative reporting was interesting and I could not help reflecting on the experience of the noble Lord, Lord Hodgson, and the range of his comments. I suppose there is one side of me that inclines to what he says—that less is probably more. He is probably right. As a small shareholder myself in a number of companies, how many times do I bother to wade through the annual report? It is not very often, unless I am really desperate in my reading material. However, I think that the companies that we are talking about have a duty to report comprehensively and responsibly. We do not want any more of it than is necessary but we cannot honestly say that everything is right these days and that we are in a climate where nothing bad happens or where companies’ behaviour is always perfect. The Minister conveyed a lot of interesting information to us about narrative reporting.

Overall, I welcome the new strategic report section and the way that it will deal with environmental, social and human rights issues. The Minister mentioned Bangladesh, which is just one example of how this can impact on companies. What I did not hear in all his comments was any mention of ethics, which are important to the way that companies behave. If this points them in that direction, that is a good thing. Company policy on ethical behaviour is becoming more and more important. We see large companies behaving very irresponsibly and unethically, and then being required to make enormous payouts. The recent example of payment protection policies is one of a number of such cases. These regulations would certainly not do those companies any harm.

The Minister then talked about the action plan on business and human rights, and the requirement to report. I think I am right in recalling that the Foreign and Commonwealth Office are supposed to be publishing a document soon on the UN Ruggie principles. Will this legislation encompass those principles?

I welcome the section on gender reporting, especially on board members, although not on that alone. It is important that we see how much progress has or has not been made. In the current climate, if we are serious about controlling greenhouse gas emissions, that is perfectly reasonable as well. An area that interests me, which I would not mind seeing in an annual report, is—

[Lord Hodgson of Astley Abbotts]

The noble Lord talked about gender reporting on boards. I understand that and am in favour of it. However, he has only to look at the list of the directors at the front of the annual report to see who are men and who are women and to draw his own conclusion. We do not have to have a section on gender reporting. The information is all there and people can gather it together.