Principles-based reporting – a failed concept that needs axing - FutureValue 800-2312-323
Principles-based reporting – a failed concept that needs axing
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The UK prides itself on its distinctive approach to narrative reporting in published Annual Reports and Accounts. Principles-based reporting uses a broad set of conduct principles enshrined in legislation and set out by government and the financial services regulator.  It means that entities covered by reporting regulations can decide on how to implement them most appropriately. Despite much smug self-acclaim in the UK, principles-based reporting has never really worked effectively. Few companies aspire to and achieve a high standard in their strategic and director’s reports. There is no required audit of narrative reports and most of those who advise companies on what and how to report are largely devoid of the appropriate breadth and depth of business experience needed. The regulator has also shown a reluctance to take companies to task over their reporting standards. A simple rules-based approach to reporting that defines precisely what is required might make life easier, cutting cost and aiding comparability between companies. It would leave the stage clear for companies that want to differentiate themselves in their reporting and demonstrate long-term potential, on a voluntary basis. In a technology-driven reporting world could this be a simpler, more realistic future?

There is more than a little of the British values of fair play, trust and integrity underlying the concept of principles-based regulation and reporting. Its effective application requires good intention on the part of listed companies as well as a number of checks and balances. First, it requires these reporting companies to adhere to the spirit as well as to the letter of a broad set of reporting regulations and requirements; there is an expectation of expansive and informative disclosure almost as a minimum. It demands reporting advisers who have extensive business understanding and experience as well as detailed knowledge of what good governance looks like. It requires an institutional investment community that holds investee companies to account if a company’s reporting is not to the minimum standard or is otherwise perceived to be inadequate.  Above all it requires an objective and fully independent regulator prepared to make examples of those who do not comply, while at the same time acknowledging high standards of reporting by those entities that demonstrate the highest principles.

The reality has proven different to the concept. Despite much trumpeting, principles-based reporting has never really worked. A very high proportion of reporting companies sets the basest of standards, aiming at best merely to comply; but, comply with what? A broad set of principles leaves a lot open to interpretation. Even then few reporting advisers have the depth of business knowledge or experience to set their clients on the right path, covering business models, strategy, KPIs, risks, resources, relationships, integration etc. Investment analysts, those who should be challenging investee companies, do little better. Despite the good intentions of the Stewardship Code analysts remain focused on financial and transactional reporting, reflecting their own particular skills and experience. Indeed, FutureValue’s decade-long research confirms that the general standard of narrative reporting by listed companies has not improved, contrary to exaggerated claims made by the FRC. In addition to this fact is the reality that narrative content in reporting is not audited while at the same time there is little evidence of the FRC performing an adequate role of policing the application of reporting regulations. The recent lacklustre report from the FRC’s own Corporate Reporting Review Committee, rapidly rushed out, bears testimony to this. Principles-based reporting amounts to a nebulous concept wide open to abuse in its application.

What is required is a more prosaic future where required narrative reporting does not pretend to be all things to all people. We should stop kidding ourselves that UK reporting standards are unique and exceptional. Convincing others that they are has been a clever con trick that has helped spawn the IIRC with it integrated reporting framework – a silver lining to the reporting cloud at least. Imprecise and vague narrative reporting that defies comparability also does not lend itself to a more technology driven reporting world that is more transactional in nature and focused on numbers and words more than on meaning. What matters going forward is a reporting environment that prescribes a simple, minimum standard of compliance to a rule-based set of closely defined business terms, published in a specified formulaic manner and varied only for sectors that have quite distinct circumstances. Companies that recognise the value in richer, more expansive standards of narrative reporting, and want to invest in achieving those standards, can adopt the IIRC’s integrated reporting framework on a strictly voluntary basis. In our opinion basic no-frills reporting that conforms to technology constraints and meets XBRL requirements should be the focus and pre-occupation of the regulator. FRC or its successor can then hold reporting companies to account more overtly, with more conviction and without the need for interpretation of what is published. After all, is it the job of the regulator to encourage anything more than mere compliance to a basic reporting standard? We would argue it isn’t.