EQ Bulletin - August 2022

In This Edition

• Financial Reporting Council - Position Paper Corporate Governance And Audit Reform
• HM Treasury UK Secondary Market Capital Raising Review
• Data Protection - Consultation Response
• HM Treasury – Financial Services And Markets Bill 2022-23
• Consultation On Audit Quality Indicators
• Audit Quality Review Results
• Research On Revised Stewardship Code
• Guidance On Running Effective AGM’s
• Feedback Statement 22/4 and Primary Market Bulletin 41
• Consultation Paper CP22/12
• Statutory Instrument

Financial Reporting Council - Position Paper Corporate Governance And Audit Reform

The Financial Reporting Council (FRC) has published a Position Paper setting out the next steps to reform the UK’s audit and corporate governance framework. The Position Paper sets out proposed changes to the UK Corporate Governance Code (the Code) which will be effective for periods commencing on or after 1 January 2024. It is intended that consultations on the proposed changes will take place from the first quarter of 2023. 

The focus of revisions to the Code will be as follows:

• Providing additional support in the existing Code Provisions, where reporting is currently weaker, taking account of issues raised in recent research and reports. These areas are outlined in the Review of Corporate Governance Report and Corporate Culture;
• Revising those parts of the Code which deal with the need for a framework of prudent and effective controls to provide a stronger basis for reporting on and evidencing the effectiveness of internal control around the year end reporting process;
• Making necessary revisions to reflect the wider responsibilities of the Board and Audit Committee for expanded Sustainability and ESG reporting and, where commissioned by the company, appropriate assurance in accordance with a company’s audit and assurance policy;
• Including a Provision for boards to consider how audit tendering undertaken by the company takes account of the need to expand market diversity; and
• Updating the Code to ensure that it covers proposed changes to legal and regulatory requirements as set out in the Government Response, including strengthening reporting on malus and clawback arrangements.

The revisions to the Code will be supported with updated guidance on Guidance on Audit Committees, Guidance on Board Effectiveness, Guidance on Risk Management, Internal Control and Related Financial and Business Reporting.

In relation to Corporate Reporting, guidance will be developed in the following areas The Resilience Statement; Fraud Reporting by Directors; The Audit and Assurance Policy and related disclosure requirements; and Capital Maintenance and Dividends, including distributable profits – to succeed the existing ICAEW/ICAS guidance. However, there will be the need for either primary or secondary legislation to be passed before these changes are implemented. The FRC Guidance on the Strategic Report will also be updated, although this will be delayed until the Government has set out its policy regarding the use of International Sustainability Disclosure Standards in the UK.

Read More: The Position Paper

HM Treasury UK Secondary Market Capital Raising Review

HM Treasury (HMT) has published its report into the review of the UK Secondary Capital Market.

The report contains 21 recommendations some of which are being recommended for immediate implementation, in summary these are:

• the Pre-Emption Group (PEG) should be put on a more formal and transparent footing. This would include having a dedicated website with a searchable database of pre-emption regime information and the publication of an annual report on the operation of the pre-emption regime.
• routine support for disapplication resolutions up to 20%, on a 10%+10% basis. The ability for companies to issue up to 20% of their issued share capital that was introduced when the Covid-19 pandemic first hit in 2020 should be made permanent and the PEG’s Statement of Principles updated accordingly.
• post-transaction reporting. After a placing, companies should report publicly on how it was carried out. This should be done using a short, template form downloadable from the Pre-Emption Group’s website and made available publicly via an RIS in the week after the placing. 
• PEG guidance to restrict use of the cash box structure to circumvent pre-emption rights. In connection with undocumented placings, cash box structures should only be used for up to the amount of the pre-emption disapplication authority that has been granted by shareholders at the company’s most recent annual general meeting.
• PEG guidance to support case-by-case consideration of higher disapplication authorities for capital hungry companies. Companies that need to raise larger amounts of capital more frequently should be supported by shareholders, if appropriate in the circumstances, if they request a disapplication of pre-emption rights of more than 20% in any one year or a disapplication over a longer period. 
• Issuers should give due consideration to the interests of retail shareholders, as well as other existing shareholders, and how to include them in a non-pre-emptive offer as fully as possible. On all capital raisings, including undocumented placings of up to 20% of issued share capital, companies should give due consideration to the interests of retail shareholders, as well as other existing shareholders, and how to involve them in the offer as fully as possible.

