According to a report from the Financial Reporting Council’s financial reporting lab, (the lab) investors believe it is essential to have an understanding of a company’s principal risks, both before making an investment and while holding it. A change in a company’s risk profile is one factor that could lead investors to change the size of their shareholding.
One of the “reliable sources” of information on risk is the annual report and they use it as part of a suite of information (including investor presentations, prospectuses and media, among others) to help them assess a company’s principal risks and mitigating activities.
So, over the last decade since the financial crisis, investors have benefited greatly from companies’ increasing focus on risk management and the comprehensive reporting of principal risks that it has given rise to.
They have also gained from improved engagement with companies which in turn has led to better understanding of how boards identify and manage risk.
However, the lab's discussions with companies and members of the investment community, together with a survey of 200 private investors, reveal that the investors would like to see further improvements.
In particular, they want companies to provide greater contextualisation of principal risks and make sure there is good linkage to relevant areas in the annual report. They also complain about the use of “excessive business jargon and too technical aspects of risk management”.
As one investor is quoted as saying, “The more honest and open a company is on risk, the more confident we’re going to be that they’re looking at the issues in the right way and have an intelligence around the table considering it.
“If it is all good news, you’d worry that they are burying things. Honesty has to be the best starting point.”
In response, the companies say that they are concerned about reporting principal risks comprehensively without giving away commercially sensitive information and competitive advantage.
While investors have generally welcomed the improvements in risk reporting, they are less impressed by the progress companies have made with their viability statements.
The lab found that companies tend to treated the statement as an extended going concern confirmation rather than a means of communication positive messages about the long-term prospects of the company.
Most companies in the FTSE 350 pick three years as the period for their viability statement but investors would like companies to look beyond three to five years to show their stewardship responsibility and to make it clear that they are thinking about the company’s future beyond the tenure of the current executive management.
And while they don’t expect companies to give unrealistic expectations, they would like to see the board’s assessment of the wider risks and prospects of the company beyond the medium term.
“They are looking for disclosure which gives them confidence that the board is addressing long-term threats to the company’s business model and is making strategic decisions which maintain the relevance of the company in the long-term,” the report says.
The lab report contains examples of best practice taken from annual reports and accounts and includes a letter sent at the end of last year by Schroders to its FTSE investee companies.This explains what it expects to see in their viability statements and points to the statement in the 2015 accounts of FTSE 100 precious metals group Fresnillo as a good example of what it is looking for.