Reporting guidance all at sea? - FutureValue 800-2312-323
Reporting guidance all at sea?
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Dear Financial Reporting Regulator

Brighton pier is a good way of getting to France – but only so far as it goes. It’s a good start, but no more than that. This analogy summed up our evaluation of the initial Guidance on the Strategic Report published in June 2014. It was a good start but needed to go an awful lot further if it was to fulfil its declared purpose as enshrined in statute.

We had hoped that any future revision to the guidance might go further and close the metaphorical gap. Our considered opinion is that this 8/2017 draft guidance does add some important aspects but still has a long way to go, leaving report users metaphorically stranded in mid-Channel. The destination hasn’t changed. The declared purpose remains the same – “to inform members of the company and help them assess how the directors have performed their duty under section 172”. The addition of the EU non-financial reporting requirements simply helps to give more definition to the destination.

As regulator, you can add further refinement in finalising this revision to the guidance. We hope you will do so, although we question whether the timing of this consultation process, so close to the first adoption and application of the guidance by more than two thirds of FTSE350 reporting entities, will give you freedom to make substantive change to the draft guidance.

For more than a decade our business has been working with FTSE350 clients to improve the effectiveness of their corporate reporting and the strategic value added in that reporting – first in operating and financial reviews and latterly in strategic reports. Over this period we have established that there is a broad positive correlation between the quality of strategic value in reporting and market performance. However, our research and analysis has revealed only limited improvement generally in the quality of long-term, strategic value-added corporate reporting across the FTSE350, with some singular exceptions.

We have observed that companies have found the effort and cost of reporting to the highest standard outweighs in their estimation the potential benefits and their achievability. Innovation is also anathema in corporate reporting despite your exhortations as regulator. Companies will always look to what others have done before them. This has led us to conclude that if guidance is to drive best practice, it needs to be better than good. It needs to be exemplary to the point of being unimpeachable. This draft guidance has a long way to go to achieve that.

Guidance also needs to be directive. As regulator, you seem to pussyfoot around giving specific direction for fear that it will seem prescriptive and erode the principles-based approach that underlies UK reporting. This is a fallacious assumption. Good direction is essential and above all to matters of strategy. It is this strategy content reported in a broad, cohesive manner that can do most to communicate the long-term potential of decisions and outcomes that are also central to helping shareholders in line with S172 CA2006.

Good direction amounts to guidance that presents a clear and logical strategy framework. This framework should show unequivocally how FRC sees the cascade of the constituent strategy elements with a precise definition offered for each strategy term used. Reporting entities will then match their own thinking and plans to the logic. Better consistency and comparability will have marked benefit for investors and other stakeholders – consistency and comparability that is presently absent. This is being directive, not prescriptive.

Our extensive experience and these observations have shaped the lens through which we have reviewed the draft guidance. Our detailed comments follow in respect of each of the questions you have posed.

Question 1: “Do you agree with the approach for updating the Guidance for the changes arising from the implementation of the non-financial reporting Directive?”

Incorporating the non-financial disclosure requirements within the strategic report as part of a single cohesive document and in an integrated manner is the right thing to do. This pertains under any circumstance. However, we do not concur that this revision of the guidance should additionally seek both to enhance the linkage between S172 and the purpose of the strategic report and, to make targeted improvements to the guidance to reflect key developments in corporate reporting. Addressing these other two aims in the same revised guidance that addresses the statutory non-financial reporting requirements adds complexity in scope and content that a significant proportion of reporting entities will struggle to cope with adequately.

Question 2: “Do you support the enhancements that have been made to Sections 4 and 7 of the Guidance to strengthen this link?”

FRC claims that: “this update is not intended to be a fundamental review”. Conflating these three aims in this revision to the guidance serves to create a complex revision that will seem very challenging, if not wholly fundamental, to a significant proportion of reporting entities. Our considered opinion is that FRC should have addressed these revisions in two stages over two reporting cycles, at least. FRC should have concentrated on introducing the statutory non-financial reporting requirements this year alone, deferring its other aims for the guidance until 2018, and until after the revisions to the corporate governance code have been settled upon. Given that this revision of the guidance does address these other two aims and that FRC is unlikely to row back on including them in the final guidance we feel obliged to comment on them in our response to the consultation.

We address our specific recommendations for improvement to Sections 4 and 7 in our response to Question 3 that follows directly.

Question 3: “Do you have any suggestions for further improvements in this area?”

We are firmly of the opinion that Section 4, in addressing the purpose of the strategic report, should recognise the key role of the two fundamental elements of the strategy framework – ‘purpose’ of an entity and its ‘business model’. ‘Purpose’ is the fundamental existential statement that explains why the entity exists. ‘Business model’, in its full strategic form that this guidance now and at last correctly seeks to give it, establishes the basis that drives the profitability and success of a business – what an entity does, how it leverages its key sources of value and why these sources of value will drive the entity’s profitability and growth over time. New paragraph 4.3 does not mention ‘business model’ or for that matter ‘purpose’, the new elemental piece of strategy framework, introduced for the first time in Section 7.

