Auditors' reports on firms that report on compliance with the UK Corporate Governance Code
Alongside strengthening its Governance Code for premium-listed companies in 2012, the FRC, in its role as regulator of external auditors, now requires them to provide an expanded audit report for those companies. This guidance note explains how AFM is incorporating the new standard for its members.
From 30 September 2013 year-ends, the external auditors of FTSE companies are required to:
Those auditors are also required to report by exception any inconsistences they detect concerning whether the following requirements of the Code are adhered to, that:
The intention is that there will be a fuller description of the work the auditor has undertaken giving more insight to investors, or other users of the accounts, than the existing binary pass/ fail model of published audit reports.
The auditors are expected to coordinate descriptions of overlapping topics addressed in the section of the annual report describing the work of the audit committee in discharging its responsibilities and to avoid duplication of reporting about them.
Whilst the auditor may already document and communicate its judgments in private reports to the board or audit committee, there will no doubt be more time and effort devoted going forward as to how the information should be published and as to the appropriate place in the annual report and accounts.
The FRC has published a new standard, as well as an example auditor's report on its website.
FRC states that its new requirements apply to entities that choose voluntarily to report on how they have applied the UK Corporate Governance Code. We have tested this position with FRC and with a number of audit firms, as follows:
First, does "the Annotated Code" constitute "the Code" itself?
The AFM has an involved process for updating the Annotated Code in line with the Code, promoting adherence by members through the annual Questionnaire, collecting systematically "comply or explain" responses and reporting overall results to regulators. Members report in "comply or explain" terms on individual provisions of the Annotated Code in their annual report and accounts. This appears, in substance, as close to the Code as you can get, even if a legal argument could be mounted to the contrary.
Second, there has been a debate amongst auditors on the intended reach of the requirement beyond premium-listed companies.
The FRC noted in feedback on the proposals that some mutuals (Industrial and Provident Societies were cited) may not be as well equipped to deal with the demands and that they may not meet a cost-benefit test. They further noted that the proposals may deter voluntary compliance - which cannot be a desirable outcome. Elsewhere they state that the changes "may" apply to friendly societies in circumstances where the friendly society has voluntarily chosen to report on how it has applied the UK Corporate Governance Code.
The problem for mutuals and their auditors is that the requirement is in an Auditing Standard, ISA 700, and so there would not normally be a "comply or explain" choice in the matter. To limit the scope of an audit is not tenable. As FRC's view is that AFM members, as voluntary subscribers to the UK Corporate Governance Code, should adopt the standard, there appears little if any discretion.
This is reinforced by the views of ICAEW, which recently reported on firms that voluntarily apply the Code, citing AFM's approach and stating: 'If entities decide they have reported voluntary compliance then this will not only require their auditors to adopt the new ISA (UK&I) 700 reporting paragraphs but will also require the directors to include a statement that they consider the annual report is fair, balanced and understandable and state whether the annual report appropriately discloses those matters that the auditors communicated to the audit committee.' In short AFM members that subscribe to the Annotated Corporate Governance Code should apply the new audit standard in consultation with their auditor. Your external auditor should be aware of the nature of recent discussions with FRC, not withstanding the late confirmation of the application of the standard.
AFM members should therefore adopt the new standards now, taking account of the following likely impacts:
In addition to the requirements introduced via the new audit standards, the most recent version of the Code, which comes into effect for 2013, includes some other new audit requirements, in particular, that the audit committee should include in its report within the annual report details of the significant issues that the committee considered in relation to the financial statements, and how these issues were addressed.
As an example of how listed companies are already adopting the standard, see pages 88 and 89 of the Vodafone 2013 annual report.
AFM would welcome feedback on any concerns from members on applying these new requirements.
The Annotated Corporate Governance Code was updated in October 2012, and as well as reflecting the above, carries across the requirement from the FRC Code for FTSE 350 companies to put their audit out to tender every ten years. AFM anticipates its members will seek to adopt the same practice where practical and proportionate.
