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The new “Section 172(1) Statement” – What do you need to do?

You may be aware of the new reporting requirements approved by Parliament in the form of The Companies (Miscellaneous Reporting) Regulations 2018, which are due to come into effect on 1 January 2019. In this blog, we outline what the new requirements are, when they come into force, who has to comply, and how companies might go about making the changes.

black fountain pen with lid resting across barrel on purple backgroun

What are the new reporting requirements?

The new reporting requirements relate to the directors’ duty to promote the success of the company, which is prescribed in section 172 of the Companies Act 2006.

This duty states that:

172(1)  A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to –

  • the likely consequence of any decision in the long term
  • the interests of the company’s employees
  • the need to foster the company’s business relationships with suppliers, customers and others
  • the impact of the company’s operations on the community and the environment
  • the desirability of the company maintaining a reputation for high standards of business conduct
  • the need to act fairly as between members of the company.

In addition to the mandatory information already required in the strategic and directors’ reports, directors will now also have to include a separate, clearly identifiable Section 172(1) statement which describes how the directors have had regard to the matters set out in section 172(1)(a) to (f) when performing their duty under section 172.

When do the new reporting requirements come into force?

The new requirements will take effect for the financial year starting on or after 1 January 2019. As the requirements relate to statements being made in the annual report and accounts, in practice, the first annual reports needing to include this statement will not be written until 2020.

However, despite the statements themselves not being due until 2020 it is important that company secretaries and directors start thinking about the requirements now. Although the Board should already be having regard to s172 in its decision making, it might want to think about how it would evidence this in its future s172 statement.

Which companies need to include a s172 statement?

Any company defined as large under the 2006 Act (including private and AIM-listed companies) by meeting two of the following:

  • £36m or more turnover
  • £18m or more balance sheet assets
  • 250 UK employees (excluding any employees who work mainly or wholly outside the UK).

It is worth noting that for quoted companies, there is likely to be links and overlaps between the reporting requirements in the strategic and directors’ reports and the Section 172 statement.  Companies should therefore consider clear cross-referencing where appropriate which could reduce the duplication within the annual report.  Further, as the new Section 172 Statement will be included in the annual report it will be publicly available.

What about subsidiaries?

Subsidiaries who qualify will also have to report, separately, as under the Companies Act 2006, directors owe their duty to the specific company, and not the parent company.  However, the regulations do accept that some decisions will be taken at the group level, and in this case clear cross-referencing may be appropriate. Directors will need to consider carefully how to do this to ensure the necessary statements are made and that they are clear as to which organisation they refer to, especially where the subsidiary may meet the criteria but the parent does not or vice versa, or through consolidation.

What if your company does not have to make its strategic or annual report public?

Unquoted companies do not have to make their strategic / annual report publicly available, but will be required to make their Section 172 Statement available as soon as reasonably practicable. This will likely be on the company’s or group’s website, or another suitable website provided it is clearly identifiable as the company’s Section 172 Statement.

Reporting on stakeholder engagement

Section 172 separates stakeholders into two groups; employees and “suppliers, customers and others”.

Employee engagement

In relation to reporting on employee engagement, the s172 statement is in addition to the Part 4 Employee Statement for companies with more than 250 UK employees (where 250 is the average number of persons employed during the financial year), and so must be cross-referenced to the Section 172 Statement. The Part 4 requirements are:

(a) describing the action that has been taken during the financial year to introduce, maintain or develop arrangements aimed at:

(i)    providing employees systematically with information on matters of concern to them as employees

(ii)   consulting employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions which are likely to affect their interests

(iii)  encouraging the involvement of employees in the company’s performance through an employees’ share scheme or by some other means, and

(iv)  achieving a common awareness on the part of all employees of the financial and economic factors affecting the performance of the company, and

(b)   summarising:

(i)    how the directors have engaged with employees;

(ii)   how the directors have had regard to employee interests, and the effect of that regard, including on the principal decisions taken by the company during the financial year. 

Other stakeholder engagement

Reporting on engagement with other stakeholders should summarise how the directors have fostered the company’s business relationships with suppliers, customers and others, and how regard to those groups have effected principal decisions taken by the company during the financial year.  It can be less detailed than the statement given in regard to employees as there are many different types of stakeholders to be reported against, but can still include information on how the business engages with different groups and takes their views into account.

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What should the statement look like and how detailed should it be?

There is no specific guidance on the format that should be used. One example, would be to include a stakeholder map to show the key groups and their inter-relationships, including the wider environment and the impact of the company’s decisions on all stakeholders.  It is possible that the interests of one group cannot be aligned with the interests of another, and the directors should explain how they have balanced this.  The company could also explain how the values, vision and mission of the company contribute to the business’s long-term success, and the impact of policies and decisions such as workforce, diversity, corporate social responsibility or dividend payments.

There is no guidance on the level of detail required from companies.  The statement should be clear, with enough information for shareholders to see that meaningful discussions took place, taking into account, for example, the needs of individuals compared to those of institutional investors.   It can also go beyond the absolute legislative requirements if the company wishes, such as discussing the UK Corporate Governance provisions regarding a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director.

