Engaging stakeholders

The next wave of annual reports will shed more light on how companies are taking the needs of their stakeholders into account when running their business. Companies are under increasing pressure to justify how they are contributing to wider society – looking at the broader value they create in the long-term for stakeholders and the importance of those stakeholders for the company’s sustainable long-term success.

Investors are increasingly looking at non-financial information when making investment decisions. The climate change challenge we are currently facing highlights more than ever how crucial it is that companies articulate the environmental, social and governance (ESG) factors that will lead to long-term success and a resilient business model. The new disclosure requirements described below present directors with a real opportunity to showcase good governance and how they are discharging their duty to all stakeholders.

What’s new?

The Companies (Miscellaneous Reporting) Regulations 2018 (Miscellaneous Regulations) introduced various new requirements, listed below, for periods commencing on or after 1 January 2019. The scope of these requirements and which companies they affect, also summarised below, is not straightforward and needs careful study – it’s not just quoted companies!

1. Large’ and ‘ineligible medium sized’ companies (as defined in the Companies Act), including subsidiaries, need to include a section 172(1) statement in the strategic report detailing how directors have complied with their duty under s172 of the Companies Act, and publish it on a website.

s172 Duty to promote the success of the company

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

Section 172 is not a new duty in itself but the requirement to explicitly report on it is.

2. Large companies need to include a statement in the directors’ report summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others, and the effect of that regard, including on the principal decisions taken by the company during the year.
3. Companies where the monthly average of UK-based employees exceeds 250 must include a statement in the directors’ report summarising how directors have engaged with employees, how they have had regard to employee interests, and the effect of that regard, including on the principal decisions taken by the company during the year.
4. 4. Very large UK companies (those with 2,000 or more global employees or those with global turnover over £200m and a global balance sheet over £2bn) must disclose their corporate governance arrangements in their directors’ report and on their website.
5. All quoted companies with more than an average of 250 UK employees during the year must also make various additional remuneration disclosures including reporting annually the ratio of CEO pay to the average pay of their UK workforce.

While the s172(1) statement need only focus on matters that are of strategic importance to the company there is no materiality threshold for the new directors’ report requirements.

Interaction with other requirements

Some of the requirements look familiar - think the Non-financial Information Statement, 2018 Code, existing directors’ report requirements on employees etc. It is important not to fall into the trap of thinking that existing disclosures will meet the requirements of the s172(1) statement.

The new requirements focus on the board’s role. For example, employees are often cited as a resource a company depends on and in turn should be investing in. But how is the board engaging with its employees and considering their feedback in decisions such as a restructuring? Deloitte’s Annual Report Insights 2019 found that 90% of listed companies surveyed discussed how they engaged with employees (with the aim of getting feedback) but they are not necessarily explaining board involvement or the effect this has had on decision making.

A step change?

Only the odd company has produced a s172(1) statement early. On a recent webinar I presented for the Financial Reporting Faculty, only 15% of those required to prepare a s172 statement had started drafting it. But perhaps encouragingly, in Deloitte’s Annual Report Insights 2019 which looked at the 2018 reporting season, 31% already referred to the s172 duty to promote long-term success taking into account broader stakeholders. Companies are also identifying stakeholders more clearly and setting out how they engage with them; 29% discussed outcomes of engagement with stakeholders other than investors, such as work undertaken with suppliers to maintain standards and adhere to human rights policies.

Private companies, including subsidiary companies, may well find these new requirements more of a challenge, as they may need more incremental disclosure to meet the requirements if they have not previously had to prepare a strategic report that includes non-financial matters.

Given the requirement for website publication, s172(1) statements that cross-refer to other parts of the annual report will only be possible if that annual report is also available on the website. If not (historically many private companies have not published reports online), then cross-referencing would need to be the ‘other way round’ (ie, required information needs to be in the s172(1) statement).

Approaching the s172(1) statement

All companies are different and the aim is for meaningful disclosure rather than boilerplate. FAQs issued by the Department for Business, Energy and Industrial Strategy (BEIS) which accompany the Miscellaneous Regulations, the FRC’s 2018 Guidance on the Strategic Report and guidance from the GC100 are all useful sources of reference. Given s172 is not new, for many companies the statement is just reporting on what the board is already doing. However, some may take this as an opportunity to revisit and strengthen their policies and procedures. 12% of those on the webinar said directors are now more aware of the duty and changes have been made to the decision making process and 58% thought that maybe change is needed.

One approach, which is similar to that suggested by the FRC and BEIS, is to cover the following:

1. What is the board’s approach to its s172 duty? How is it covered on the board agenda, embedded in policies, practices, training and culture of the business?
2. Who are the key stakeholders that you depend on and impact, and how do you identify them?
3. What are the issues and factors relevant to complying with s172 and how did the directors form that opinion?
4. How have the directors engaged with, not just communicated to, those stakeholders to understand the issues?
5. What are the key decisions, such as those on acquisitions, disposals, capital allocation and dividend policy, that have been made in the period?
6. How has engaging with stakeholders affected the company’s decisions and strategies?

About the author

Amanda Swaffield is a director at Deloitte