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Operating and Financial Review


16th March 2006

This is a story of incompetent government, the misleading of British companies, the failure of co-operation between the Department for Trade and Industry and the Treasury, and a fundamental misunderstanding of the needs of British business on the part of

Mr. Djanogly: I basically agree with the hon. Member for Kingston and Surbiton. It is a sad state of affairs that gives rise to this statutory instrument. This is a story of incompetent government, the misleading of British companies, the failure of co-operation between the Department for Trade and Industry and the Treasury, and a fundamental misunderstanding of the needs of British business on the part of this Government.

As has already been stated, the OFR is a report that was to be required by about 1,200 of the largest quoted companies, providing certain information such as the objectives and strategies of a company and the main factors affecting and likely to affect the company's performance. That included information on matters such as the environment, employees and social and community issues.

These regulations remove the requirement for companies to prepare an OFR. Although the Conservative party originally opposed the OFR as an exercise in Labour gold-plating of European regulations, we recognise the wasted millions of pounds spent by companies preparing for the OFR's introduction and we recognise also the need to question the chaos that the Government have caused with the OFR and its replacement.

Rob Marris: Perhaps the hon. Gentleman will explain why-to use his words-millions of pounds are being wasted when a company could, even if this statutory instrument goes through, produce an OFR anyway, quite voluntarily and according to the framework.

Mr. Djanogly: I shall come to the hon. Gentleman's point later. Business wants certainty, let me put it that way. That is the weakness in his argument.

Despite our opposition to more regulation on business, supporting corporate best practice and social and environmental responsibility very much continues to be Conservative party policy on corporate governance issues. However, that can best be done by promoting best practice rather than by creating uncertainties for directors in relation to their liabilities. Parts of the Company Law Reform Bill dealing with directors' duties purport to promote best practice.

Many of our companies have for some years been showing the highest principles of involvement in environmental and community projects at home and abroad. They should be given the opportunity to demonstrate their achievements to a wider audience. As research by the accountants Deloitte and Touche showed, 82 per cent. of quoted companies already produce OFR-style reports. Government should be holding up those companies as an example. As I will demonstrate, the scrapping of the OFR and the resultant confusion will place a significant extra burden not least on unquoted companies, which will need to write extensive business reviews.

Meanwhile, companies remain uncertain about their obligations, and it is uncertainty that business does not like. As has been said, some companies are still preparing their OFRs. The Financial Times this morning reported John Davidson, a corporate lawyer with Lovells, the City law firm, saying:

"'Companies have done a considerable amount of OFR work. They will continue with that.' But anything that carries any sort of risk of possible liability will not appear. 'They will take the template for the OFR and strip out any forward-looking information,' says Mr. Davidson."

In other words, there is uncertainty about what information has to go into the OFR.

The history of the OFR is a fascinating insight into a Government who have clearly lost their sense of direction on corporate regulation generally, and on best practice corporate governance specifically.

On 5 May 2004, the Department of Trade and Industry announced a consultation on draft regulations for the OFR and highlighted the publication of guidance drawn up to help companies prepare for their OFRs. On 25 November 2004, the DTI announced that the new OFR would "help strengthen corporate Britain". On 22 March 2005, the Companies Act 1985 (Operating and Financial Review and Directors' Report) Regulations 2005 came into force, with affected companies obliged to produce their OFRs by 1 April 2006. In May 2005, the Accounting Standards Board issued an accompanying reporting standard; namely, that compliance with RS1 raised a rebuttable presumption of compliance with the OFR regulations.

On 28 November 2005, as the hon. Member for Kingston and Surbiton explained extremely well, the Chancellor announced that the Government had decided no longer to require quoted companies to prepare an OFR in addition to the business review now required under the EU accounts modernisation directive. The Chancellor gave no supporting research or information for his decision-or should I say diktat?-and the only reaction from the DTI, which was meant to be running the process, was deathly silence.

On 15 December 2005, the DTI announced that regulations had been laid before Parliament to repeal section 243AA of the Companies Act 1985, which required quoted companies to publish OFRs. In January 2006, the Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations 2005 became effective, thereby removing the requirement for quoted companies to produce an OFR, and the Accounting Standards Board converted RS1 OFR into a voluntary statement on best practice.

On 1 February 2006, the Chancellor agreed to consult on the OFR nine weeks after scrapping it. The Minister confused the issue somewhat by talking about consultation on the Company Law Reform Bill [Lords], but I believe he will admit that the Chancellor did not consult on getting rid of the OFR. In fact, on 7 March 2006, Treasury documents were released that showed that the Chancellor scarcely bothered to consult Cabinet colleagues before scrapping the OFR. Today we are debating the scrapping of the OFR by regulations, despite an ongoing consultation on it that is meant to end by the 24th of this month.