It should be noted that there are transitional rules which apply to the FRC guidance; this may be important to members over the next 10 years in avoiding unnecessary cost: Corporate Governance Code
FRC has produced some helpful good practice notes on undertaking an audit tender.
Association of Financial Mutuals, October 2013
AFM Predecessors are Association of Mutual Insurers and Association of Friendly Societies
Annual election of all board directors has become commonplace in PLCs, since it was incorporated into the Code in 2010. This was a reaction to governance failures and their contribution to the financial crisis. Annual elections give members an opportunity to react to the performance of the company and are also required for directors that have served for more than nine years.
Board includes committee of management.
The UK Corporate Governance Code (previously called The Combined Code), subject to the annotations made by AFM in the Annotated Corporate Governance Code (current version dated 2012).
Company means a mutual insurer and includes a friendly society.
Code Provision of the Code.
Diversity includes but is not limited to gender. Directors may differ in many important characteristics, such as educational and functional background, industry experience, social connectedness, insider status, gender, and race. The Davies report in 2011 put forward a voluntary target for gender diversity for the boards of listed companies of 25% by 2015.
The organising of a group of people to achieve a common goal using proactive entrepreneurial behavior by optimising risk, innovating to take advantage of opportunities, taking personal responsibility and managing change within a dynamic environment for the benefit of the organisation
Externally facilitated performance evaluation
An external facilitator brings rigour and struture to the performance evaluation of a board, as well as an independent and impartial perspective. Evaluation of the board of larger companies should be externally facilitated at least every three years. The external facilitator should be identified in the annual report and a statement made as to whether they have any other connection with the company.
Fair, balanced and understandable
This broad definition of the basis on which the annual accounts was prepared is intended to address the concern that the narrative report should reflect the board's considered view of the information that members and other users of the annual report and accounts needed, rather than being viewed as promotional in nature, and to ensure that the narrative and financial sections of the report were consistent.
Independent non-executive director
Member of the Board of Directors of an entity who is an outsider, meaning he or she is not an employee of or otherwise closely connected with that entity. An example is a broker sitting on the Board of a client company. Such directors are important because they bring unbiased opinions regarding the company's decisions and diverse experience to the company's decision-making process. In order not to have a conflict of interest, independent directors should not participate on the boards of directly competing businesses. Directors are typically compensated based on a standard fee for each board meeting, or on an annualised basis.
A Large Company is any mutual that does not meet the definition of a small mutual i.e. because it has gross premium income on average over the preceding three years of £20 million per annum or more and/or it has assets on average at the end of the last three financial years of £100 million or more.
Although mutual insurers do not have shareholders, the principles underpinning the provisions of the Code are relevant and should be considered in relation to appropriate methods for facilitating direct member dialogue and involvement that may be in place (such as member forums or panels and/or delegate systems) and/or any members with significant membership rights. Also referred to as principal shareholders and significant shareholders in the Code.
Main Principle of the Code.
A recommendation from: "The Myners review of the governance of life mutuals published in December 2004"
Performance evaluation is a key means by which boards can recognise and correct corporate governance problems and add real value to their organisations. Boards who commit to a regular evaluation process find benefits in terms of improved leadership, greater clarity of roles and responsibilities, improved teamwork, greater accountability, better decision making, improved communication and more efficient board operations.
Senior independent director
The role of the Senior Independent Director includes the following:
Small Company means a mutual with gross premium income of under £20 million per annum on average over the preceding three financial years and assets of less than £100 million on average at the end of the last three financial years.
Supporting Principle of the Code.
The Companies Act 2006 codified certain common law and equitable duties of directors for the first time. The Act sets out seven general duties of directors which are:-
The statutory duties do not apply to the directors of friendly societies, although they must comply with very similar duties under the common law.
Unfettered powers of decision
No one person should be able to make major decisions about the organisation on his or her own.
Unitary boards include both executive and non-executive directors and make decisions as a unified group. By comparison a two-tier board has a separate management and supervision board
"Year" means the financial year of the company in respect of which the questionnaire is being completed