- There was broad support for Sir Donald Brydon’s recommendation for a new Resilience Statement, with investors expressing frustration with the lack of clarity in disclosures today.
- Participants in our roundtable called for change to be implemented now, this includes:
- clarity around the narrative on the business model;
- higher quality disclosures on risks and the links to resilience; and
- more transparency on downside scenarios and what is driving the different outcomes.
- Investors value disclosures that clearly link business risks and viability to the key aspects of the company’s business model.
- The link to capital maintenance and adequacy of distributable reserves was also noted by participants.
- Participants expressed diverse views on the role of the auditor: some were in favour of more assurance, others believed that leaving it to directors’ discretion was sufficient.
- We strongly encourage all stakeholders to respond to the upcoming BEIS consultation to ensure their voice is heard on this important recommendation.
KPMG recently issued a paper to prompt further thought and discussion around this important recommendation. It is designed to outline KPMG’s views on the benefits of his proposals, as well as the key questions which we believe need to be resolved to avoid unintended outcomes and what can be done to improve the way in which company resilience is reported today using existing requirements.
We invited institutional investors, analysts and investor associations to discuss and debate what a resilience statement should look like to meet shareholder needs. The discussion yielded several key insights which we trust will assist in progressing the debate.
Participants expressed a broad range of views on several of the topics discussed in our paper, which fall broadly under three themes:
- Change is needed now
- Which disclosure elements investors value most
- What the auditor’s role should be
There was broad support for Sir Donald’s recommendation. However, it was noted that these proposals will require changes to reporting standards and will inevitably take time to implement. Some say this could take at least three to four years.
There was unanimous agreement that current disclosures are too boilerplate and limit the ability of investors to engage with companies. Company reporting needs to improve now using existing requirements. According to one participant:
“Right now, reporting from companies on business model is very poor. It’s very generic. There is very little clarity on what the business model really is, how the company achieves its strategic advantage and maintains it in its marketplace.”
Attendees at our roundtable discussion were frustrated that the existing disclosures do not give them the information they need and the meaningful business context to make an informed assessment. They noted that the front half of the annual report is often too lengthy and yet doesn’t tell them much. They called for better narrative disclosure and improved risk reporting to focus their attention on the most important threats.
Participants also noted that many companies routinely make investments over time horizons of 10 to 20 years or more – e.g. in the energy sector. They contrasted this with the ‘insufficient’ time horizons used in companies’ viability statements, which are typically limited to only three years.
What can investors do to encourage change now?
We encourage investors to engage with companies they invest in and call for change now using existing requirements. Here are some examples of disclosures they can ask for:
- Mitigations: more transparent disclosures around the use of mitigations and whether these are within management’s control.
- Time horizon: directors to assess a period of at least 5 years in the viability statement.
- Scenarios tested: to avoid boilerplate disclosures, companies could include within viability statements descriptions of the scenarios that have been tested.
- Strategic report: this should demonstrate a story coherent with the directors’ conclusions and include detail of the assessment of long-term threats and the response to those risks.
- Financial statements disclosures: These should provide sufficient detail into prospects for future cash flows in the light of current uncertainty.
Which disclosure elements do investors value most?
One of the key benefits attendees saw in Sir Donald’s recommendation was the link between viability and business models. The proposals would shine a light on business models that are not resilient to those risks directors have identified. Shareholders will in turn gain a better understanding of how risks can impact a company and the board’s risk appetite.
Investors also welcomed the proposal aimed at delivering better information on the scenarios that could jeopardise the resilience of the business. This is something they feel they do not get at the moment, even though companies do sometimes provide sensitivity analysis on certain factors – e.g. the impact of currency or interest rate fluctuations on earnings per share and debt. These analyses are considered insufficient because under extreme scenarios, the observed correlations tend to change radically.
