Companies and Partnerships (Accounts and Audit) Regulations 2013

Viscount Younger of Leckie Excerpts

Wednesday 17th July 2013 Grand Committee

Moved by

[Viscount Younger of Leckie]

That the Grand Committee do report to the House that it has considered the Companies and Partnerships (Accounts and Audit) Regulations 2013.

Relevant document: 6th Report from the Joint Committee on Statutory Instruments.

[The Parliamentary Under-Secretary of State, Department for Business, Innovation and Skills (Viscount Younger of Leckie)]

My Lords, I beg to move that this Committee considers the following three statutory instruments, which I will speak to in turn: first, the Companies and Partnerships (Accounts and Audit) Regulations 2013; secondly, the Companies Act 2006 (Strategic Reports and Directors’ Report) Regulations 2013; and, thirdly, the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013.

With my apologies to noble Lords for beginning this debate with a technical and specialised subject, I will introduce the Companies and Partnerships (Accounts and Audit) Regulations 2013. These regulations close a loophole in the implementation of the EU Fourth Company Law (Accounting) Directive. They do this by amending the Companies Act 2006 and the Partnerships (Accounts) Regulations 2008.

The businesses most affected by these amendments are limited partnership investment funds in the private equity, venture capital and real estate sectors. These specialised businesses have been aware of the planned changes as far back as 2010, when BIS consulted on closing the relevant loophole. The loophole allows certain limited partnerships to avoid preparing accounts and reports where these are required by EU law. Accounts such as those for limited liability companies are required where the partnerships in question are structured to have limited liability.

Work on these regulations started as soon as this problem was identified. Following the 2010 consultation, we have continued to work with stakeholders who responded. Certain other unlimited companies and general partnerships are also affected, but we believe there are few, if any, of these in existence. The amendments in the regulations close the theoretical loophole that is available here also.

By way of background, these loopholes originated in the 1993 regulations that first implemented the relevant provisions of the EU fourth directive, after they had been inserted into that directive, in 1990. The defective drafting that caused the loophole was then carried over from the 1993 regulations into the Companies Act 2006 and the Partnerships (Accounts) Regulations 2008, so these regulations insert a new systematic definition of a “qualifying partnership” into the Partnerships (Accounts) Regulations 2008. This replaces the previous definition, which contained a technical drafting error. The regulations also insert a systematic definition of what is meant by the “members” of a qualifying partnership. This addresses similar technical drafting errors and removes some previous unnecessary gold-plating.

The regulations also correct the implementation of requirements relating to the publication of a qualifying partnership’s accounts. Where a qualifying partnership has no UK limited company members or EU equivalents, the regulations ensure that accounts are made available for inspection in the UK. Where the qualifying partnership has no principal place of business in the UK, it will now have to publish the accounts at a nominated UK address. This ensures that the directive requirements are met and are enforceable under UK law.

These regulations also address a separate and unrelated issue in order to complete the implementation of the 2009 EU electronic money directive. They ensure that all forms of e-money issuers are covered by the full audit and accounting requirements of the Companies Act. These amendments were missed when the EU electronic money directive was implemented in 2011 and have been developed in consultation with the Financial Conduct Authority and HM Treasury.

The impact assessment published with these regulations estimates that between 5,000 and 8,000 limited partnership investment funds are affected. The costs are likely to be between £8,000 and £30,000 per fund per year in accounting and audit. These costs would be likely to double in the first year, as the relevant partnerships and their auditors will have to prepare and audit full accounts for the first time. The costs will also be higher for around 10% of limited partnerships, which will have to prepare consolidated accounts. The remaining 90% will be able to take advantage of recent changes introduced to UK accounting standards, which allow them not to produce consolidated accounts.

The revised regulations have the following important effects. First, they increase the transparency of accounting and reporting by the partnerships affected and, secondly, they address outstanding issues with the implementation of two EU directives. The changes take effect for accounting years beginning on or after 1 October. The limited partnerships affected will have at least the whole accounting year to prepare.