These changes should be implemented by the Financial Reporting Council and PEG.

There are several recommendations to be implemented in the near term, which includes the shortening of the period a prospectus for an IPO involving a retail offer has to be made available to the public to a maximum of three working days. This should be implemented by the Financial Conduct Authority (FCA) in the near term as part of its wider review of the prospectus regime on implementation of the outcome of the UK Prospectus Regime Review.

Admission to trading prospectuses should remain subject to prior FCA approval but should be required for secondary offers only where the offer size is at least 75% of existing share capital, The FCA’s approach to working capital statements, whereby clean statements cannot be accompanied by disclosure of assumptions made by the company in making its confirmation, should be reconsidered and revised to allow greater flexibility. A secondary offer should not trigger the need to appoint a sponsor.

Other recommendations include the flexibility to reduce the notice period where a general meeting is required. The Companies Act 2006 should be amended to give the Secretary of State the flexibility, without further primary legislative change, to reduce the notice period for shareholder meetings other than annual general meetings to seven clear days as soon as the necessary operational systems are in place. This should be implemented by the Department for Business Energy & Industrial Strategy (BEIS) in the medium term. Companies should continue to be able to seek annual allotment and pre-emption rights disapplication authorities from their shareholders of up to two-thirds of their issued share capital, but with authority extending not just to rights issues as is currently the case but to all forms of fully pre-emptive offers made based on the updated pre-emption provisions. The Investment Association should implement this in the near term.

The pre-emption provisions in the Companies Act 2006 should be amended to align them to the process that is usually followed on a rights issue or open offer when a disapplication resolution has been used to modify statutory pre-emption rights. This should include the ability to exclude shareholders in overseas jurisdictions where the cost and burden of extending the offer to them would be disproportionate, flexibility to deal with fractional entitlements through aggregating and selling them, as well as permitting the new shares to be offered to securities holders with a contractual right to them (such as convertible bondholders, warrant-holders and preference shareholders) as if they were holders of ordinary shares. This should be implemented by BEIS in the near to medium term.

Ahead of the proposed move to the full digitisation of shareholding an amendment should be made to Section 793 of the Companies Act 2006 to additionally require disclosure of the identity of the ultimate investment decision maker or beneficial owner in relation to a share. This is in addition to the information about its shareholders that is already provided to a company when it does a section 793 "sweep", the identity of the ultimate investment decision maker or beneficial owner in relation to a share is also disclosed. This should be implemented by BEIS in the near to medium term.

Move to a system where all shareholders, institutional and retail, hold their shares in fully digitised form. The move to a digitised shareholding system should be made more of a priority. It should be coordinated and driven by a newly established Digitisation Task Force, with an independent chair to head it and a technically experienced second-in-command. This should be implemented by HM Treasury and BEIS in the near term.

Read More: HM Treasury UK Secondary Capital Market Report

Data Protection - Consultation Response

The Department for Culture, Media and Sport has published its response to a consultation on proposed UK data protection laws reforms. The Government intends to introduce a Data Reform Bill in 2023, which will include a range of proposals, including matters relating to AI, accountability requirements, cookies, and reforms of the Information Commissioners Office.

Reform of accountability framework: In recognition of the disproportionate burden weighing on some organisations, the Government will introduce a more flexible accountability framework underpinned by a ‘privacy management programme’ for businesses (‘PMP’). The intention is to move away from a tickbox mentality and enable organisations to take a more flexible and measured approach to compliance, based on the level of processing activities and the volume and sensitivity of personal data they handle. The requirement for a data protection officer will be replaced with the requirement to appoint a designated senior individual (‘DSI’) responsible for embedding an organisation-wide culture of data protection. Organisations will still be required to identify, manage and mitigate risks, but they will be granted greater flexibility to do so and the requirement for data protection impact assessments (‘DPIA’) will be removed. The requirement to consult the ICO prior to any high-risk processing activity will be removed. 

Legitimate interests and the “balancing test”: Where a data controller is relying on “legitimate interests” as a lawful means for processing personal data, the data controller must always consider whether the interests of the employer or relevant third party are outweighed by the rights of the relevant data subjects. This is known as the “balancing test”. The government intends to introduce a limited list of circumstances for which organisations could rely on “legitimate interests” without applying the “balancing test” and without unnecessary or inappropriate recourse to consent.