Investors believe that what is truly needed is clearer narrative on the types of external shock or internal failures that would really cause a company to fail. At the moment, companies are typically very reluctant to talk about such extreme scenarios publicly. At our event, an example given was that of the many companies that gave guidance in Summer 2020 that did not consider scenarios in which their business would be affected by further pandemic-related lockdowns. One participant noted that, to the best of their knowledge, no companies really considered scenarios where there would be a massive decline in economic activity or where interest rates would significantly increase.
Participants also noted that the information provided should not be limited only to what it takes for a company to ‘go bust’. While investors would take comfort in seeing that it would take a lot to cause a company to fail, the issue many investors have is that disclosures on downside scenarios often lack granularity – e.g. on key issues like the split between fixed and variable costs. If there is a macroeconomic shock, such as a lockdown, it’s very hard for investors to assess how this might impact the company.
While this wasn’t the focus of the discussion, attendees also called for improved disclosures on distributable reserves. KPMG issued a paper in December 2019 to prompt further thought and discussion around this complex and important topic. We also held a roundtable discussion with investors and other key stakeholders earlier this year. You can read the highlights from the discussion here.
What should the auditor’s role be?
Sir Donald recommends that the auditor should report to the Board if they have anxieties over a company’s resilience that are not reflected in the Resilience Statement. If the auditor does not consider that the Board has paid enough attention to their concerns, the auditor would be obliged to report that fact to ARGA (the Audit, Reporting and Governance Authority – the proposed successor of the Financial Reporting Council (FRC)). Attendees agreed with our view that if auditors have concerns, then this information should also be shared with company shareholders (e.g. in the audit report) instead of only reporting concerns privately to regulators.
The investors we spoke to would like to better understand how risks and disagreements between the auditor and the Board are handled. This information was considered important to drive more meaningful engagement with Boards and potentially better voting decisions. While there is often challenge and disagreements between auditors and Audit Committees this is not usually visible to the investor community. Attendees valued qualitative commentary from auditors – and what we describe as graduated findings – to provide better information on whether the assumptions made by management are conservative or optimistic.
Sir Donald recommends that the short-term Resilience Statement be audited in the same way as today’s going concern statements. The directors would have the option to obtain independent assurance and commission further work on the medium- and long-term statements. This would be outlined in the Audit and Assurance policy (also recommended in the Brydon Review), which would be subject to an advisory vote by shareholders at the AGM.
Some participants believed that assurance over the medium- and long-term statements should remain optional, and that the advisory vote on the Audit and Assurance policy was sufficient. However, a number expressed concerns that, given the current requirements were not applied appropriately today, assurance would be needed to hold companies to account and deliver the change envisioned.
Those in favour of greater assurance noted that they would welcome the auditor’s views of assumptions used and consistency in application in other areas where forward looking assumptions are made. Consistency across peers or within the industry they operate in would also be helpful. Some also called for the auditor to ensure there was consistency between what is in the financial statements and other information shared with the capital markets such as preliminary announcements.
At the time of writing, it is our understanding that the FRC is planning to develop further several of the key public policy recommendations, including this one on a new Resilience Statement.
The Department for Business, Energy and Industrial Strategy (BEIS) is also expected to publish its consultation on audit market reform soon, including a response to the recommendations suggested in the Brydon Review and the BEIS Select Committee Report on the Future of Audit.
We strongly encourage all stakeholders to respond to the consultation to ensure their voices are heard as regulatory and legislative changes take shape. In the meantime, we would welcome any further comments from investors and other key stakeholders on which disclosures they feel would be valuable in this area.
About KPMG Investor Insights
Our roundtable discussion with investors and analysts was held on 3 December 2020. It is one of a series of investor outreach events we hold to discuss and share perspectives on how corporate reporting, auditing and assurance, and stewardship can evolve to meet investors’ needs today and in the future. To find out more, visit our web page or follow KPMG Investor Insights on LinkedIn. If you would like to discuss any of the areas in more detail on a one-to-one basis, contact us at email@example.com.
Latest developments and perspectives on corporate reporting and stewardship for investors.
Latest developments and perspectives on corporate reporting and stewardship for investors.