July 23, 2015 Comply or Explain
“An effective corporate governance framework is of key importance to society, as well-run companies are likely to be more competitive and more sustainable in the long term.” Those are the opening lines from the European commission’s recommendation on the quality of corporate governance reporting (‘comply or explain’).
The recommendation, which was set out in April 2014, aimed to provide guidance to those responsible for national corporate governance codes with a view to improving the overall quality of corporate governance and reporting statements. As part of the recommendation, EU member states were invited to inform the Commission of measures taken to strengthen the ‘comply or explain’ element within their own financial reporting systems. The Financial Reporting Council (FRC) has now responded on behalf of the UK, with the full text of the response being available on the FRC website.
Welcoming the European commission recommendation, the FRC commented that “The ‘comply or explain’ method of adherence has given companies flexibility and made it possible to set more demanding standards than can be done through hard rules.” This has led to a sea change in reporting with the 2014 Grant Thornton survey of compliance by FTSC 350 companies concluding that 94% companies comply with all, or all but one or two, of the code provisions.
The FRC itself monitors compliance through a mixture of sample company reports and third-party analysis. Although compliance levels are high, the FRC continues to push for improvements; for example, having recently commenced a communications exercise to promote the flexibility of ‘comply or explain’. Further work is ongoing to monitor reporting by companies which have provided explanations that are not compliant with the code.
One of the benefits of the’ comply or explain’ code is that it moves reporting away from a completely standardised model and therefore enables companies to paint a true and fair picture of the state of the business, particularly when extraordinary items appear on the balance sheet. ‘Comply or explain’ is therefore not simply just an exercise to improve the clarity of reporting. Rather, it is a vital element of the relationship between companies and their shareholders, investors and other stakeholders.
Reporting in a clear, accurate and informative way helps those who are interested in investing in an organisation to make a balanced judgement about the way in which an organisation is governed and its future prospects. As such, code compliance helps organisations to not only look towards good governance principles but also to promote the delivery of business objectives.