Read More: Data Protection – Consultation Response

HM Treasury – Financial Services And Markets Bill 2022-23

The Financial Services and Markets Bill (the Bill) received its first reading in the House of Commons on 20 July 2022.

The Bill which has 73 clauses and 12 Schedules will amongst other matters:

• give the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) a new secondary objective to advance long-term UK economic growth and international competitiveness. Also included is new regulatory principle for the FCA and the PRA, requiring them when discharging their general functions to have regard to the need to contribute towards achieving compliance with section 1 of the Climate Change Act 2008.

• Revoke and replace certain financial services retained EU law through a transition to new requirements under the regime established by the Financial Services and Markets Act 2000. A list of the EU regulations and related legislation to be revoked is detailed in Schedule 1 of the Bill.
• Encourage the development of innovative technologies, including the safe adoption of cryptocurrencies.

The Bill is scheduled to have its second reading on 7 September 2022. Apart from certain provisions as detailed in clause 72, the reforms to be made by the Bill will commence on dates to be appointed by HM Treasury in statutory instruments.

Read More: Financial Services And Markets Bill 2022-23

Explanatory Notes

Financial Reporting Council - Consultation On Audit Quality Indicators

The Financial Reporting Council (FRC) has issued a consultation on the publication of audit quality indicators (AQI’s) for the largest UK audit firms, which would provide users of audited information with greater detail on audit firms’ efforts to deliver high quality audit. The 11 proposed AQIs would provide stakeholders with a range of comparable indicators on perceived culture within an audit firm, audit quality inspection results, staff workloads, and the level of partners’ involvement in individual audits. Currently there is limited available information that compares audit quality between the firms so setting out AQIs to enable discussions between Audit Committee Chairs (ACCs) and audit firms on the drivers of audit quality will help ACCs to make more informed comparisons between firms when appointing external auditors.

The consultation will close on 18 August 2022. Views are sought on the following matters amongst others:

• Whether the requirements should apply to all firms that audit more than 20 PIEs or at least one FTSE350 company.
• Whether the AQIs should include all audit engagements but be presented separately for PIE and non-PIE audits.
• Whether it would be useful for firms to provide supporting narrative for the numerical data.
• Its proposed AQIs. These include, briefly, the percentage of favourable and unfavourable responses from audit staff to certain annual survey questions; percentage of audits meeting key planning milestones by target completion date; internal quality review hours as a percentage of total audit hours; percentage of audits inspected externally, by quality grading; number of audits internally reviewed as a percentage of total number of audits completed during the period, with quality grading; average hours spent on audits as a percentage of total audit hours by engagement partners and key audit partners; average staff utilisation rate by grade in the audit practice, with a separate number for the busy period of January to March; average staff attrition rates by grade in the practice; average number of mandatory training hours per person; and the percentage of individuals in audit leadership, by gender and ethnicity.

The FRC intends to publish a final version of its proposals in late 2022; and a guidance note providing definitions, to aid consistency. Subject to responses, it plans that the reporting of AQIs should cover the period 1 April – 31 March each year, taking effect from 1 April 2023, with a view to reporting them to the FRC by the end of May 2024, for publication by the FRC shortly thereafter. The FRC advises there may need to be a transition period for those firms that do not currently publish AQIs.

Read More: Financial Reporting Council – Consultation On Audit Quality Indicators

Audit Quality Review Results

The Financial Reporting Council (FRC) has published its annual inspection and supervision results of the largest audit firms (BDO, Deloitte, EY, Grant Thornton, KPMG, Mazars and PwC). Overall, 75% of audits inspected were good or required limited improvement (compared to 71% in 2021 and 67% in 2020). Five of the largest firms had no audits requiring significant improvements. The inspection results at Mazars and BDO remain unacceptable. Four of the eight audits reviewed at Mazars, and five of the 12 audits reviewed at BDO required more than limited improvements. Specific supervisory plans have been developed to closely monitor BDO and Mazars’ priority actions.

Read More: Financial Reporting Council – Audit Quality Review Results

Research On Revised Stewardship Code

The Financial Reporting Council (FRC) has published a report it commissioned on “The influence of the UK Stewardship Code 2020 on practice and reporting”. The report has identified the positive impact the revised UK Stewardship Code (Code) has had on the practice and reporting of asset managers and owners. The research, which took evidence from 55 asset managers and owners, found that both groups are very positive about the impact of the Code and that there was strong evidence of material changes to practice in the areas of governance, resourcing, stewardship activities, outcomes and reporting.