I now turn to the second statutory instrument under consideration, the Companies Act 2006 (Strategic Reports and Directors’ Report) Regulations 2013, which covers narrative reporting. The Government cannot overemphasise the importance of clear concise narrative reporting by companies. The annual report is a key tool for shareholders to understand how their company operates, to hold it to account and to promote informed discussion at the company’s annual general meeting.

Over the years, the average length of annual reports has risen to more than 100 pages, with the longest being more than 500. This makes key information difficult to find and makes it hard for shareholders to gain an immediate understanding of how their company operates. To quote Sir Winston Churchill:

“The length of this document defends it well against the risk of its being read”.

That is why we propose a simplified framework to help companies focus on the key messages that they want to communicate to their shareholders.

Specifically, the Government will require the creation of a new section of the annual report—the strategic report—in which we expect companies to discuss their strategy, their business model and their principal business risks. The current structure is unhelpful to shareholders as this information is not in a prominent place and can be hard to find. We will also ask quoted companies to disclose other information necessary to understand their business, including about their impact on the environment, social and community matters, their employees, and human rights issues that the company needs to address.

For example, the tragedy in Bangladesh brings into sharp focus the need for companies to produce high-quality reporting on their social, environmental and human rights issues. Although there is no specific requirement for companies to report on their supply chains, the requirement in these regulations to report on human rights will provide a proportionate regulatory response. However, we recognise that business and government can do more, and the Government intend to publish the UK action plan on business and human rights later this year.

Businesses should be aware of the compelling case for respecting human rights in their activities, as it reduces operational risk, promotes prosperity and helps to establish a stable and sustainable market. The requirement to report on human rights will focus the corporate mind on these obligations and provide evidence for shareholders to hold their company to account.

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[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.

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The noble Lord, Lord Hodgson, made a valid point on a three-year review process. We do not want these reports to be any longer than they need to be. I am sure that over a period we will see what the Government would see as best practice and encouragement to develop it. With those thoughts, I look forward to the Minister’s response.

[Viscount Younger of Leckie]

My Lords, I thank my noble friend Lord Hodgson and the noble Lord, Lord Young, for their contributions to this rather short, succinct debate. I am very sorry to hear that my noble friend Lord Hodgson is so pessimistic about these proposals to make improvements to reporting. He made one or two good points, and I will pick them up, but he will not be surprised to hear that I do not agree with all the points he made.

My noble friend made a good point about the size of the report. The noble Lord, Lord Young, mentioned concern about extending the report to include a strategic report given the history of reports and the example of my noble friend Lord Hodgson of a report that was 15 pages a few years ago and is now 70 pages. It will be up to companies to decide how long their reports will be and, no doubt, they will want to make them as succinct and readable as possible to include the extra requirements. I hope that will include cutting down on other areas so that the reports will be more readable.

My noble friend Lord Hodgson was concerned about the disclosure of risk. He raised an important point. The guidance on the strategic side of the report will provide guidance for businesses on deciding their key risks. He made the important point that it is quite challenging for a company to decide what risks are under its control and what risks are not, such as the economy. The guidance is designed to help with that approach but it will be up to the company to decide what it puts into its report on an annual basis. This guidance will be published for consultation and I encourage my noble friend to respond when it comes out.

My noble friend Lord Hodgson and the noble Lord, Lord Young, raised the safe harbour provision. The answer to the question, “Is there a safe harbour provision for directors?” is yes. The detail is in paragraph 17 of the schedule. It extends the safe harbour provision in Section 463 to the strategic report. The Companies Act permits directors a defence that they were not reckless, and we have made a consequential change to the law to extend this safe harbour defence to the preparation of the strategic report. I hope that that gives some comfort to my noble friend Lord Hodgson.

My noble friend Lord Hodgson raised the issue of the numbers of women being included in the report. It is fair to say that he was somewhat exercised by this. However, I hope I can reassure him, and answer a question about this matter from the noble Lord, Lord Young, by saying that this is about ensuring that businesses are managing their boards better to understand their customers, investors and staff. Evidence suggests that diverse boards are better boards and help employees who may hope to move up into management. The whole objective is to be transparent and to provide full and purposeful figures and to allow stakeholders to look at the reports. The measure is designed to be helpful to them as opposed to simply not including them.

