This post – about the s172(1) statement – is our second covering the new annual report disclosure requirements for 2019. Our first post explained the purpose of purpose, and how it fits within your annual report.
The new reporting requirements are effective for December 2019 year ends. They arise from the 2018 UK Corporate Governance Code and the Companies (Miscellaneous Reporting) Regulations 2018.
The s172(1) statement
Both the Code and the Regulations introduce new requirements for boards to explain how they have taken account of stakeholder views and met the requirements of s172 of the Companies Act. Specifically, the Code states that:
“The board should understand the views of the company’s other key stakeholders and describe in the annual report how their interests and the matters set out in section 172 of the Companies Act 2006 have been considered in board discussions and decision-making.”
The Regulations formalise this by requiring companies to include a s172(1) statement in their annual reports, 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.”
The matters set out in section 172(1) (a) to (f) are:
(a) the likely consequences of any decision in the long term;
(b) the interests of the company’s employees;
(c) the need to foster the company’s business relationships with suppliers, customers and others;
(d) the impact of the company’s operations on the community and the environment;
(e) the desirability of the company maintaining a reputation for high standards of business conduct; and
(f) the need to act fairly between members of the company.
Taken together, the Code and the Regulations now require companies to do two things:
- explain how the company and (in particular) the board have engaged with key stakeholders; and
- explain how the board has reached key decisions and the likely impact of those decisions, including how it has taken account of the company’s stakeholders in doing so.
The business model identifies your company’s primary stakeholders, which for most companies are their customers, employees, suppliers, communities and shareholders. Depending on the nature of your business and how it’s financed, you might also have other significant stakeholders, including debt providers, regulators, pension funds and others.
You should discuss every stakeholder you reference in the business model in the stakeholder engagement section. However, there’s no need to include every possible stakeholder group. The FRC’s Guidance on the strategic report states that the s172 statement should only focus on matters of strategic importance, so feel free to leave out any stakeholders that aren’t key to your business. Ideally, the report will explain the methodology you used to identify your stakeholders.
For each stakeholder group, best practice is to set out:
- why it’s important to you;
- how your company engaged with that stakeholder group, including identifying whether the board also directly engaged or whether it was kept informed by other means (e.g. reports from management);
- what the key issues are for each stakeholder group; and
- what actions the company took as a result of stakeholder feedback.
You can present this in tabular format or as regular body text.
Some of the information required here may already be included elsewhere in the report and you should cross-reference it to avoid repetition. For example, you might not have any specific environmental stakeholders you engage with. Cross-referencing to environmental reporting elsewhere in the annual report should meet the requirement for the board to consider the impact of the company’s activities on the environment. You may also find it suits you better to discuss engagement when reporting on particular topics (e.g. how you manage your people) rather than in one place, and you should cross-reference in these cases too.
Impact on decision making
Nothing in the regulations or the Code requires you to describe specific board decisions and how they were reached. However, as best practice emerges from the next round of reports, we expect that the leading reporters will describe their key board decisions. Others may choose to select one important decision as a case study. The alternative is a general description of how the board reaches its decisions but this is likely to appear boilerplatey and lack real insights for the reader.
If you do decide to include key decisions, these will probably be matters reserved for the board’s approval and could include:
- changes to the strategy
- M&A activity
- major capital allocation decisions, such as new investment, share buybacks or special dividends
- approval of significant new policies
- changes to remuneration and incentive structures
In practice, there are likely to be very few decisions each year that the annual report needs to describe.
For each decision, the s172(1) statement should cover:
- the consequences for the company’s long-term success;
- the impact on risk management and the company’s principal or emerging risks;
- how stakeholder interests were considered and what influence they had on the decision; and
- the impact on affected stakeholders and (where relevant) the environment.
Depending on the nature of the decision, the report could also cover its impact on the company’s culture and its reputation for high standards of business conduct.
Most business decisions will not have any impact on the need to act fairly between members of the company. However, there may be cases where, for example, companies consult major shareholders ahead of a particular decision. In these circumstances, your report will need to explain how the interests of all shareholders were protected.
Where does the s172(1) statement go in the annual report
The Regulations are clear on this: it’s a strategic report disclosure. This might seem surprising, since the statement focuses on the board and its decision making, but it is part of a general blurring between corporate governance reporting and the front end of the annual report.
The s172 statement is a significant change and as at the date of this post (October 2019) very few companies have adopted it early. Among the handful that have, implementation is patchy, with an emphasis on stakeholder engagement and very little on principal decisions. It’s likely that practice will evolve over several reporting cycles.
Complying with s172 – an alternative view
There is an alternative way to comply with s172, which is to bear in mind the s172 requirements as you are drafting the strategic report and work the content in where it fits best. The chairman and chief executive statements are obvious candidates for some of this. This would allow the s172 statement itself to be a simple acknowledgement of compliance with the requirements, coupled with a table of cross references to where the relevant information can be found.