The amended Section 7 does enhance the linkage and add helpful encouraged content elements. However, Section 7 is complex and will prove to be a challenge to many. It introduces new reporting concepts without providing a credible overall context or rationale in the form of a robust, logical strategy framework. The introductory paragraphs 7.1 to 7.7 are a hotchpotch.  They include: an amended schematic of the section’s content [7.1]; a reference back to the purpose of the strategic report (yet again) [7.2]; a mention of interdependencies and materiality [7.3 & 7.4]; the freshly added concept of ‘purpose’ [7.5 & 7.6]; and, the demotion of ‘objectives’ [7.7] from their previous role in the earlier extant guidance. The schematic in 7.1 adds little, if any, insight, beyond covering the contents of the section. The transfer of ‘Trends and factors’, as shown on the 7.1 schematic, from being a contextual ‘Business environment’ matter to becoming now a ‘Business performance’ issue, defies logic and suggests that the architect of these changes may lack an inherent understanding of strategy.

Missing from Section 7 is an indicative structure that sets out a complete clear, logical basic strategy framework for reporting companies to identify with, and to provide an essential rationale. While strategy terminology will be unique to each reporting entity, the logic of the strategy framework in Section 7 of the FRC’s guidance should be clear, unequivocal and universal.  ‘Purpose’ sets out why an entity exists. ‘Business model’ (as re-defined in the draft) expounds what an entity does what it does, how it does it and why it will remain profitable and grow. These two – purpose and business model – are the foundations of strategy.

The concept of ‘ambition’, ‘vision’ or ‘mission’ (or perhaps more specifically a ‘goal’) is missing from the guidance. While entities may use these varied strategic terms in subtly different ways to suit their own strategic thinking (and they have different definitions for strategists) these words share a common function – to confer an essential sense of strategic direction – the outcome that the elements of an entity’s strategy are collectively working towards. This sense of strategic direction is missing from the guidance.

A report user should be able to look at the declared strategic direction of an entity and broadly appreciate that the elements of the strategy presented in a strategic report seem both individually necessary and collectively sufficient to achieve the declared outcome. This should give a quick and intuitive understanding of an entity’s long-term rationale to the most strategically illiterate report user. Presently, they cannot do this based on the current or proposed revised guidance. ‘Objectives’ will be the measured achievements (sometimes called targets when attached to KPIs) that help explain the relative success in the pursuit of each element or priority of an entity’s strategy; as such they are typically short- to medium term, tend more to be operational and, as such, are indicators of strategy implementation.

FRC’s guidance should present the minimal basic strategy framework for entities to match in the presentation of their own strategies. Report users and particularly investors will then be able to make comparisons between entities more readily and more effectively. The logic of strategy is universal, adaptable to every company and should in no way be a straitjacket. FRC should put the minimal basic strategy framework for entities to match in the presentation of their own strategies at the heart of this guidance.

Without a broad sense of strategic direction included in Section 7, strategy presented under this guidance will tend to be devoid of logic, structure and even meaning. It will also seem to be more of a current operating plan in its content and focus, and removed from the FRC’s express desire to have reporting entities address the longer term per S172.  FRC makes the point of wanting to avoid being prescriptive. This predisposition has led to an unfortunate outcome in that FRC avoids giving clear direction, to the point of seeming even vague and woolly in some of its guidance, particularly in respect of its base strategy framework and terminology.  Ten years of evaluating first operating and financial reviews and latterly strategic reports for the quality of strategic value added by FTSE350 entities have demonstrated to us at FutureValue that most reporting entities will make minimal effort, aiming at compliance more than best practice. Lack of clarity in the FRC’s expectations and guidance, and its subsequent policing, are strong contributory factors to a sufficing, compliance culture among the reporting community.

In summary of our answers to Questions 2 and 3, we support the enhancements in Sections 4 and 7 in concept but not the structure or scope of the amendments. We believe that Section 7 needs an extensive re-think and re-working around a closely defined, well-presented and clearly articulated strategy framework to give clear direction.

Question 4: “Do you agree with the draft amendments to Section 5?”

These seem consistent with the aims of the revised guidance and the scope of the revisions.

Question 5: “Do you have any suggestions on how the Guidance could encourage better linking of information in practice, or common types of disclosures that would benefit from being linked?”

A clearer and more logical strategy framework presented graphically as a basis for reporting entities to draw on (and as suggested in our response to Question 3) will demonstrate the linkages that entities should aim to make. (We can elaborate on these, if asked to do so)

The most important yet presently absent linkages are between strategic reports and corporate governance reports. Strategy is about process as well as content. It is a living entity. Strategy processes are as important as, if not more important than strategy content in the strategic management of an entity. The strategic report as constituted is all about strategy content linked to an entity’s past performance, its present status and its expected application.

