Article:

FRC guidance on principal risk and longer-term viability reporting

11 December 2017

All companies that are required to prepare a strategic report must include in it a description of the principal risks and uncertainties faced by the company. Companies that adopt the UK Corporate Governance Code (the Code) and, for certain categories of risk, companies that fall within the scope of the new non-financial reporting requirements, are also explicitly required to indicate how those risks are being managed or mitigated. For other companies, this requirement is considered to be implicit from the more general strategic report requirements. Companies that apply the Code must also make certain disclosures about their longer-term viability.

The FRC’s Financial Reporting Lab (the Lab) has published a Project Report on disclosure of principal risks and uncertainties and longer term viability statements which identifies and gives examples of good practice and highlights areas for further improvement.

 

Principal risk reporting

The Report indicates that all investors are looking for principal risk reporting that is specific to the company and which avoids boilerplate disclosure and jargon. It notes that investors seek to understand both the principal risks identified by the company and how the company is managing those risks. It says that investors gain confidence in management when risk disclosures are:

  • Clearly linked to the business model,
  • Show any changes in risk year-on-year, and
  • Give some indication of the potential effects and likelihood of risks crystallising.

 

Longer-term viability statement

The Report states that disclosures provided by companies are not providing the information or insight that was intended when the longer-term viability statement requirement was first introduced into the Code in 2014. It observes that, when drafting these disclosures, directors tend first to identify the period over which the formal viability statement will be made (often three or five years) and then consider other aspects of the disclosure over that period. This approach makes the disclosures less useful for gaining an understanding of the longer-term prospects of the business.

To improve the usefulness of disclosures, the report recommends that companies adopt a two-stage approach to the viability statement.

  • Firstly, the directors should firstly consider and report on the longer-term prospects of the company taking into account its current position and principal risks; this period of assessment might be regarded in the context of strategic and business cycles, debt repayments, lease and capital investment periods and technology development periods.
  • Secondly, the directors should make the explicit statement on whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, drawing attention to any qualifications or assumptions as necessary. While the Code suggests that the time periods for the assessment of prospects and the explicit statement should be the same, the Report highlights that many investors would accept the period covered by the explicit longer-term viability statement to be shorter than that used to assess the business’ prospects.

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