My noble friend Lord Hodgson did not agree that the single figure disclosure would provide accurate and useful information for shareholders. I think that he was referring to the new figures that will be required. He gave the example of a director’s pension. I totally understand his point about pensions being pretty complex and that to reduce them to a single figure is challenging. As regards the example that he gave, it would be fair to say that, just as in company reports and auditing reports, you would have a codicil saying, “This figure is particularly high because of a particular aspect”, which would make the issue clear. Perhaps my noble friend was making the broader point that if you put in single figures the whole time you may obscure the bigger picture. I hope I can reassure my noble friend that companies will have guidance on this and will have to make simplicity a byword when reporting these figures. The regulations will prescribe the minimum requirements but there is nothing to stop companies providing any other material that would help shareholders better understand the information or put it into context, which is the nub of the matter. My noble friend asked whether the Government would undertake to review the regulations and their effects. The noble Lord, Lord Young, also asked about reviewing. The Government have committed to review the regulations in 2017, which is not too far off, so I hope that gives some comfort.

The noble Lord, Lord Young, asked whether the strategic report would include a company’s ethics policy, which is an interesting point. The annual report will promote discussion at the annual general meeting on the ethics of the company’s business practice, so I hope that reassures the noble Lord. He also raised an interesting point about charitable donations and asked why we were planning to cut the figures relating to those donations. The format of the charitable donations disclosure required companies to disclose the name of the recipient, the amount and the true purpose. For those companies which make a lot of donations this was becoming a burdensome requirement. The total figure is still included in the accounts but the objective of this move is to leave out figures that are becoming somewhat meaningless and rather burdensome.

The noble Lord asked whether these measures had any tax consequences. There are no direct consequences and the tax transparent status of partnerships is unaffected. The changes that we are proposing do not amend the tax law. The noble Lord also asked about pay ratios and, specifically, why we did not require companies to report on the pay ratio between directors and the average worker, which is a fair point. Companies will have to say more about how the remuneration committee has taken into account employee pay and publish the percentage increase in the pay of the chief executive and that of the workforce. However, disclosure of pay ratios has its limitations and could provide misleading information. For example, a company with a large number of low-paid employees would have a big ratio but a company that had outsourced such employees, which might be less socially responsible, will none the less have a better ratio for entirely artificial reasons.

The noble Lord, Lord Young, asked whether apprenticeships could be covered in the report. Indeed, the company can include in it additional useful material. Where a company has several apprentices, we hope that it will inform shareholders of that and shout it from the rafters.

[Lord Young of Norwood Green]

I refer not only to apprenticeships but to training, given the importance of reskilling.

[Viscount Younger of Leckie]

Training, I would argue, comes under human resources policy. Again, it would be up to companies to decide whether they want to include specific training aspects. There is no obligation to do so, but they are wise to do so if it is going to materially benefit shareholders.

The noble Lord, Lord Young, asked why payment to creditors was omitted. The disclosure required companies to make a statement as to how they paid their creditors. Most companies, even rogue traders, stated that they paid their creditors on time. So we feel that the work on the prompt payment code, to which I alluded in my speech, will provide a better response.

The noble Lord also asked why there was a request to state the principal risk, which was a point that I made earlier in response to a question from my noble friend Lord Hodgson. It implements the terms of the EU accounting directive. That was a separate and extra point that I wanted to make.

I hope that I have answered all questions raised. If not, I shall be more than happy to write to noble Lords.

[Lord Young of Norwood Green]

I asked about the effect of the action plan and the requirement to report on business and human rights, and whether it had embraced or taken into account the UN Ruggie principles.

[Viscount Younger of Leckie]

Indeed, the noble Lord did ask that question. The human rights reporting requirement is broadly worded deliberately. However, it was inspired by the words of Professor Ruggie, which may be of some comfort to him. The FRC will provide guidance on how this may work.

Motion agreed.