If the engagement is not related to a strategic item or intent, it can be cross-referenced to the directors’ report rather than the strategic report.

Information that is prejudicial

Companies do not have to report anything that could be seriously prejudicial to the interests of the business, such as matters currently being negotiated or finalised.

There may be situations where to secure the long-term future of the company, a decision to close or reduce a particular part of the business is required.  This will obviously have a significant impact on employees, customers, suppliers and others. In these situations, directors should explain the process they have worked through in making such decision, and how the impact has been mitigated as much as possible.

What other changes are made by these new reporting regulations?

As well as the new s172 statement, the regulations also impose regulations on companies of a certain size:

  • to set out their governance arrangements in their directors’ or strategic report; and
  • for quoted companies to disclose certain pay ration information in regards to CEO pay.

Directors’ Report obligations for large, private and public unlisted companies

The thresholds for compliance are much higher than that required for the Section 172 Statement, and applies to unlisted companies with either:

  • More than 2000 employees; or
  • A turnover of more than £200m and total balance sheet assets of more than £2bn globally.

It should be noted that the Wates Group is looking at reporting requirements for large private companies (due to be published in December 2018) and so this may change following the conclusion of their work.

Large UK-operating subsidiaries of global organisations which meet the criteria for reporting, will have to make a Statement.

The regulations require:

  • … the directors’ report must include a statement (a “statement of corporate governance arrangements”) which states:
    • which corporate governance code, if any, the company applied in the financial year,
    • how the company applied any corporate governance code reported under (a), and
    • if the company departed from any corporate governance code reported under (a), the respects in which it did so, and its reasons for so departing.
  • If the company has not applied any corporate governance code for the financial year, the statement of corporate governance arrangements must explain the reasons for that decision, and explain what arrangements for corporate governance were applied for that year.

The company can choose the most appropriate code for them to follow. This “code” may not describe itself as such and may use the term “framework” or “guidance” instead.  However, companies should include enough information to explain how they have applied the code and any deviations from that code.  

For companies whose workforce may flex under or over the 2000 employees, there is a provision for a two-year time lag, which directors should be aware of if this applies.

The statement should be available on the company’s website, or a website on behalf of the company. 

Companies exempt from this reporting requirement

  • Companies who declare under the Disclosure Guidance and Transparency Rules 7.2 are exempt from this requirement. Premium and Standard-listed companies are required to report this information under different regulations
  • Community Interest Companies
  • Charities
  • Those companies under the AIM Rule 26 and Quoted Companies Alliance Code may see some additional reporting.

 

Directors’ Remuneration Report obligations for quoted companies

As part of the directors’ remuneration report, quoted companies will be required to include a defined table of the ratios between the CEO’s Single Total Figure of Remuneration (STFR) to the 25th, 50th(median) and 75thpercentile FTE total pay and benefits for their UK employees.  Any changes from year-to-year will also need to be explained, and how the ratios reflect the company’s policies on pay, reward and progression.  If there has been more than one postholder within the financial year, the total pay and benefits should be used. 

UK employees are defined as “a person employed under a contract of service by the company, other than a person employed to work wholly or mainly outside of the UK” and should be calculated across the group where appropriate.  Agency staff and contractors who are employed by a separate organisation, or who may be working for more than one company, are not included within the count.  

The regulations provide three methodologies for calculating the ratios, and the company should explain the reason for the option chosen, assumptions made and comparisons to previous years.  There is guidance if some of the information required to calculate the total pay and benefits is not available.   These ratios should build to a ten-year record, or longer if the company so wishes.

The impact of share price appreciation or depreciation on executive remuneration should be explained within the directors’ remuneration report, and specifically the impact of a 50% growth in the share price.  The Remuneration Committee Chair should outline any discretionary decisions taken in relation to executive remuneration. The 250 minimum employees does not apply to share price implications, as companies of all sizes base their executive remuneration on share price.  

The report should be clear and concise, highlighting to the shareholders the key areas within the reporting period. 

Quoted Companies are as defined by the Companies Act 2006 as being quoted on the UK Official List, the New York Stock Exchange, the NASDAQ or a recognised stock exchange in the European Economic Area. 

Companies exempt from this reporting requirement

  • Companies listed on the Alternative Investment Market are not required to report on remuneration ratios.
  • Other corporate structures, such as Limited Liability Partnerships, are also exempt.

 Need more advice and guidance on the new requirements?

As Governance experts, the team at Bridgehouse can assist your business with the new reporting requirements. Call on us to help ascertain which of the requirements are applicable to your business, or to assist with drafting or reviewing your annual reports.

For more information and to get in touch click here.

 

References

Department for Business, Energy and Industrial Strategy – Corporate Governance: The Companies (Miscellaneous Reporting) Regulations 2018 – Q&A  (June 2018)

Financial Reporting Council – Guidance on the Strategic Report  (July 2018)

PricewaterhouseCoopers In Brief – A look at current corporate governance and reporting issues  (June 2018)