Amongst other things the report found in relation to governance that large asset managers had separate environmental, social and governance (ESG) and stewardship teams, which worked more closely with specialist investment teams. In contrast, stewardship responsibilities were embraced directly by the investment team of small asset managers. Both asset owners and asset managers reported increases in the resourcing of stewardship, mostly dedicated to the growth of stewardship teams and use of external experts. Respondents noted that the development of the Code has been useful for their engagement practices, with all respondents undertaking some form of engagement and escalation with companies. Asset owners reported that the most significant way the Code has influenced their approach is that they now feel more empowered to monitor their investment managers. Respondents were also supportive of the Code’s contribution to industry-wide change, with some celebrating the Code’s focus on long-term goals for the investment community.

Read More: Financial Reporting Council – Research On Revised Stewardship Code

Guidance On Running Effective AGM’s

For the first time the Financial Reporting Council (FRC) has published guidance for listed companies to enhance effective shareholder participation when planning and conducting Annual General Meetings (AGM’s) although the seven principles identified in the guidance can also be applied to general meetings (GM). The guidance gives practical advice in the form of suggested actions to help companies ensure that meetings are well-run constructive forums for effective engagement. The seven principles identified are:

• Information disseminated prior to the GM must offer clear instructions on how to attend the meeting and participate, in order to enable effective shareholder engagement.
• Whether meetings are physical, hybrid or virtual (should the legal position be clarified), shareholders should, as far as practicable, be able to engage in the business of the meeting.
• The board should provide an update at the AGM on matters raised by stakeholder groups that are considered by the board to materially affect the company’s strategy, performance, and culture.
• Companies should seek the broadest access to and participation in GMs by a diverse range of shareholders. Whether attending virtually or in person, shareholders should have the opportunity to raise questions pertinent to the meeting agenda.
• Shareholders should be able to cast their vote in real-time or submit a voting instruction in advance via the appointment of a proxy, depending on the format of a meeting. Appropriate technology should be used by companies to ensure that shareholders have the ability to appoint proxies and send instructions to proxies prior to the meeting.
• Companies should be as transparent as possible with shareholders in relation to matters discussed and raised by shareholders at the GM
• Effective and transparent shareholder engagement should not be limited to an annual event. Opportunities to update shareholders on company matters should be offered throughout the year, with an emphasis on ensuring all shareholders have access to similar information.

Read More: Good Practice Guidance For Company Meetings

Feedback Statement 22/4 and Primary Market Bulletin 41

The Financial Conduct Authority (FCA) has published Feedback Statement 22/4 and Primary Market Bulletin 41 following the issue of consultation paper CP21/18 Enhancing climate-related disclosures by standard listed companies and seeking views on ESG topics in capital markets.

The major focus is on ESG related debt instruments with the FCA:

• encouraging issuers of ESG-labelled Use of Proceeds (UoP) debt instruments to consider voluntarily applying or adopting relevant industry standards, such as the Principles and Guidelines that the International Capital Market Association (ICMA) has developed for green, social, and sustainability bonds,
• reminding issuers, their advisors and other relevant market participants of their existing obligation to ensure any advertisement is not inaccurate or misleading, and is consistent with the information contained in the prospectus, and

• encouraging issuers and their advisors to consider verifiers’ and assurance providers’ expertise and professional standards, and to engage with second party opinion (SPO) providers and verifiers who adhere to appropriate standards of professional conduct, such as ICMA’s Guidelines for External Reviewers.

Read More: Feedback Statement 22/4

Primary Market Bulletin 41

Consultation Paper CP22/12

The Financial Conduct Authority (FCA) has issued a consultation paper CP22/12: Improving Equity Secondary Markets. The consultation is open until 16 September 2022. The FCA states that it wants to improve how equity markets operate. They aim to reduce harm by amending provisions that impose compliance and operational costs on firms, but which do not deliver demonstratable benefits to end users or to the functioning of equity markets. The FCA are also seeking views on amendments which aim to improve the quality of post-trade information and the efficiency of consolidating trade reports from multiple sources. Additionally, views are sought on future guidance on outages, with the aim of enhancing the resilience of UK markets and on the structure of UK markets for retail orders. Specifically, on whether improvements can be made to the way retail orders for shares are executed in the UK. 

Read More: Financial Conduct Authority – Consultation Paper CP22/12