For a shareholder or other report user to ascertain how effective is the strategic management of an entity, he/she will have to do some detective work when reviewing an annual report to learn more about the strategic processes and their outcomes. Does the Chairman mention the strategy processes in his statement or perhaps in his introduction to governance? Where is the viability statement? Is it at the end of the risk section or perhaps buried as a procedural item in the Directors’ Report? Has the viability statement been expanded to give some insight into strategy processes underlying the company’s affirmation of viability over whatever period? And if all these draw a blank, what do the reporting of the leadership or even the accountability principle in the corporate governance report say about how the Board engages with its strategy?

In summary, given that there are separate strategic reports and governance reports, there needs to be a clear linkage between an entity’s strategy processes – including also consequent outcomes, decisions and actions – and its strategy content. After all, the strategy presented in a strategic report is in effect a snapshot in time. Strategy processes reveal the quality of ongoing strategic management, and an entity’s capacity to review, adapt and assess its strategy effectively on a continuing basis. Good intuitive strategy and clear credible processes can show an investor how strategic management transcends into strategic leadership. It is this infusion of confidence among investors that helps to reduce market volatility at least.

FRC should re-consider paragraphs 6.21 to 6.25 to address specifically linkage to strategy process to strategy content. Siting of information about strategy processes and their outcomes would need to be added to Section 4 and Section 7.

Question 6: “Do you agree with how the sources of value have been articulated in the draft amendments to the sections on strategy and business model in Section 7?”

‘Sources of value’ are an essential addition to the guidance.  To enable entities to understand and interpret their sources of value it will help to persuade them to look at their complete value systems and the relationships that make up the linkages across their respective value system. Value is in part a function of relationships and of how entities interact with suppliers, distributors, partners, influencers and customers across and beyond their organisational boundaries. FutureValue’s experience indicates that value in the form of intangibles is a concept not well understood by a significant number of reporting entities. The rationale for inclusion of sources of value needs to be better made in the guidance. The only possible place for this at present is as an extension to paragraph 7.17.

While 7.12 makes the connection between business model and sources of value, 7.17 could do more to make clear why it is important for reporting entities to address and include them. Distinct sources of value contribute uniquely to current profitability. Sustainable and distinct sources of value contribute uniquely to future profitability and to growth. Communicating an understanding of these should be pivotal to engaging the shareholder effectively.

Innovation in corporate reporting is restricted to very, very few reporting entities. FRC cannot seriously expect reporting innovation to drive future best practice. It has not done so to any extent, despite FRC’s appeals in the 2014 guidance for the strategic report. Changes to any entity’s strategic report, in our experience, inevitably start with inquiry about what its peers or competitors are doing or have done. Imitation not innovation is the order of the day in UK corporate reporting. This is another reason why FRC needs to be more directive in its guidance and be less concerned about seeming to be prescriptive.

Question 7: “Do you consider that disclosures on how value is generated would be helpful?”

This is a good idea in principle but a bridge too far at this stage for the large majority of reporting entities. EY’s ‘Accounting for Long Term Value’ model seeks to interpret value generated for various stakeholders and so examples from their research might be useful.

Question 8: “Do you consider that the draft amendments relating to reporting of non-financial information give sufficient yet proportionate prominence to the broader matters that may impact performance over the longer term?”

Yes, and these are perfectly adequate on a standalone basis. FRC could and should have presented these as the sole required changes to strategic reports in this reporting cycle.

Question 9: “Are there any other specific areas of the Guidance that would benefit from improvement?

We have made a point in answer to Question 5 that merits re-iteration and emphasis here.

The strategic report and corporate governance reports are two separate chapters of the annual report typically prepared in most reporting entities by two quite different functions and with limited interaction between them during annual report preparation. Yet these two chapters of annual reports are two sides of the same coin.

How a Board and its executive team engage with the entity’s core strategy processes adds insight to the shareholder and to other report users. The outcomes, decisions and actions that flow from these processes – monitoring strategy implementation; assessing performance against strategy; reviewing, exploring, renewing strategy; allocating capital – are critical to establishing the long-term success of an organisation. This information may conceivably appear in the chairman’s statement in the strategic report, in his introduction to the corporate governance report, in the viability statement that may of itself be in different places, or within the corporate governance report itself. There is a case to be made for coverage of the Board’s engagement with strategy processes to be included principally in the strategic report.

Long-term corporate success is due more to the processes underlying strategy and their outcomes and actions than it is to the snapshot of strategy content that is to be found in the strategic report. These processes and their outcomes confirm the entity’s capacity to renew and to repeat its success. The essential change required to capture strategy process is beyond this revision to strategic report guidance. There is a case at least for better linkage of strategy content and strategy process with signposting or even referencing between strategic and governance reporting.


We trust you will give our comments due consideration. We will be pleased to elaborate or add further clarification of our comments.

Your sincerely

for FutureValue