The most recent development is hardly a surprise, considering the lack of co-ordination between Departments that is demonstrated by this debacle. Furthermore, it appears that the Government were trying to placate as many different groups as they could within the space of four months. It is the opinion of some groups, including Friends of the Earth, that the Chancellor's decision to scrap the OFR was due to his eagerness to be seen as pro-business. So why is business now saying that the decision has harmed their interests?

In a letter to the Government quoted in the Financial Times on 20 January, shareholders and governance groups said that companies had been left in the dark about their reporting obligations after the scrapping of mandatory operating and financial reviews. The letter went on to say that companies' reporting efforts could be destabilised by a lack of Government guidance following the OFR's demise, which has dismayed regulators and some people in the Government.

The letter states that

"it is now more difficult for companies to judge the necessary standard of reporting to meet their statutory obligations, and avoid the risk of criminal penalties (and of a tarnished reputation) associated with non-compliance."

It goes on to call on the Government to clarify the legal position by amending the Company Law Reform Bill [Lords] and by indicating which provisions of pre-existing OFR guidelines will satisfy the business review's requirements. Signatories to the letter included Jupiter Asset Management, Henderson Global Investors, Fortis Investments, the London Pensions Fund Authority and the Universities Superannuation Scheme.

A further indication of the Government's confusion was provided by voluntary guidelines released on 24 January 2006 by the Department for Environment, Food and Rural Affairs. They were intended to be used by companies to assess their impact on the environment, but they indicate confusion about what the Government believe companies should be reporting now that plans for the OFR have been scrapped.

According to Mark Goyder, the director of the think tank Tomorrow's Company, the guidance is no more than a piecemeal attempt to fill the gap created by the abolition of the OFR. Furthermore, since the relevant EU directives make little or no reference to the systems and process implications of the new requirements under the business review, it might be inferred that the systems impact of the legislation is limited. At first glance it could be assumed that the requirements should be part and parcel of regular reporting within any publicly-listed organisation or at the least easily implemented with minor modifications. However, years of underinvestment in management information systems allied to the complexity of systems architectures and tools have rendered many organisations unable to respond immediately to the exacting demands imposed by the changes.

Isobel Sharpe, audit partner at Deloitte, commented on 15 March:

"We also urge the Government not to make any further changes to narrative reporting in the short term. Preparers are now getting to grips with the new Directors' Report requirements and the revised recommended Reporting Statement from the Accounting Standards Board. As with all new regimes, time is now needed to understand the new rules and to establish practices in meeting them. Further changes in 2006 would be unwelcome, especially as 2007 promises further changes caused by the EU Transparency Directive".

Martyn Jones, audit partner at Deloitte, added:

"No further guidance is necessary on the changes to the Directors' Report requirements in the Companies Act 1985. Indeed, any more guidance may actually lead to greater confusion and increase the burden of legislation. Reporting practices need to be given time to be put into practice before any further changes are made to the relevant law.

"Uncertainties over the status of the OFR in recent months, as well as the resource needed to handle other regulatory changes in 2005/06 . . . means that additional requirements or guidance would be unlikely to improve narrative reporting practices. Further reform which leads to new requirements or guidance should be founded on evidence of real needs and a study of narrative reporting by listed companies".

What we are seeing is a lot of different people saying a lot of different things. What we are not seeing is Government giving a lead. According to the DTI press release the OFR was originally introduced as a way of improving:

"the quality, usefulness and relevance of information provided by quoted companies, helping shareholders get a better understanding of the quoted company's business and future prospects".

Yet the Chancellor's announcement of the scrapping of the OFR was intended as the opportunity for a

"deregulatory win with appeal to big business".

The decision to reconsult-I say reconsult in the truest sense nine weeks after announcing that the OFR is no longer required-followed a flurry of press reports on the issue. The Chancellor then seemed to answer Friends of the Earth as well as all the business groups that were baffled by his move to scrap the OFR.

Under the threat of legal challenge from Friends of the Earth, it seems as though the Chancellor felt obliged to reverse his decision to avoid the formality of consultation on whether the OFR should be scrapped. According to the Treasury documents released, Treasury officials urged the Chancellor to consult his Cabinet colleagues about the proposed abolition in a series of strongly-worded memorandums in the two months preceding his announcement. I agree with the hon. Member for Kingston and Surbiton that the documents should be looked at closely, as they reveal that the Chancellor failed even to inform the Secretary of State for Trade and Industry of his decision.

Not only is the lack of communication between the Chancellor and the DTI Secretary of State extremely worrying but we also have concerns as to the cost and application of the OFR and its alternative, the business review. The confusion for UK plc here is astounding. The OFR has been scrapped; the alternative business review under the EU Accounts Modernisation Directive is secretly creeping into boardrooms and the Government have been reticent to explain its real cost. Not only do the 1,200 companies that spent millions of pounds preparing for the OFR now have to prepare for the business review but the business review will apply to 37,290 companies. That is significantly more onerous for UK business across the board; and furthermore, the cost to British companies of preparation and audit is estimated at over



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